Incumbent Incentives in Response to Entry

How should an incumbent respond to the arrival of an entrant? A long-standing literature documents a host of potential responses, but little work explores when each strategy will be more or less effective. This paper develops a model of incumbent-entrant competition between vertically and horizontally differentiated firms and applies that model to understand the incentives that shape an incumbent’s response to entry and ultimately, long-run profits. Analysis reveals the conditions under which an incumbent facing the full strategy space of possible exogenous entrants has incentive to attack an entrant and conditions where the incumbent has incentive to retreat. By viewing the incumbent and entrant in terms of their level of vertical and horizontal differentiation, this paper offers a unified view of prior work that generates insights about incumbent responses to entry that have been underappreciated. Further, this unified view offers insight on the effectiveness of a particular incumbent response. Supplemental Material: The online appendix is available at https://doi.org/10.1287/stsc.2022.0060 .