Strategic Investment and Market Integration



1 Introduction

Established firms can restrict or prevent competition, due to first-mover advantages.1 Despite the
fact that most industrialized countries have regulations against monopolization, recent empirical
evidence suggests that entry deterrence is common business practice.2

This paper considers a model where established firms can invest in capacity to the extent that
entry by other
firms is deterred. While previous studies have characterized entry deterrence in a
single market, this paper analyzes entry deterrence in a multi-market game.3

The crucial condition for strategic entry deterrence is that the incumbent can make early
decisions, in order to restrict its future freedom of action. While this might be possible in the
single-market game, the conditions may change when
firms compete in many markets. Even if the
cost of capacity is sunk, the multi-market incumbent can redistribute some of its capacity from
markets with competition, to markets without. Thus, the
firm maintains some degrees of freedom
when acting in more than one market.

This paper is therefore based on two sets of questions: What is the scope for an incumbent
to exploit its
first-mover advantage in a multi-market game? Does an incumbent firm have an
incentive to make a commitment to a speci
fic market, in order to prevent competition in that
market, even if such commitment is costly?

If multi-market competition facilitates entry-deterrence, it should be expected that integrated
markets are more concentrated than segmented markets. On the other hand, if the opposite
holds and multi-market competition obstructs the incumbent’s possibilities to restrict competition,
1Strategic variables considered in the literature on entry deterrence include price (Bain , 1996, Sylos-Labini, 1962,
Gaskins, 1971, Kamien and Schwartz, 1971, Matthews and Mirman, 1983), cost (Smiley and Ravid, 1983 , Spence,
1981), patent policy (Gilbert and Newberry, 1982), product variety (Schmalensee, 1978 ), advertising (Comanor and
Wilson, 1967) and capacity (Spence, 1977, Dixit, 1980, Gelman and Salop, 1983, Allen, 1993).

2For a summary of different features of national competition laws in industrial countries, see OECD (1996), and
for empirical evidence on strategic entry deterrence, see Smiley (1988), Bunch and Smiley (1992), and Allen et al
(1995). It should be noted, however, that American case law has placed a heavy burden on plainti
ffs to prove that
a capacity expansion is clearly meant to hurt competitors and harm competition, which would be the case if such
conduct were to be considered illegal (see Dobson et al, 1994).

3Entry deterrence through capacity investment in single market games was first analyzed in Spence (1977) and
Dixit (1980).



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