Preempting the Entry of Near Perfect Substitutes

Abstract

When firms compete on price and quality-enhancing promotion in a market for differentiated products, entry of a nearly perfect substitute to one of such products, for example, a generic version of a pharmaceutical drug, intensifies price competition but softens quality competition. We show that consumers are likely to gain from entry when quality is relatively unimportant for them, when business stealing generated by promotion is substantial, and when products are poor substitutes. We also show that entry may be more attractive for consumers in less concentrated markets, as a smaller number of firms and asymmetric market shares may be associated with higher quality.