Are Entry Threats Always Credible?

Abstract

This paper studies the efficacy of entry threats in a contestable environment using experiments. It is hypothesized here that the entrant firm’s home market profits influence the entrant’s competitive behavior even when entry is costless and completely reversible. In the experiment, entrants and incumbents tacitly collude when each has its own monopoly market. In contrast, an entrant from a competitive market practices hit-and-run entry whenever such opportunities exist, forcing the incumbent monopolist to price at average cost. The experiment results suggest that the usefulness of hit-and-run competitive threat in a contestable environment depends crucially on the relative profits in the entrant’s and the incumbent’s home and entry markets.

Keywords: experiment, contestable market, potential competition, hit-and-run entry