Incumbent Pricing Responses to Entry

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Strategic Management JournalStrat. Mgmt. J., 26: 12291248 (2005)

Published online in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/smj.502

INCUMBENT PRICING RESPONSES TO ENTRY

DANIEL SIMON*

Department of Applied Economics and Management, Cornell University, Ithaca,New York, U.S.A.

Empirical research on incumbent pricing responses to new entry has yielded mixed results. Somestudies find that incumbents cut prices post entry, while others find that incumbents accommodateentry by leaving prices unchanged (or even raising prices). To better understand these findings,this study explores the conditions under which incumbents are more likely to cut prices when

faced with entry. I argue that incumbents vary in their incentives to cut prices; incumbents withgreater incentives are more likely to respond aggressively to entry. Using data on magazinesubscription prices, I find that, on average, incumbent magazines do not reduce prices followingentry. But, the results suggest that newer incumbents cut prices more than older incumbents, whileincumbents that compete in fewer and in more competitive markets cut prices less following entry.These results help to explain inconsistent empirical results in the literature, and support a moregeneral explanation of when firms respond aggressively to entry: incumbents respond to entrymore aggressively when their incentives to do so are greater. Copyright 2005 John Wiley &Sons, Ltd.

INTRODUCTION

The entry of new firms has important effects on

incumbent firms and consumers. New entrants

increase competition, reducing market share and

profits of incumbent firms. New entrants also intro-

duce new products and processes, forcing incum-

bents to become more efficient and innovative

(Geroski, 1995). As a result, incumbents have

strong incentives to deter entry, while consumers

welcome new entrants.

When facing new entry, incumbent firms must

decide how to respond. They may reduce pricesbefore or after entry, either to deter potential

entrants or simply to maximize current profits in

Keywords: entry; incumbent response; pricing; maga-zines; competitive dynamics*Correspondence to: Daniel Simon, Department of Applied Eco-nomics and Management, Cornell University, Ithaca, NY 14853,U.S.A. E-mail: [email protected]

the face of increased competition. Alternatively,

incumbents may accommodate entry, leaving pri-

ces unchanged (or raising prices). This study

examines incumbents pricing responses to new

entry in the consumer magazine industry.

Theories of entry deterrence and incumbent

response to entry have evolved, with a large num-

ber of studies generating a variety of predictions.

Early limit pricing studies predicted that incum-

bents would reduce prices before entry, but leave

them unchanged after entry. More recent game-

theoretic studies suggest that incumbents may

reduce prices post entry as a way to drive out

entrants and deter future entrants.

These evolving theoretical predictions have

prompted many empirical studies of incumbent

responses to entry. The results of these stud-

ies are very inconsistent: some find that entry

has a negative effect on incumbent prices; oth-

ers find that entry has no effect on incumbent

Copyright 2005 John Wiley & Sons, Ltd. Received 24 September 2002

Final revision received 4 June 2005


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1230 D. Simon

pricing. Even within the same industry, incumbent

responses to entry may vary (Frank and Salkever,

1997; Yamawacki, 2002). These inconsistent find-ings may indicate that incumbents only respond

aggressively to entry under certain conditions.

This study argues that incumbents heterogeneous

responses reflect varying incentives to respond

to entry; incumbents with stronger incentives are

more likely to respond.

To consider the inconsistent findings regarding

incumbent pricing responses to entry, I examine

whether incumbent and market characteristics may

influence the incumbents pricing response. That

is, this study seeks to better understand the hetero-

geneity in incumbent responses to entry by exam-ining the conditions under which incumbent firms

have a greater incentive to cut prices in response

to entry.

Consistent with prior empirical work, this study

finds substantial heterogeneity in incumbents pric-

ing responses. The results indicate that incumbent

and market characteristics influence the incum-

bents incentive to respond to entry; newer incum-

bents cut prices more than older incumbents,

while incumbents that compete in fewer and in

more competitive markets cut prices less following

entry. These results suggest that some of the incon-

sistent findings may reflect variation in incumbent

and market characteristics.

While this study focuses on pricing responses

to entry, it should be pointed out that incum-

bents are not restricted to reducing prices as a

way to respond to the threat of entry. As dis-

cussed below, firms can use various non-price

weapons to deter entry (Geroski, 1995). This study

examines pricing behavior because theory offers

more testable predictions regarding heterogeneous

pricing responses by incumbents, and because the

inconsistent empirical results regarding incumbent

pricing responses pose a mystery to researchers.Moreover, prices are observable and measurable,

while many non-price responses are unobserved or

difficult to measure.

