42 Pages Posted: 18 May 2020 Last revised: 5 Mar 2023
Date Written: May 2020
Venture capitalists suggest that incumbent internet platforms create a kill zone around themselves, where any competing entrant is acquired quickly. Consequently, financing new startups becomes unprofitable. We construct a simple model that rationalizes the existence of a kill zone. The price at which an acquisition is done depends on the number of customers the entrant platform can attract if it remains independent, which in turn depends on the number of apps that have adapted to the platform. The prospect of a quick acquisition by the incumbent platform, however, reduces the app designers’ benefits from adaptation, making it harder for a technological superior entrant to acquire customers. This reduces the stand-alone price of the new entrant, decreasing the price at which they will be acquired, and thus reducing the incentives of VCs to finance their entry. We discuss the policy implications of this model.
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