Preemptive Investment, Toehold Entry, and the Mimicking Principle

This article explores the ability offirms to successfully enter against an initial monopolist by pursuing sinking entry costs early and planning to produce only later. We endow the incumbent with strongfirst-mover advantages; for example, capital is the only input and is completely sunk, and in each period the incumbent invests before entrants. Nevertheless, the incumbent's profit can easily be negative if it tries to deter all entry when the market is growing. The incumbent may need prohibitive capital in place early on, because once toehold entry has occurred the incumbent's planned capital expansion might no longer be rational. Surprisingly, even if market conditions remain stationary, the incumbent may still allow some entry. In the model some firms are always deterred, showing that several firms can deter others more effectively than can a singlefirm. The difference arises because onefirm cannot commit to the (aggregate) investment path that several independent firms would choose. This mimicking principle offers a general perspective for understanding when a monopolist finds deterrence optimal.