LITERATURE REVIEW

A great deal of research has examined entry and

incumbent responses to entry. But as Geroski

(1995) notes, empirical research on entry is much

less conclusive than theoretical research. Theoret-

ical models suggest that firms can use price as an

entry deterrent before or after entry has occurred.

Limit pricing models emphasize deterring entry

before it occurs. Predation models focus on cut-ting prices after entry as a way to drive out entrants

and deter future entry. But empirical research has

provided little support for any theory of price as

an entry deterrent. It appears that in an effort to

be parsimonious and tractable, theoretical models

have omitted important contingency factors that

influence the incumbents incentive to respond to

entry.

Early theoretical research, notably by Bain

(1956), Modigliani (1958), and Sylos-Labini

(1962), emphasizes limit pricing: an incumbent

firm setting its pre-entry price low enough tomake entry appear unprofitable. Implicit in the

limit pricing models is the belief that potential

entrants use current industry profits as an indicator

of future profits (Masson and Shaanan, 1982).

Such a strategy makes sense for incumbents if

the foregone pre-entry profits are less then the

additional profits earned by deterring entry and

subsequently raising prices back to monopoly

levels (Geroski, 1995).

Empirical evidence provides little support for

limit pricing strategies. A survey of U.S. firms

by Smiley (1988), and a survey of U.K. firms

by Singh, Utton, and Waterson (1997) both find

that firms report rarely using prices to deter

entry. Dynamic limit pricing models, which sug-

gest that incumbents use their prices to regulate

entry behavior continuously, also find little support

empirically.

Game-theoretic models emphasize that under

conditions of complete information limit pricing

is not a credible deterrent. Limit pricing models

traditionally assume that potential entrants believe

that incumbents will not change their price or out-

put after entry. But game-theoretic models demon-

strate that under conditions of complete informa-tion, regardless of its pre-entry behavior, maintain-

ing the limit price after entry is not profit maxi-

mizing; once entry has occurred, the incumbent

has an incentive to raise the price from the limit

price to the post-entry equilibrium level. In other

words, with complete information, pre-entry prices

or profits do not predict post-entry profitability

(Milgrom and Roberts, 1982a). Rational poten-

tial entrants will not be affected by low pre-entry

prices, and thus incumbents only squander prof-

its by limit pricing (Milgrom and Roberts, 1982a).

These game-theoretic models emphasize the need

Copyright 2005 John Wiley & Sons, Ltd. Strat. Mgmt. J., 26: 12291248 (2005)


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Incumbent Pricing Responses to Entry 1231

for incumbents to credibly commit to low post-

entry prices in order to deter entry.

Game-theoretic research has considered a vari-ety of strategies and conditions that might provide

credible deterrents to entry. Spence (1977) and

Dixit (1980) develop a model in which an incum-

bent invests in excess capacity as a way to deter

entry. The excess capacity allows the incumbent to

commit to increased post-entry output and a lower

post-entry price. This commitment to price reduc-

tion makes entry less attractive.

But empirical research provides little support

for the use of excess capacity as an entry deter-

rent. Masson and Shaanan (1986) and Lieberman

(1987a) find no evidence that incumbents investin excess capacity to deter entry, although Lieber-

man (1987b) does find that in more concentrated

industries firms build capacity after entry. In a sur-

vey of U.S. firms, Smiley (1988) finds that almost

none of the respondents used excess capacity to

deter entry. Singh et al. (1997) received similar

responses from U.K. firms.

Another game-theoretic approach uses asymmet-

ric information to make low prices a credible

threat. Milgrom and Roberts (1982a) develop a

signaling model in which the entrant is uncer-

tain about the incumbents costs. In this model,

the incumbent tries to signal that it has low costs

by setting a low price pre-entry, as a way to

deter entry. Kreps and Wilson (1982) and Mil-

grom and Roberts (1982b) show that when the

entrant is uncertain about the incumbents pay-

offs the incumbent may have an incentive to cut

prices after entry as a way to build a reputation for

fighting entry. A tough reputation may deter future

entrants by reducing the expected profitability of

entry.Few studies have explicitly tested theories of

predatory pricing, largely because it is difficult

to identify predatory pricing. But several papers

have examined incumbent pricing responses to

entry, yielding inconsistent results. Some find that

incumbents cut prices post entry while others find

no response, or even a positive response.

