Entering a New Market • 221

ENTERING A NEW MARKET

Thus far we have described entry as a battle between an incumbent firm and the newcomers it would like to keep out. We now consider entry into a new market. As always, a potential entrant into this market must weigh postentry profits against sunk entry costs. When thinking about entry into a new market, however, several scenarios must be considered. In one scenario, any firm can access the production technology and market demand is large enough that many firms can profitably coexist. The result is a competitive market in which the exact number of firms depends on the size of market demand and the extent to which the technology involves scale economies. We explore this situation in greater detail in Chapter 7.

At the other extreme, a single firm has access to the production technology, perhaps because it has a patent and chooses not to license to competitors. In a static (i.e., single period) world, the monopolist should enter if postentry profits exceed sunk entry costs, excluding those costs already sunk into creating the technology. In reality, the monopolist faces a future of changing demand and costs. For example, suppose that the market is small but growing, as is common for new technologies, and current demand is so low that current operating revenues are below current operating costs. In this case, the monopolist should delay entry until demand has increased and operating revenues exceed operating costs.

Preemptive Entry and Rent Seeking Behavior

Things get more interesting when a small number of firms have access to the technology, but the market will never be large enough to support them all. To make this example concrete, consider a small, growing community, Blueville, that is large enough to support a single cement maker but will never be large enough to support two firms. A cement plant requires sunk costs of $10 million; net lifetime profits therefore equal net discounted future profits minus the $10 million entry cost. Big D Cement and Giant E Cement are the only two potential entrants in Blueville. If either firm enters today and faces no competition in the future, the discounted present value of future monopoly profits would be $16 million, giving it net lifetime profits of $6 million. But if both firms enter today, the duopolists will generate postentry future profits of $6 million, incurring net lifetime losses of $4 million apiece. These payoffs are depicted in Figure 6.4.

We can use the concept of the Nash equilibrium to determine the earliest point at which entry is likely to occur. (We discussed the Nash equilibrium in the Economics Primer and in Chapter 5.) Remember, Big D and Giant E’s entry decisions to enter the market are a Nash equilibrium if each is happy with its choice, given what the

FIGURE 6.4

Entry Game (all figures in $millions)