Market Incumbents Research Articles

Limit pricing with complementary goods

PurposeThis paper aims to examine the equilibrium limit price charged by a producer trying to deter the entry of a firm that can choose one of the two markets of complementary goods.Design/methodology/approachThe authors model a dynamic game of incomplete information solved using a “perfect Bayesian equilibrium” approach.FindingsIt is shown that an incumbent will be willing to spend more resources – i.e. charge a lower limit price – to deter entry into its market as products become more complementary. This is because additional benefits are gained from entry deterrence by facing a more competitive market in the complementary product. The additional benefits of entry deterrence are shown to be a function of the degree of complementarity between goods.Practical implicationsA managerial implication of this article is that firms are willing to compete more fiercely to send an entrant to the other's incumbent market as the degree of complementarity between goods increases. An interesting conclusion that is derived from the above analysis is that managers should invest to understand the interdependences (e.g. complementarities) of the goods they sell, since the strategic variables chosen to compete may be affected by them, in some cases in a non‐trivial way.Social implicationsFrom a public policy perspective, the main contribution of this paper is to point out that regulators who analyze predatory pricing, or other (probably) illegal “low‐price strategies”, should consider the degree of complementarity between goods and its effect on pricing.Originality/valueAs far as the authors' knowledge goes, there are no other papers that analyze entry decisions involving multiple markets of complementary goods.

Capital structure and investment in regulated network utilities: evidence from EU telecoms

This article analyzes the relationship between firm financial and investment decisions and regulatory outcomes in network industries, where regulatory opportunism is often viewed to lead to underinvestment. We develop a model to describe the effect of an increase in leverage on regulated rates, retail as well as wholesale, and company investment. We then test the model's predictions using a panel of 15 EU Public Telecommunication Operators (PTOs) over the period 1994-2005. Our results show that the data cannot reject the model's predictions that leverage positively affects regulated wholesale and retail rates, as well as the PTOs' investment rate. Moreover, since leverage does affect wholesale charges that alternative operators pay to access to the incumbent's network infrastructure, we also find that an increase in leverage is followed by a decrease in the number of competitors and by an increase of the incumbent's market share. This suggests that the use of debt to discipline the regulator's lack of commitment within a vertically integrated network industry may somewhat impair or delay retail market competition, but has a favorable counterpart in mitigating the underinvestment problem

Consolidation in the European banking industry: how effective is it?

The European banking industry is becoming increasingly consolidated as banks engage in domestic and cross-border merger and acquisition (M&A) activities. Due to cultural differences in cross-border consolidations, the benefits of domestic and cross-border consolidations are likely to differ. This paper examines the effectiveness of merger processes, with a detailed analysis of both domestic and cross-border consolidations in Europe from 1998 to 2004. Effectiveness is measured via several criteria: improvement in costs, return on assets (ROA), and return on equity (ROE). To analyze potential cost efficiency improvement, we use a stochastic cost frontier approach. The same methodology is used for ROA and ROE to estimate efficiency in profitability. Finally, considering cross-border mergers as a form of entry, we carry out an analysis of the entry effect in response to the performance and profitability of the incumbent market participants. Results show that mergers in the European banking industry have been effective. Although domestic M&As are more common than cross-border M&As, banks involved in cross-border M&As are more efficient. Moreover, cross-border merged banks seem to outperform incumbent banks.

Which Firms Buy Licenses? Market Positions and License Expenditures*

This paper presents the empirical results of a comparison of technology licensing expenditures of German companies in order to test implications of the Gilbert and Newbery (1982) model. Aside from standard control variables, the motives for innovation expenditures are also taken into account. We differentiate between firms intending to secure their present position in the market (incumbents) and those intending to enter a new market (challengers). In line with the prediction of the Gilbert and Newbery model, we find that incumbents show higher expenditures for technology licenses than potential entrants.

Disruptive Internet-service innovation diffusion

A disruptive innovation strategy (DIS) entails innovation that makes customers embrace new value propositions shifting the basis of competition. Prevalent in fast-changing Internet and IT markets, DIS challenges incumbent firms and has the potential to transform industry structure. This article contributes toward rigorous DIS theory building with a system dynamics (SD) simulation model of disruptive innovation diffusion. The model shows disruptive innovation diffusion as a replicable process that can enable business growth for disruptive innovators. It builds on diffusion processes in marketing and epidemiology to show customer switching in the market segments that disruptive innovators exploit. Multiple computed scenarios examine the dynamic performance effects of disrupters' attack on high-end market segments and incumbent retaliation. Data from firm d, an entrant Internet-services provider, enable model calibration and examination of the strategic concerns of a real start-up firm, providing multiple insights into disruptive Internet-service innovation management.

