Entry for Buyout

Abstract

The possibility of buying out an entrant has an important effect on entry deterrence. Entrants can blackmail the incumbent by threatening to keep prices low, and buyout can make entry profitable which otherwise would not be. In particular, the entry deterrence policy of excess capacity to reduce the post-entry price can not only fail, but work against the incumbent. The presence of multiple oligopolistic incumbents or multiple potential entrants, however, can discourage entry for buyout. THE LONG literature on entry deterrence has always assumed that if entry is made unprofitable, no entry will occur. But as followers of professional football may have suspected, a clearly unprofitable competitor might rationally enter a market in the hopes of selling out to the incumbent. I will model such a situation, and try to show what conditions facilitate entry for buyout. In the simplest entry deterrence model, the incumbent successfully maintains monopoly by threatening to expand output and cut price after other firms enter, but he succeeds only because potential entrants believe the threat. If entrants are rational this strategy fails: price warfare hurts the incumbent as well as the entrant, so the monopolist would let the entrant have a share of profits after entry; potential entrants, foreseeing the accommodating response, ignore the threat. Deterred entry is a Nash equilibrium, but not a Nash equilibrium. It is Nash because the entrant chooses to stay out, given the incumbent's strategy of cutting prices after entry, and the incumbent does not mind committing himself to cutting prices, given that entry never occurs. A perfect Nash equilibrium is a set of strategies that is a Nash equilibrium for every proper subgame: if the game is started at any of the nodes of the game tree, including those off the equilibrium path, the strategies the agents pick to maximize their objective function from that node onwards must be part of the equilibrium strategy for the entire game. In the subgame which begins after entry has already occurred, the incumbent would not choose to cut prices, so cutting prices after entry is not part of a perfect equilibrium. In the perfect equilibrium, entry occurs and is accommodated.