How Do Incumbents Respond to Low-End Firm Entry?

Abstract

This article investigates how incumbents respond to low-end firm entry. Prior theory suggests that high-end incumbents raise their price in response to a profit-maximizing low-cost entrant but lower their price in response to a welfare-maximizing low-end entrant. This paper uses a dataset of 206 narrowly-defined pharmaceutical markets in India; proposes a method to identify welfare-maximizing low-end firms; identifies such a firm with a mission defined more broadly than profit maximization; and presents evidence of a decline in high-end prices and dosage sizes offered by incumbents due to anticipated and actual low-end firm entry. Next, the paper examines the reasons for the low-end firm’s success by testing for observable differences in its business model relative to that of the incumbents, arising from the underlying differences in the objective functions of firms. Understanding market competition among firms with differing motives is especially important in light of 1) the growing view that shareholder value maximization alone may be unsustainable in the long term; and 2) the growing number of low-end entrepreneurial experiments across several countries and industries to serve consumers with limited purchasing power profitably.

Keywords: entry, mixed markets, low-end firms, pharmaceuticals, India