Early Entrant Protection in Approval Regulation: Theory and Evidence from FDA Drug Review

Early entrant protection in approval regulation exists when the first incumbents in an exclusive market niche receive more favorable regulatory treatment than later entrants. We show theoretically and empirically that this pattern can prevail for two reasons: regulatory capture and consumer co-optation. We consider a decision-theoretic model of dynamic product approval by an uncertain regulator. The model predicts early entrant protection even when later entrants offer quality improvements over market incumbents. We then test the model using duration analyses of NDA approval times for 1,629 new molecular entities submitted to the U.S. Food and Drug Administration (FDA) from 1950 to 2000. FDA approval times are shown to be increasing in order of market entry for the entire period studied, and across numerous sub-samples. A standard-deviation rise in the log of order of entry is associated with a 3.5-month increase in expected FDA approval time. The entryorder gradient appears to be heavily influenced by disease-level variables but not by firmlevel effects, supporting a consumer cooptation explanation and disfavoring capture and producer rent-seeking accounts. In addition, we present modest evidence that the entryorder gradient is conditioned upon factors affecting the pipeline value of the regulatory problem, suggesting that FDA regulatory decisions may anticipate the pipeline of future drugs for any given disease.

Bundling and collusion in communications markets

This paper deals with competition in communications markets between an incumbent and a competitor. We analyse the effect of bundling strategy by a firm that enters an incumbent market. This market dimension has deep implications on the sustainability of collusion. In an infinitely repeated game framework, we show that the bundling strategy of the entrant might hinder collusion. Furthermore, we consider a setting in which the competitor uses a one-way access that the incumbent possesses. In such a situation, we show that when the competitor bundles its products, a low access charge might increase the feasibility of collusion. This result has an important policy implication.

NASA pressure-relieving foam technology is keeping the leading innerspring mattress firms awake at night

The over $6 billion US wholesale mattress market is driven mostly by metal innerspring technology originally innovated by blacksmiths in the 1800s. New bedding market entrant Tempur-Pedic continues to enjoy phenomenal growth and the industry's best profit margins founded on viscoelastic foam technology innovated by NASA. Visco mattress innovations are clearly disrupting the mattress industry as evidenced by several management, market, and financial metrics. However, visco mattress innovations cannot be classified as a disruptive innovation (DI) because the popularized term as commonly accepted and practiced requires that a DI cannot be used by mainstream users. Visco mattress innovations can be used by mainstream mattress users. Technology management researchers and practitioners may miss significant opportunities by rejecting potential innovations that would disrupt incumbent competitors and markets because they do not fit their current conceptual requirements for DIs such as that they cannot be used by mainstream users. Therefore, for this essay, a visco mattress innovation is characterized as a radical-disruptive innovation (RDI) with most characteristics of both radical and disruptive innovations in that it: (1) uniquely delivers new customer-demanded benefits useful even to mainstream users, (2) requires new organizational core competencies relative to the incumbent firms, and (3) disrupts the business models and markets of incumbent firms. This essay explores some of the management/organizational behaviors and market dynamics associated with the continuing disruption of the mattress industry by visco foam mattress RDIs. In addition, this essay briefly explores the managerial and financial constraints that LBO owners place on their firms that: help to allow a new firm with an RDI to enter the incumbent market and successfully compete, as well as mitigate the success of the new market entrant, both as the result of low organizational/financial slack. In conclusion, it is expected that Tempur-Pedic will continue to outperform innerspring incumbents by executing their current successful business model based on viscoelastic foam RDIs, albeit at slower rates. Also, it is expected that visco foam RDIs will become ubiquitous in the bedding and other industries, particularly in the high margin healthcare and sports industries, which is beneficial to all.

Strategic Responses to Multiple Dimensions of Low-Cost-Country Competition

This paper presents theoretical and empirical analyses of strategic responses to competition from low-cost countries (LCCs). Surveying 423 firms in the U.S. and Germany, we consider the nature of low-cost competition and strategic responses by advanced market incumbents. The theoretical framework develops multiple dimensions of foreign competition, i.e. intensity and quality, and introduces three new strategic responses, relocation, avoidance and deterrence. The results strongly support the hypotheses that firms employ relocation, avoidance, and marketing differentiation strategies when LCC competition rises. As LCC product quality increases, firms increasingly use relocation strategies but reduce their reliance on avoidance and market differentiation.

