Entry Deterrence, Coordinating Advertising and Pricing in Markets with Consumption Externalities

Abstract

Abstract This paper extends the entry deterrence literature by examining coordinating advertising and pricing in markets with consumption externalities using a stochastic success function. Optimal advertising and pricing strategies are analysed when an incumbent firm faces a challenger with a product of equal quality. I show that strategic entry deterrence using advertising is possible and optimal entry deterrence involves strategic pre-commitment to over-investment relative to the non-strategic simultaneous advertising benchmark. I show that when entry deterrence is not possible the incumbent does not possess a first mover advantage and optimal entry accommodation involves strategic investment in advertising with intensified price competition congruent with the non-strategic simultaneous advertising benchmark. The findings suggest that an incumbent’s ability to deter entry through coordinating advertising in a market with products of equal quality is sensitive to the size of the fixed cost of entry that the challenger must incur and the consumption externality parameter.