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ENTRY AND EXIT |
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L ong before the film The Social Network made Facebook founder Mark Zuckerberg a household name, another social networking web site was taking the Internet by storm. Founded in 2003 by ex-employees of Friendster (a very early social networking site), MySpace allowed members to create user communities, post content to community boards, publicize parties, and send instant messages to fellow community members. Perhaps the most exciting feature in the early days was the ability of MySpace members to create their own web pages. MySpace and its parent company were purchased in 2005 by Rupert Murdoch for $580 million, and by 2008, MySpace had over 100 million unique visitors each month, making it the most popular social networking Internet site.
Few people realized it at the time, but the decline of MySpace began in 2004, when Zuckerberg launched Facebook. Facebook differed from MySpace in several critical ways. Facebook required that members use their actual names and that their web pages conform to a standard format. In contrast, MySpace members routinely used online pseudonyms, and their web pages were bastions of creative design. Facebook developed an iPhone app in 2007; MySpace did not respond until a year and 12 million iPhones later. Facebook made an explicit effort to be business friendly, for example, by restricting search results. MySpace, with its roots in the Southern California music scene, was much slower to reach out to business. The rest, as they say, is history. By 2009, Facebook had over 250 million unique visitors monthly, while MySpace was on the decline. Today, MySpace hangs on by a thread, largely because there are few ongoing costs associated with maintaining the site.
The world of Chapter 5 was static; that is, firms existed at a single point in time and made decisions simultaneously. There was no before or after in the Cournot and Bertrand worlds. There was only that one moment when quantities and prices were chosen. If we are to fully understand competition, we must understand how business decisions evolve over time, or what we might call the dynamics of competition. We start examining dynamics in this chapter by considering entry and exit. In the next chapter we consider a range of other issues associated with competitive dynamics. In analogous manner, Chapter 9 will examine how firms can outposition their rivals at a given point in time while Chapter 11 explores how firms attempt to sustain their success over time.
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
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away from incumbents. This is the primary way that Facebook harmed MySpace. Second, entry often intensifies competition, leading to lower prices. This is a natural consequence of the Cournot and differentiated Bertrand models discussed in the previous chapter, in which more firms imply lower prices. Moving beyond these models, note that entrants often reduce prices to establish a foothold in the market. There was some element of this in the social networking market, for example, when Facebook allowed small businesses to post banner ads at prices well below the minimum charged by MySpace. 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. We discuss contestability near the end of this chapter. Exit has the opposite effect on competitors: surviving firms increase their share and competition diminishes.
We begin this chapter by documenting the importance of entry and exit. We then describe structural factors (i.e., factors beyond the control of the firms in the market) that affect entry and exit decisions. We also address strategies that incumbents may employ to reduce the threat of entry and/or encourage exit by rivals.
SOME FACTS ABOUT ENTRY AND EXIT
Entry is pervasive in many industries and may take many forms. An entrant may be a new firm, that is, one that did not exist before it entered a market. An entrant may also be a firm that is active in a product or geographic market but has chosen to diversify into others. The distinction between new and diversifying firms is often important, as it may affect the costs of entry and the appropriate strategic response. Recent new entrants in various markets include Cards Against Humanity (a raunchy parlor game), Five Guys (an “upscale” hamburger chain), British Midlands (which provides airline service to the British Isles and several European destinations), and AcousticSounds. com (which sells audiophile recordings over the Internet). Recent diversifying entrants include the Chicago Symphony Resound (which records and distributes its own orchestral performances), Barnes and Noble Booksellers (which sells the Nook eReader), and Netflix (a video-by-mail rental service and online video server, which has entered new geographic markets in Canada, Mexico, and South America).
Exit is the reverse of entry—the withdrawal of a product from a market, either by a firm that shuts down completely or by a firm that continues to operate in other markets. In the last two decades, Rhino Records exited the music recording industry, Renault and Peugeot exited the U.S. automobile market, and Sega exited the video game hardware market.
Timothy Dunne, Marc Roberts, and Larry Samuelson offer important, if dated, evidence on entry and exit patterns for over 250,000 U.S manufacturing firms.1 Their data span two decades ending in 1982. To summarize the main findings, imagine an average industry in 2012. This industry has 100 firms, with combined annual sales of $100 million. 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. By 2017, between 30 and 40 new firms will enter, with combined annual sales of $12 to $20 million. At the same time, a similar number of firms will exit.
2.Entrants and exiters tend to be smaller than established firms. A typical greenfield entrant will be only one-third the size of a typical incumbent. Entrants diversifying from another industry tend to be about the same size as the average incumbent.