An integrative framework of pre‐emption strategies

This paper performs a review of the various pre‐emption strategies prescribed in the economics literature. These are cost superiority, consumers' switching cost, channel exclusivity, environmental barriers of entry and credible commitment to react aggressively. Through our analysis, we develop an integrative framework of the pre‐emption strategies that will result in long‐term payoffs to the firm. The framework proposes that there are two key dimensions—strategic advantage and strategic focus—and identify five generic types of pre‐emption strategies for market incumbents. These are the switching cost, blockade, credible commitment, tie‐up, and cost leadership strategies. The pre‐emption strategies and the framework presented can assist managerial decision‐making for the successful pre‐emption of potential competition to complement their existing efforts.

Competition and Market Structure of National Association of Securities Dealers Automated Quotations

ABSTRACTIn this paper, we study the relation among market structure, trading costs, and competition in National Association of Securities Dealers Automated Quotations (NASDAQ). In particular, we address the following questions: Do NASDAQ dealers exercise market power and extract economic rents in setting bid‐ask spread? How persistent is the market power of dominant dealers? Our estimate of the rent is approximately ¢8.76, or 0.54% of stock price. The half‐life of the persistence of this rent is approximately 20 months for the entire sample, while the half‐life of younger stocks tend to be shorter than those of more mature stocks. Our result supports Schultz: NASDAQ dealers make markets only for stocks where they have competitive advantages in accessing order flow and in information. It might take a while before a market maker poses effective competition to existing dominant market makers. In the meantime, incumbent market makers are able to exercise market power and appear to earn abnormally large profits.

Technology and the Architecture of Markets: Reconfiguring the Canadian Equity Market

This paper examines the relation between technical possibilities, liberal logics, and the concrete reconfiguration of markets. It focuses on the enrolling of innovations in communication and information technologies into the markets traditionally dominated by stock exchanges. With the development of capacities to trade on-screen, the power of incumbent market makers has been challenged as a less stable array of competing quasi-public and private marketplaces emerges. Developing a case study of the Toronto Stock Exchange, I argue that narrative emphasis on the performative power of sociotechnical innovations, the deterritorialisation of financial relations, and the erosion of state capacities needs qualification. A case is made for the importance of developing an understanding of: the spaces of encounter between emerging social technologies and property rights, rules of exchange, and structures of governance; and the interplay of orderings of different institutional composition and spatial reach in the reconfiguration of market architectures. Only then can a better grasp be gained of the evolving dynamics between making markets, the regulatory powers of the state, and their delimitations.

Innovation in the Swiss mail sector: deregulation versus liberalization

In this paper we discuss an incumbent postal operator's incentives to invest in an innovation in the face of upcoming liberalization and deregulation of the letter market. Our contribution is a short description of recent innovations in the Swiss mail market and their interpretation in light of an illuminative yet tractable model. Following the literature, we distinguish between product and process innovation. We characterize competitive pressure by a reduction in the incumbent's market share and an increase of his/her perceived price elasticity of demand due to consumers’ switching to competitors. This may result in adverse incentives to invest in an innovation. Likewise, deregulation leads to increased entrepreneurial freedom on the operator's side and possibly a lower burden of USO (universal service obligations), reflected in lower cost. This sustains incentives to invest in both product and process innovation.

Drug Cost Development of Citalopram and Fluoxetine Following the Introduction of Generic Substitution in Finland

Background: Spending on pharmaceuticals is increasing faster than the gross national product in western European countries. The use of generic drugs may result in direct drug cost-savings for patients, governments and insurers. Objective: The objective of this study was to examine the drug cost development of the two most commonly dispensed antidepressant drugs in Finland following the introduction of regulatory changes to mandate generic substitution by pharmacists in April 2003. Methods: The prescription claims database of the Social Insurance Institution of Finland was used to calculate the quarterly cost of reimbursements per user for citalopram and fluoxetine from January 2003 to June 2004. Price data for the originator brand of citalopram, market incumbent brand of fluoxetine, and generic versions of both citalopram and fluoxetine were extracted from the registry of the Association of Finnish Pharmacies for April 2003 to April 2004. Results: The quarterly drug cost of citalopram and fluoxetine per user to the Social Insurance Institution of Finland decreased by 45% and 48%, respectively, 1 year following the changes to the regulations regarding generic substitution. The companies that marketed the originator brand of citalopram and the market incumbent brand of fluoxetine adopted two contrasting pricing policies in response to changes in the regulations regarding generic substitution. A ‘pseudo-generic’ version of citalopram, but not fluoxetine, was available throughout the study period. Regardless of the pricing policy, equivalent drug cost-savings were realised for both patients and government. These cost reductions did not lead to a corresponding increase in the use of citalopram or fluoxetine. Conclusions: The introduction of changes to regulations regarding generic substitution was followed by a decrease in price for the two most commonly dispensed antidepressant drugs in Finland. High price elasticity was observed within but not between active ingredients. Price did not appear to be an important factor guiding antidepressant prescribing by physicians.

