How Do Firms Become Different? A Dynamic Model
45 Pages Posted: 24 May 2011 Last revised: 22 Aug 2012
Date Written: August 21, 2012
Abstract
This paper presents a dynamic investment game in which firms that are initially identical develop assets which are specialized to different market segments. The model assumes there are increasing returns to investment in a segment, for example, due to word-of-mouth or learning curve effects. I derive three key results: (1) Under certain conditions there is a unique equilibrium in which firms that are only slightly different focus all of their investment in different segments, causing small random differences to expand into large permanent differences. (2) On the other hand, if firms are sufficiently patient or if sufficiently large random shocks are possible, there is always an equilibrium in which the firm focused on the smaller segment changes its strategy, attacking its rival until it drives the rival out of the larger segment. (3) Surprisingly, a firm might sometimes want to reduce its own assets in a segment in order to entice its competitor to shift focus to this segment.
Keywords: dynamic investment games, oligopoly, marketing strategy, firms, resources
JEL Classification: C70, C72, C73, L10, L11, L13
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