PAPER 2
ENTRY TIMING
The introduction of Bollinger, Doraszelski, Judd and McDevitt
The article studies the timing and location of entry in growing markets.
● In a growing market, firms must decide when to enter and where to locate in the
product or geographic space.
● When the market is still small, it may only support one firm, leading to a monopoly
phase.
● As the market grows, a second firm may enter, creating a duopoly phase.
→ a dynamic model is needed, as market structure changes over time
PREEMPTION
Preemption means that firms try to enter earlier than their rivals in order to become the
first entrant.
If being the leader is profitable, the potential follower has an incentive to enter just before the
planned leader. Preemption can lead to three things:
1. Premature entry
Firms enter earlier than they would without the threat of preemption, even before the
market is large enough to make entry socially or economically ideal.
2. Dissipation of rents
Because firms enter earlier and compete strategically, some potential profits are lost. The
race to be first reduces the rents that firms could otherwise earn.
3. Less extreme locations
● Static Hotelling model
→ horizontal differentiation
→ no time dimension
Firms usually want to locate far apart to soften price competition:
- example: two gas stations located at the same highway exit
but if they are farther apart, they both have more local market power
→ maximum differentiation: firms locate at the ends of the line
● Adding a time dimension: dynamic growing market
The first entrant may choose a more central location
→ increases monopoly profits
→ entering is less attractive for the second firm
, There are two equilibrium concepts:
SEQPE: Sequential Pre-Commitment Equilibrium
The order of entry is fixed in advance.
→ preemption is ruled out
SPE/SPNE: Subgame Perfect (Nash) Equilibrium
The order of entry is not fixed (the leader and follower are determined endogenously).
→ firms can preempt each other
→ the higher the growth of demand, the earlier you want to enter and preempt others
In equilibria that are not subgame perfect (no preemption motive)
→ market entry is determined by the level of demand but not by its growth
The authors argue that SPE is often more realistic for growing markets:
- firms usually cannot safely assume that their rival will wait
- if the first-mover advantage is large, the potential follower has a strong incentive to
enter slightly earlier and become the leader itself
They have found evidence consistent with SPE for gas stations and three-star hotels.
→ preemption seems to matter in these markets.
For restaurants and hotels in general, the evidence is weaker.
→ these businesses don’t only differentiate themselves in location but also in other ways,
such as brand, service, quality, or type of food (vertical differentiation).
CONCLUSION:
Incentives to preempt rivals matter in practice, and they matter most in markets with
relatively undifferentiated goods.
→ You don’t want to be the third gas station at an intersection, but if an intersection already
has a McDonald’s and a Pizza Hut, maybe opening a Waffle House is not such a bad idea
ENTRY TIMING
The introduction of Bollinger, Doraszelski, Judd and McDevitt
The article studies the timing and location of entry in growing markets.
● In a growing market, firms must decide when to enter and where to locate in the
product or geographic space.
● When the market is still small, it may only support one firm, leading to a monopoly
phase.
● As the market grows, a second firm may enter, creating a duopoly phase.
→ a dynamic model is needed, as market structure changes over time
PREEMPTION
Preemption means that firms try to enter earlier than their rivals in order to become the
first entrant.
If being the leader is profitable, the potential follower has an incentive to enter just before the
planned leader. Preemption can lead to three things:
1. Premature entry
Firms enter earlier than they would without the threat of preemption, even before the
market is large enough to make entry socially or economically ideal.
2. Dissipation of rents
Because firms enter earlier and compete strategically, some potential profits are lost. The
race to be first reduces the rents that firms could otherwise earn.
3. Less extreme locations
● Static Hotelling model
→ horizontal differentiation
→ no time dimension
Firms usually want to locate far apart to soften price competition:
- example: two gas stations located at the same highway exit
but if they are farther apart, they both have more local market power
→ maximum differentiation: firms locate at the ends of the line
● Adding a time dimension: dynamic growing market
The first entrant may choose a more central location
→ increases monopoly profits
→ entering is less attractive for the second firm
, There are two equilibrium concepts:
SEQPE: Sequential Pre-Commitment Equilibrium
The order of entry is fixed in advance.
→ preemption is ruled out
SPE/SPNE: Subgame Perfect (Nash) Equilibrium
The order of entry is not fixed (the leader and follower are determined endogenously).
→ firms can preempt each other
→ the higher the growth of demand, the earlier you want to enter and preempt others
In equilibria that are not subgame perfect (no preemption motive)
→ market entry is determined by the level of demand but not by its growth
The authors argue that SPE is often more realistic for growing markets:
- firms usually cannot safely assume that their rival will wait
- if the first-mover advantage is large, the potential follower has a strong incentive to
enter slightly earlier and become the leader itself
They have found evidence consistent with SPE for gas stations and three-star hotels.
→ preemption seems to matter in these markets.
For restaurants and hotels in general, the evidence is weaker.
→ these businesses don’t only differentiate themselves in location but also in other ways,
such as brand, service, quality, or type of food (vertical differentiation).
CONCLUSION:
Incentives to preempt rivals matter in practice, and they matter most in markets with
relatively undifferentiated goods.
→ You don’t want to be the third gas station at an intersection, but if an intersection already
has a McDonald’s and a Pizza Hut, maybe opening a Waffle House is not such a bad idea
