Entry Deterence through Strategic Sourcing

Abstract:     
We demonstrate that a downstream firm (an incumbent) may source to an upstream firm (a potential entrant) for the sole purpose of entry deterrence. The reason is that, on the one hand, as a supplier, the potential entrant would have a second mover's disadvantage upon its entry into the downstream market. On the other hand, on the basis of the sourcing transaction, the surplus generated by the more concentrated downstream market is shared between the incumbent and the entrant, leaving each one better off. Under many circumstances, sourcing due to entry-deterrence improves the social welfare. For some ranges of parameters, it even benefits consumers.

Number of Pages in PDF File: 36

Keywords: Sourcing, Entry deterrence, Cournot Competition, Bertrand Competition

JEL Classification: D41, L11, L13

working papers series