Strategic Investment and Market Integration

In an extension of the model, it is demonstrated that the results also hold for strategic comple-
ments, if sufficient conditions apply. It is concluded that in many reasonable cases, the incumbent
is obliged to install extra capacity in order to deter entry in the multi-market game.

If the capacity that would deter entry is beyond the monopoly output, the multi-market incum-
bent has an incentive to induce market segmentation. In particular, the incumbent may induce
market segmentation through bundling of products and services. Firms can bundle their tradable
products with locally produced and consumed nontradables. If the product cannot be used with-
out local services, the capacity is assigned to the local market, provided that the marginal cost of
expanding the local capacity of services in other markets is sufficiently high. In this respect, these
results relate to Horn and Shy (1996), where market segmentation is endogenously determined
through bundling of tradables with nontradables.

The paper is organized as follows. Section 2 introduces four versions of the multi-market
game. Section 3 is devoted to the Hrst version of the game, which is similar to Selten’s (1978)
chain store game. In this version, a multi-market Hrm competes sequentially with several potential
entrants in distinct markets. Section 4 studies the second version of the multi-market game, where
the incumbent competes with n Hrms simultaneously, after the capacity choice has been made.
Section 5 deals with the third version, where the multi-market Hrm competes with a second large
player, which is a potential entrant in all n markets. Section 6 introduces market commitments and
analyzes under what circumstances the incumbent will serve markets from a single multi-market
plant as opposed to many local plants. Section 7 shows that our main result holds if Hrms compete
in strategic complements, if sufficient conditions apply. Section 8 illustrates three applications and
section 9 concludes.

2 Multi-Market Entry Deterrence

Four versions of a multi-market game are considered. In the Hrst three versions, production capacity
is assumed to be used at the multi-market level. The incumbent is not allowed to assign parts of its
demand, the incumbent will hold excess capacity which is idle and will be utilized only in the event of entry. This
result is easily shown in a simple model, originally set up by Bulow, Geanakopolos and Klemperer (1985). Similar
results with multiple incumbent Hrms are shown by Barham and Ware (1993).

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