Strategic Management Market Entrant

New market entrants, regardless of size, may fear head to head competition post-entry with a larger, established competitor because of the sunk costs associated with the market entry.  Ideal equilibrium in a particular industry provides a benefit for early entrants as their fixed costs have largely been met and, of the participating firms, there is no excess capacity.  Consequently, as aggregate output typically meets demand, late entrant firms bear the potential of insufficient profit to meet their sunk entrance costs resulting in a blockaded equilibrium.  In a sequential game, later entrants are typically smaller firms when compared to earlier entrants partly because there is less market share available within that market, and the entering firm cannot produce more than is demanded or risk significant losses. The effect from firms which have moved in on a market early is that the earlier entrant absorbs the bulk of market entrant costs, reducing those sunk investments for later entrants (Eaton & Ware, 1987).  The benefit for later entrants, then, is that the sunk production costs are reduced and the market share that is available to them is also reduced as the aggregate industry capacity is met by the resulting increased symmetry of firm sizes within that specific industry.

Additional benefits to planning small may come as an element of surprise to the existing market firm. A larger firm acting rationally has two options to limit entering competition: increasing production and lowering prices. If an established firm is unaware of the smaller firm’s entrance, the entering firm may maximize its own output at production and price competitive to the existing firm. In following terms, the larger firm will have the benefit of increasing its own output or reducing its prices in an attempt to affect the viability of the entering firm. In other words, the capital expenditures by the existing firm from period one to meet the increased production or lowered price in period two (Reynolds, 1985) resets the equilibrium price in that market to a pre-entry price which is typically below the monopoly price.  A firm which has met its sunk costs and reaches its output potential through variable costs can afford to enter small and plan to remain small as it competes on a new equilibrium price. 

To determine the attributes of commitment to remain small by entering participants, the dynamics of the particular industry must be examined. As new firms join the existing market, the market shares of the existing firms naturally change in response to the shifting production of each market entrant and the adoption of production from those firms which have left the market. “On average across industries and time periods, the market share of firms that entered since the previous census is .162. The average shares of firms that entered in each of the two preceding censuses are .104 and .083, respectively. Equivalently, each group of entrants is on average responsible for its largest share of industry output in the census year in which it is first observed” (Dunne, Roberts, & Samuelson, 1988).  Consequently, an entrant committed to entering small has the benefit of reduced sunk market costs resulting from the absorption of many of those costs by the earlier market entrants and has the benefit of reduced variable production costs for their market share relative to earlier entrants.  Data presented by Dunne, Roberts & Samuelson further indicate that a prediction of staying power of market participants show that the smallest decline of market share through age comes from the participants which also have the smallest initial share (1988). 

This strategy seems most effective when examined through the sequential entry subgame, college admissions. The sunk costs for a large, multi-discipline university are quite high, and the ability for the university to gain market share advantage is relatively easier as it gains standing. Whether the university increases class offerings or reduces tuition can have an impact, but the driving force for enrollment is the reputation. The university absorbs the cost of recruiting students for a fixed number of seats. Once those seats are taken, the university must either increase the seats available or turn the excess students away. The competing, small college then has the benefit of attracting those excess students without the necessity of the recruiting efforts for which the university was required to meet.  Their ability to “sweep up” the excess market share allows them to enter that market at a reduced sunk cost and build their share through subsequent periods (Boyle & Echenique, 2009).

Further differentiating new entrant concerns is the firm which enters the market as a soft competitor that's developing a new product. Dell Computers entered the market as a niche operation competing against the then-computer giant, IBM.  Dell differentiated IBM’s business model by focusing on the end-user’s needs and expectations, effectively allowing the customers to customize the product according to their needs.  Providing “next-day, at-home product assistance” and risk-free returns, Dell focused on providing precisely what was desired rather than off-the-rack systems providing a great deal of efficiency and cost savings for the customer (Dell, 2013).  

The process not only brought the customer into the design factory but also presented an image of a company which revolved its operations entirely around customer service.  The initial model “interviewing” customers over the phone and building their system together led to an expansion by establishing kiosks in major malls.  Partnering with an established retailer likely would have provided faster growth but not necessarily staying power.  The model allowing the customer to streamline their system established a soft niche for Dell in an established market with a controlling dominant actor and, in spite of the difficulty for a new market entrant, has experienced stellar growth and long-lasting success by focusing on the commitment by management and employees toward product and productivity improvements.

References

Boyle, E., & Echenique, F. (2009). Sequential Entry in Many-to-One Matching Markets. Social Choice and Welfare, 87-99.

Dell. (2013). The Birth of a Company. Retrieved from Dell Heritage: http://www.dell.com/Learn/us/en/uscorp1/birth-of-company?c=us&l=en&s=corp&cs=uscorp1

Dunne, T., Roberts, M. J., & Samuelson, L. (Vol. 19, No. 4 (Winter, 1988)). Patterns of Firm Entry and Exit in U.S. Manufacturing Industries. The RAND Journal of Economics, 495-515.

Eaton, B. C., & Ware, R. (Vol. 18, No. 1 (Spring 1987)). A Theory of Market Structure with Sequential Entry. The RAND Journal of Economics, 1-16.

Reynolds, S. S. (Vol. 75, No. 4 (Sep., 1985)). Capacity, Output, and Sequential Entry: Comment. The American Economic Review, 894-896.