Should an Incumbent Store Deter Entry of a Socially Responsible Retailer?

Abstract

Should an incumbent for-profit retailer deter a “socially responsible” store from entering the market? As a differentiation strategy to avoid direct price competition with well-established retailers, some socially responsible stores (or brands) enter the market with a “pre-commitment” to donate a certain proportion of their (A) profits or (B) revenues to charities. Because these charitable donations generate a “warm glow” effect for consumers, these socially responsible stores can use pre-committed donations to gain market access, pressuring the incumbent retailer to lower its price to deter their entry.

In this paper, we present a game-theoretic model in which a socially responsible retailer enters the market to compete with an incumbent for-profit retailer and heterogeneous consumers. We determine and compare the incumbent retailer’s deterrence strategies (i.e., deter or tolerate) across different types of socially responsible stores. Our equilibrium analysis generates the following insights. First, the incumbent retailer’s deterrence strategy depends on its cost advantage over the socially responsible store, and this deterrence strategy hinges upon the socially responsible store’s entry cost, pre-commitment level, and its warm-glow effect. Second, even if the incumbent retailer can profitably deter the socially responsible retailer’s entry, the incumbent retailer can actually be better off by tolerating instead of deterring its entrance when the socially responsible store’s entry cost is low and when the incumbent store’s cost advantage is not significant. Third, relatively speaking, a type (B) store that donates a portion of its revenue is more vulnerable than a type (A) store that donates a portion of its profit unless a type (B) store can generate a much higher warm-glow effect. Thus, if the warm-glow effects generated by the two stores are the same, then it is more likely for the incumbent retailer to deter the type (B) store’s entry. We extend our analysis numerically to examine the case when the pre-committed proportion is endogenously determined by the socially responsible stores, and obtain similar structural results.

Keywords: Competition, Incumbent, Socially Responsible Operations