In the airline industry, Joskow, Werden, and

Johnson (1994) find that incumbents cut prices fol-

lowing entry, while Windle and Dresner (1995)

report that entry by low-cost carriers induces price

cuts from incumbents. Looking at retail grocerystores, Marion (1998) finds that prices are neg-

atively affected by entry by warehouse stores. In

the retail tire industry, Bresnahan and Reiss (1991)

find that prices fall with entry. On the other hand,

Thomas (1999) finds that incumbents in the ready-

to-eat breakfast cereal industry do not cut prices

after entry (Thomas, 1999). Finally, two studies

find that incumbent pricing responses vary within

the same industry. Frank and Salkever (1997) find

that brand-name prescription drug prices increase

after generic entry, but generic prices fall with

generic entry. Yamawacki (2002) finds that some

car manufacturers cut prices in response to entry

while others do not. Table 1 summarizes the empir-

ical studies of incumbent pricing responses to

entry.

While empirical results are mixed, little is known

about why some incumbents reduce price post

entry and others do not. The literature offers little

Table 1. Summary of empirical studies of incumbent pricing responses to entry

Authors Industry Key result

Joskow, Werden, andJohnson (1994) Airlines Incumbents cut prices post entry

Windle and Dresner(1995)

Airlines Incumbents cut prices following entry by low-costcarriers

Marion (1998) Grocery stores Incumbent supermarkets reduce prices following entryby warehouse stores

Thomas (1999) RTE breakfastcereal

Incumbents accommodate on price

Frank and Salkever(1997)

Pharmaceuticals Incumbent producers of prescription drugs raise pricesafter generic entry, while generic incumbents reduceprice after generic entry

Bresnahan and Reiss(1991)

Local retailmarkets

Incumbent tire retailers reduce prices following entry inlocal retail markets

Yamawacki (2002) Automobilesegments

Firm-specific and group-specific factors determine whichincumbent auto manufacturers respond to entry



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1232 D. Simon

explanation for these inconsistent findings. Little

empirical research has considered the conditions

under which firms are more or less likely to fightentry. I believe the main reason for this gap in

the literature is that explaining why some firms

respond to entry more aggressively than others

requires detailed firm-level data, including firm-

level pricing data as well as other firm and market

characteristics.

Yamawacki (2002) argues that incumbent pric-

ing responses to entry are firm-specific, depending

on the incumbents ability to respond to entry,

which in turn depends on its relative resource posi-

tion. But he does not specify what factors influence

an incumbents ability to respond to entry. Anotherreason why incumbents may not cut prices after

entry is that they may respond to entry with non-

price tools.

In industries with differentiated products, firms

have a variety of tools available to them for

responding to new entry. Most prominently, these

include advertising and promotional campaigns,

and new product introductions (Thomas, 1999),

as well as product improvements. Firms may use

these other types of responses instead of or in addi-

tion to price responses. If firms substitute these

non-price responses for price cuts, then the nega-tive relationship between entry and price response

will not hold.

There is some evidence that firms substitute

non-price responses for price responses in highly

differentiated industries. Studies in the soda and

ready-to-eat breakfast cereal industries find that

while firms accommodate on price, they use adver-

tising to deter or limit entry (Thomas, 1999). But

this argument fails to explain why incumbents in

the airline and the auto industry cut prices after

entry.

I suggest a more general explanation for whysome firms respond to entry more aggressively

than others: incumbents vary in their incentive to

respond to entry. Incumbents with greater incen-

tives to respond to entry are more likely to respond

aggressively. In the following section I develop

this explanation more fully, arguing that the incum-

bents age (time in the market), the incumbents

corporate scope, and the market structure all can

influence incumbents incentives to respond. First,

however, I summarize the theoretical arguments

for why incumbents are expected to cut price fol-

lowing entry.

HYPOTHESES

There are two distinct reasons why incumbents

may cut prices in the face of entry: deterrence

and current profit maximization. Entry deterrence

strategies can be divided into two groups: those

that predict a pre-entry price response, and those

that predict a post-entry response. In the first cat-

egory are limit-pricing models in which incum-

bents set a pre-entry price below the current profit-

maximizing level as a way to reduce the poten-

tial entrants assessments of the benefits of entry.

In the second category are game-theoretic models

in which incumbents set post-entry prices below

the current profit-maximizing level as a way to

drive out current entrants and deter future entrants.

While neither set of models has received much

empirical support, post-entry price cutting has

received more theoretical support.

