Chapter 7 excerpts to answer the questions

Entry is the beginning of production and sales by a new firm in a market, and exit occurs
when a firm ceases to produce in a market. Entrants threaten incumbents, that is, the firms
that were already in the market, in two ways. First, they take market share away from
incumbents. Second, entry often intensifies competition, leading to lower prices, note that
entrants often reduce prices to establish a foothold in the market. In some cases, the mere
threat of entry can limit the incumbent firm’s ability to raise prices. In such cases we say that
the market is contestable.
If past patterns of entry and exit still hold, here is what that industry can expect in the next 5
to 10 years:
1. Entry and exit will be pervasive.
2. Entrants and exiters tend to be smaller than established firms
3. Most entrants do not survive 10 years, but those that do grow precipitously.
4. Entry and exit rates vary by industry
Entry and exit are highly related: Conditions that encourage entry also foster exit.
Basic terminology.
It helps to think of entry as an investment. The entrant must sink some capital that cannot be
fully recovered upon exit. The entrant hopes that postentry profits (i.e., the excess of
revenues over ongoing operating expenses) exceed the sunk entry costs. Postentry
competition represents the conduct and performance of firms in the market after entry has
occurred. The sum total of this analysis of sunk costs and postentry competition determines
whether there are barriers to entry. Barriers to entry may be structural or strategic.
Structural entry barriers exist when the incumbent has natural cost or marketing advantages,
or when the incumbent benefits from favourable regulations. Strategic entry barriers result
when the incumbent takes aggressive actions to deter entry.
Bain’s Typology of Entry Conditions
Blockaded Entry Entry is blockaded if structural barriers are so high that the incumbent
need do nothing to deter entry. For example, production may require large fixed investments
relative to the size of the market (high sunk entry costs),or the entrant may sell an
undifferentiated product for which it cannot raise price above marginal cost (low postentry
profitability).
Accommodated Entry Entry is accommodated if structural entry barriers are low, and either
(a) entry-deterring strategies will be ineffective or (b) the cost to the incumbent of trying to
deter entry exceeds the benefits it could gain from keeping the entrant out. Accommodated
entry is typical in markets with growing demand or rapid technological improvements. Entry
is so attractive in such markets that the incumbent(s) should not waste resources trying to
prevent it.
Deterred Entry Entry is deterred (a) if the incumbent can keep the entrant out by employing
an entry-deterring strategy and (b) if employing the entry-deterring strategy boosts the
incumbent’s profits. Frank Fisher calls such entry-deterring strategies predatory acts.6
Predatory acts may either raise entry costs or reduce postentry profits.
Note: most of the predatory strategies available to incumbents are also available to entrants.
Structural Entry Barriers
• Control of essential resources: An incumbent is protected from entry if it controls a resource
or channel in the vertical chain and can use that resource more effectively than newcomers.
NB the role of patents
• Economies of scale and scope: When economies of scale are significant, established firms
operating at or beyond the minimum efficient scale (MES) will have a substantial cost
advantage over smaller entrants.
• Marketing advantages of incumbency: An incumbent can exploit the umbrella effect to
offset uncertainty about the quality of a new product that it is introducing.
ENTRY-DETERRING STRATEGIES
An incumbent may expect to reap additional profits if it can keep out entrants
1. Limit pricing refers to the practice whereby an incumbent firm charges a low price to
discourage new firms from entering
2. Predatory pricing occurs when a large incumbent sets a low price to drive smaller rivals
from the market. The purpose of predatory pricing is twofold: to drive out current rivals and
to make future rivals think twice about entry.
Capacity expansion: Predatory pricing will not deter entry if the predator lacks the capacity to
meet the increase in customer demand. Disappointed customers will simply turn to the
entrant. Excess capacity makes the threat of predation credible.
Note the chain-store paradox is that many firms appear to engage in predatory pricing,
despite the theoretical conclusion that the strategy is irrational.
Note Price wars harm all firms in the market regardless of who starts them, and are
quintessential examples of wars of attrition.
3. Strategic bundling occurs when a combination of goods or services are sold at a price that
is less than what it would cost to buy the same items separately.
Barriers to exit
To exit a market, a firm stops production and either redeploys or sells off its assets. When
deciding whether to exit a market, the firm must compare the value of its assets if deployed in
their best alternative use against the present value from remaining in the market. There are
exit barriers when the firm chooses to remain in the market but, given the opportunity to
revisit its entry decision, would not have entered in the first place.
Examples: Exit barriers often stem from sunk costs, such as when firms have obligations that
they must meet whether or not they cease operations. Examples of such obligations include
labor agreements and commitments to purchase raw materials. Governments can also pose
barriers to exit. For example, most countries forbid owners of nuclear power plants from
terminating operation without government approval. Similarly, most states do not allow
privately run hospitals to shut down without regulatory approval.

Judo economics
We have argued that an incumbent firm can use its size and reputation to put smaller rivals at
a disadvantage. Sometimes, however, smaller firms and potential entrants can use the
incumbent’s size to their own advantage. This is known as “judo economics.” We have
already given one theoretical rationale for judo economics—the revenue destruction effect.
When an incumbent slashes prices to drive an entrant from the market, it stands to lose more
revenue than its smaller rivals.
Contestable market
The key requirement for contestability is “hit-and-run entry.” When a monopolist raises price
in a contestable market, a hit-and-run entrant rapidly enters the market, undercuts the price,
reaps short-term profits, and exits the market just as rapidly if the incumbent retaliates. The
hit-and-run entrant prospers if it can set a high enough price for a long enough time to
recover its sunk entry costs. If sunk entry costs are zero, then hit-and-run entry is profitable
whenever the incumbent’s price exceeds the entrant’s average variable costs. If the incumbent
raised price above the entrant’s average cost, there would be immediate entry and price would
fall.