Tuesday, April 10, 2012

What I am reading: Threatening Entry

Does the mere threat of entry cause existing companies to price more competitively?  In 2008, Chad Syverson and Austan Goolsbee published a fascinating paper that provides a direct and positive answer to this question.  The paper -- "How do Incumbents Respond to the Threat of Entry?  Evidence from the Major Airlines" -- uses the particular nature of the expansion of Southwest Airlines into regional routes to identify routes where Southwest is more likely to enter in the future.  Here is their abstract:

We examine how incumbents respond to the threat of entry by competitors (as distinct from how they respond to actual entry). We look specifically at passenger airlines, using the evolution of Southwest Airlines’ route network to identify particular routes where the probability of future entry rises abruptly. We find that incumbents cut fares significantly when threatened by Southwest’s entry. Over half of Southwest’s total impact on incumbent fares occurs before Southwest starts flying. These cuts are only on threatened routes, not those out of non-Southwest competing airports. The evidence on whether incumbents are seeking to deter or
accommodate entry is mixed.
How do Syverson and Goolsbee distinguish threatened entry from actual entry?  A figure (screenshot from this link) is useful to see this.



In sum, Syverson and Goolsbee find that Southwest's effect on rival prices, largely takes place prior to Southwest's actual entry when Southwest is merely threatening entry.

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