Absent any efforts to deter entry, incumbents

may be expected to reduce prices in order to max-

imize current profits. New entrants force incum-

bents to reduce prices by increasing market supply,

stealing market share, and reducing incumbents

ability to tacitly collude. Moreover, because new

entrants often introduce new technologies, they

may force incumbents to become more efficientas well (Geroski, 1995). As a result, incumbents

often have incentives to reduce prices that do not

involve entry deterrence.

While incumbents have incentives to cut prices

in response to entry, this incentive is weaker in

differentiated product markets because demand is

more inelastic with respect to price and more

elastic with respect to other marketing tools. In

such cases, firms may accommodate on price

and respond aggressively with another competi-

tive weapon (Gruca, Kumar, and Sudarshan, 1992).

However, firms in differentiated markets may alsorespond aggressively with more than one com-

petitive weapon (Gatignon and Hanssens, 1987).

For example, an airline may both reduce its price

and increase the number of flights it offers as a

way to drive out a new entrant from a particular

route. Moreover, several papers in the marketing

area argue that incumbents in differentiated mar-

kets are almost always better off reducing price

post entry (Hauser and Shugan, 1983; Kumar and

Sudarshan, 1988; Gruca et al., 1992). As a result, I

offer the following hypothesis (given the substan-

tial prior testing of this relationship, this hypothesis



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is included for theoretical completeness rather than

for its original contribution):

Hypothesis 1: Incumbent prices are negatively

related to entry.

While theory predicts an incumbent response

to entry, evidence shows that incumbents respond

selectively (Geroski, 1995). The heterogeneous

responses to entry may reflect varying incentives to

respond. Incumbents that stand to lose more from

entry, or gain more from deterring entry, are more

likely to respond aggressively to entry.

Incumbent characteristics, such as the incum-

bents time in the market, may influence its incen-tive to respond. Reflecting the liability of newness

(Stinchcombe, 1965), newer firms are more vul-

nerable to entry than older firms. There are two

possible explanations for this vulnerability. Both

arise from the need for non-tradable assets that are

characterized by time compression diseconomies

(Dierickx and Cool, 1989).

Older firms are more likely to have well-es-

tablished reputations. Reputation cannot be ac-

quired; a firm must invest in its reputationfor

quality, for integrity, for innovation, etc. over

time (Dierickx and Cool, 1989; Fombrun and

Shanley, 1990). The longer a firm has been in

existence, the greater its opportunity to develop

a favorable reputation with customers, suppliers

and investors. A firms reputation can provide a

competitive advantage by differentiating the firms

products, allowing the firm to charge higher prices

(Fombrun and Shanley, 1990). Newer firms that

invest more to create reputations more quickly are

likely to be unsuccessful because of time compres-

sion diseconomies in the production of a reputa-

tion. As a result, one might expect newer firms to

be more threatened by entry due to their weaker

reputations.Newer firms may also have higher costs or lower

quality because they lack firm-specific resources

and know-how that older incumbents possess

(Geroski, 1995). Firm-specific skills and know-

how are developed through on-the-job learning and

training (Williamson, 1979). This tacit knowledge

is difficult to acquire because in most cases it is

embedded in the company and cannot be codified

(Nonaka, 1994). Firms with more experience have

a greater opportunity to develop this tacit knowl-

edge and move down the learning curve, reducing

costs and/or improving quality. Learning by doing

may give older incumbents a competitive advan-

tage over newer incumbents and new entrants.1

The case of Steinway & Sons (Kotha and Dun-bar, 1996) exemplifies a learning-by-doing advan-

tage. Manufacturing a Steinway piano is a complex

process, requiring about 300 skilled artisans that

develop their skills through years of apprenticeship

(Kotha and Dunbar, 1996). Quality is embedded

throughout the process, as each step is contingent

upon the success of the previous steps (Kotha

and Dunbar, 1996: 10). Through years of trial

and error, Steinway has developed a unique craft

approach that has hardly changed for the last

century (Kotha and Dunbar, 1996: 8). Using an

apprenticeship system to transfer skills, Steinwayhas maintained its quality advantage in the face of

entry: It has proved impossible to produce a piano

equal to the Steinway piano, even though Stein-

ways were copied to the minutest detail (Dolge,

1911). Over time, Steinway has developed know-

how that protects it from the threat of entry.

Empirical evidence supports the view that new

firms are more vulnerable to entry as well. From

1963 to 1982, nearly 80 percent of all new firms in

the United States failed within 10 years (Geroski,

1995), with new entry being a primary cause:

One of the clearest features of the data on entry

. . . is that most entry results in exit, first byrecent entrants (Geroski, 1995: 434). Because of

their increased vulnerability to new entrants, newer

firms are more likely to cut prices in response to

entry, as a way to protect themselves.