Advertising in Response to Entry: An Empirical Analysis of the Prescription Drug Market

Rationale: Because pharmaceutical firms often engage in non-price competition, understanding the strategic role of advertising in market competition is important not only to marketing managers when formulating marketing strategy but also to policymakers when setting pharmaceutical advertising regulations. Objective: This analysis examines how pharmaceutical firms advertise when faced with a competing new entrant. Methods: Quarterly advertising and sales data from leaders of eight therapeutic markets (asthma, depression, gastric/duodenal ulcer, dyslipidemia, migraine, obesity, seizure disorder, Parkinson's disease) from Jan 1995 to Dec 2001 were obtained from Scott-Levin Market Research and Sales Performance Audits. New products were classified across two dimensions: 1) whether the product is a new chemical entity; and 2) whether the new product had priority status for FDA review (an indication of significant therapeutic advance). Random effects generalized least squares regression was used to estimate the effect of new product novelty on incumbent firms' advertising expenditures while controlling for prior advertising expenditures, market characteristics and incumbent market position. An alpha level of 0.05 was used. Results: The number of product entries and the presence of a new chemical entity entrant had no significant effect on advertising expenditures, but incumbent firms significantly decreased their advertising expenditures after the entry of FDA priority review products. Incumbents with larger market shares, in less concentrated or growing markets had significantly lower advertising expenditures. Advertising expenditures significantly decreased with time on market. On average, market leaders had significantly higher advertising expenditures compared to non-leaders. Conclusion: Incumbent firms' advertising activities are mostly determined by market characteristics and market position. In response to new products with significant therapeutic advance, incumbents may decrease their advertising activities to minimize spillover effects.

Bundling and Collusion in Communications Markets

This paper deals with competition in communications markets between an incumbent and an entrant. We analyze the effect of bundling strategy by a firm who enters an incumbent market. This market dimension has profound implications on the sustainability of collusion in an infinitely repeated game framework. We show that the bundling strategy of the entrant might hinder collusion. Futhermore, we consider a setting in which the entrant uses a one-way access that the incumbent possesses. In such situation, we show that when the entrant bundles its products, a low access charge for call termination on the incumbent network might increase the feasibility of collusion. This result has an important policy implication.

Alleged Transmission Inadequacy: Is Restructuring the Cure or the Cause?

There is a chance that inadequate separation between generation and transmission may result in reduced investment, in order to preserve incumbent market power in generation. However, consideration of transmission price caps and coordinated generation investment support other analyses that conclude that vertical separation itself may be a culprit.

Alleged Transmission Undersupply: Is Restructuring the Cure or the Cause?

Widespread concern over transmission capacity requires theoretical support to infer inadequacy from observed trends indicating reductions in the ratio of transmission to generation capacity over time. If integrated utilities had been regulated with allowed returns exceeding capital costs, transmission-generation ratios would have been excessive, and observed trends might be a correction. However, numerous commentators claim that post-restructuring transmission rates have been too low, with NIMBY effects also discouraging investment. We model the possibility that inadequate separation between generation and transmission may result in reduced investment, in order to preserve incumbent market power in generation. However, consideration of transmission price caps and coordinated generation investment support other analyses that conclude that vertical separation itself may be a culprit.

Industry performance gradient indexes and market entrance: an empirical tool for market researchers

This paper examines the Industry Performance Gradient Index as an analytical tool for market researchers, specifically for screening markets for potential entrance. The identification of the Industry Performance Gradient Index as a market entrance tool is examined empirically in the Tennessee banking industry. This highlights the potential benefits of using the Index to identify potential profits from easily obtained data including: incumbent profits, market structure and output sensitivity to price changes in the market. An outline for employing this Index and additional uses for incumbent firms are also suggested.

The Positive Effects of Unbundling on Broadband Deployment

This POLICY PAPER examines whether there is a relationship between regulated rates for local loops and deployment of broadband technology by incumbents and entrants. Using an econometric model that analyzes 2002 and 2003 local loop rates and takes into account price variability and other factors that may impact broadband deployment, this POLICY PAPER finds that unbundled loop prices based on Total Element Long Run Incremental Cost (TELRIC) are associated with increased availability of broadband services and increased availability of competitive broadband services (four or more providers). As a result, this POLICY PAPER concludes that current policies which are hostile to the market-opening provisions of the 1996 Act will actually make it harder to achieve President Bush's stated goal of universal, affordable access for broadband technology by 2007 and will, instead, lead to greater economic concentration and incumbent market power in the industry as firms are forced to exit the market.