Hypothesis 2: Newer incumbents cut prices more

in response to entry.

Corporate scope can also affect a firms incen-

tive to respond to entry. By fighting entry in one

market, a multi-market incumbent can build a rep-

utation for fighting entry that may deter entry inits other markets (Kreps and Wilson, 1982; Mil-

grom and Roberts, 1982b). The value of such a

reputation increases with the number of markets

in which a firm can use this reputation: The more

markets that a firm serves, the greater its incentive

for building and maintaining its reputation (Mil-

grom and Roberts, 1982b). Single-market firms

1 While older firms are likely to have moved further down thelearning curve, not all knowledge must be developed throughexperience. In many cases new entrants have a cost or qualityadvantage based on new technology that they developed oracquired (Geroski, 1995).



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1234 D. Simon

have less incentive to build a reputation for fight-

ing entry because the benefits of deterring entry are

restricted to the market in which they compete. Anincumbent competing in multiple markets can ben-

efit in its other markets by deterring entry in any

one market.

For example, if a locally owned department store

cuts prices when a new department store opens

up in town, this may reduce the likelihood that

other potential entrants will open a department

store in town. However, if Wal-Mart aggressively

cuts prices when a new store enters one of their

markets, this may reduce the likelihood of entry

into the focal market and into all other cities in

which Wal-Mart competes. Potential entrants intoother markets may infer that because Wal-Mart

responded aggressively in one market, it will do

so in others as well. Because it may deter entry in

multiple markets, Wal-Mart has a greater incentive

to respond aggressively to entry in any market.

There are several counter-arguments to this rea-

soning. Some might argue that incumbents who

compete in only one market have more to lose to

new entrants, because they have no other alterna-

tive. But this argument applies only if exit is more

costly for single-market incumbents than for multi-

market incumbents.2 Another counter-argument is

posed by Smith, Grimm, and Gannon (1992), whoargue that firms with more complex organizational

structures are less likely to respond to competi-

tive attacks. They posit that in structurally complex

firms decision-makers receive information more

slowly and are more likely to receive misinfor-

mation. This weakens the ability of these firms to

respond to competitive attacks. But, Smith et al.

(1992) find little support for this hypothesis.

Finally, research on multi-market competition

indicates that firms may compete less intensely

against each other when they meet in multiple mar-

kets (Gimeno and Woo, 1999). This suggests thatwhen incumbents compete against new entrants in

other markets the incumbents are less likely to

respond aggressively. But, de novo entry (entry by

2 For this to be true, two conditions must hold. The incumbentmust have assets that are transferable across markets, but firm-specific, such that it cannot sell them when it exits the market.Additionally, entering another market must require the entrantto incur some sunk costs (invest in assets that are both firm-and market-specific) as well. However, to the extent that mostof the important assets in the industry are not market-specific,then the single-market firm incurs little additional cost (relativeto the multi-market firm) in transferring its resources to a newmarket.

new firms) is much more common than entry by

diversifying incumbents (Geroski, 1995). There-

fore, it is likely that in most cases incumbents donot meet entrants in other markets. As a result, the

net effect of multi-market incumbency is likely to

negatively influence incumbents pricing response

to entry.

Hypothesis 3: Multi-market incumbents cut

prices more in response to entry.

Market structure may also influence the incum-

bents incentive to aggressively respond to entry.

Generally, the threat posed by entry should be

greater in more concentrated markets (Hannan,1979). In highly competitive markets entry should

have little effect on incumbents as competition has

already forced high prices down towards marginal

cost, while in more concentrated markets entry

threatens to erode rents by making it more diffi-

cult to maintain tacit collusion. Therefore, incum-

bents in highly concentrated markets have a greater

incentive to cut prices, both to drive out entrants

and to deter further entry (Hannan, 1979; Kessides,

1990).

Alternatively, higher concentration may reflect

entry barriers or incumbent capabilities which

make it difficult for new firms to enter a market. In

this case, the entry barriers would grant the incum-

bents a competitive advantage over new entrants,

reducing the need for incumbents to aggressively

respond to entry. But, while entry barriers appear

to be high in many industries, they have little

effect on rates of entry (Geroski, 1995). This sug-

gests that they also have little effect on incumbent

responses.

Hannan (1979) finds that incumbents in concen-

trated markets cut prices more in response to entry.

Similarly, Lieberman (1987b) finds that incum-

bents in concentrated markets increase capacity bya greater amount following entry. Therefore:

Hypothesis 4: Incumbents in concentrated mar-

kets cut prices more in response to entry.

METHODS AND DATA

To test these hypotheses, I use data on U.S.

consumer magazines. The consumer magazine

industry provides a good setting for studying

incumbent responses to entry because it has



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well-defined markets, allowing the researcher to

identify entrants and incumbents. Furthermore,

the existence of multiple markets allows meto examine how entry affects pricing behavior

across markets while holding constant other

industry characteristics which influence entry

barriers and/or pricing behavior. Moreover, there

is uniform price data available, allowing one to

examine how pricing varies with entry.

Magazines are differentiated products. Even

within the same market there are differences

in editorial quality, subject matter, and style.

Therefore, publishers may cut prices or they may

improve some dimension of quality to deter or

limit entry. For example, an incumbent magazinemight publish more articles about celebrities as

a way to improve its quality and make it more

difficult for an entrant to attract subscribers. But

it is difficult to adjust quality in the short run,

especially in the market for subscribers, which is

the focus of this study.

Data

This study uses data on consumer magazines sold

in the United States whose circulation is audited

by the Audit Bureau of Circulation (ABC). ABC

collects data on circulation, advertising rates, and

cover prices, providing verified circulation figures

to advertisers. The data span an 11-year period

from 1990 through 2000. The sample includes 449

incumbent magazines,3 owned by 246 publishers,

competing in 42 different markets.4 In total, there

are 3715 magazineyear observations.

Markets are defined by magazine topics. For

example, there are markets for cooking magazines,

car magazines, sports magazines, etc. Table 2

lists the magazine markets and a sample maga-

zine from each. These market definitions reflect

3 I define incumbents as magazines selling at least four issuesper year, offering subscriptions, which were not founded duringthe current or previous year. This is to avoid coding the samemagazine as both an entrant and an incumbent in the same year.I also exclude magazines acquired during the current year.4 I exclude magazines in three markets. I exclude mens and gen-eral editorial magazines because the definitions of these marketsused by the Audit Bureau of Circulation did not correspondclearly with the same markets in the entry data. I exclude maga-zines in the metropolitan/regional/state market because, owing toits geographic nature, magazines in this market generally do notcompete with each other, e.g., Chicago magazine does not com-pete against Atlanta magazine. Therefore, incumbents should notbe expected to respond to new entrants (except in the rare casewhen they compete in the same geographic market).

Table 2. Magazine markets and sample magazines

Market Sample magazine

Art and antiques Art & AntiquesAutomotive Road & TrackAviation FlyingBabies Twins MagazineBlack/African-American Todays Black WomanBoating and yachting Salt Water SportsmanBridal Modern BrideBusiness and finance Entrepreneur MagazineCamping and outdoor

recreationBackpacker

Computers Byte MagazineCrafts, games, hobbies,

and modelsCrafts

Dogs and pets Aquarium FishDressmaking and

needleworkMccalls Needlework &

CraftsEducation and teacher Creative ClassroomEntertainment and

performing artsUs Weekly

Epicurean Food & WineFashion, beauty, and

grooming Harpers Bazaar

Fishing and hunting American AnglerFitness Walking, The Magazine

For Smart Health &Fitness

Gardening (home) Flower and GardenGay publications The Advocate

Health PreventionHome service and home Decorating RemodelingHorses, riding, and

breedingEquus

Literary, book reviews,and writingtechniques

The New York Review OfBooks

Mature market New Choices: LivingEven Better After 50

Military and naval Army TimesMotorcycle Cycle WorldMusic Rolling StoneNature and ecology WildbirdParenthood ChildPhotography American Photo

Political and socialtopics

National Review

Popular culture InterviewReligious and

denominationalCatholic Digest

Science/technology DiscoverSports TennisTeen Tips & TricksTravel Conde Nast TravelerTV and

radio/communicationsand electronics

Video

Womens CosmopolitanYouth Disney Adventures



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1236 D. Simon

the interaction among magazines competing for

readers and advertisers. For example, ArtNews

magazine and Art in America magazine are bothin the art and antiques market, competing for

the same customers and advertisers. Similarly,

Bowhunting magazine competes for customers and

advertisers with Deer & Deer Hunting magazine in

the hunting and fishing market.

Data on entry were collected from annual edi-

tions of Samir Husnis Guide to New Consumer

Magazines (Husni, 1991 2001). Each volume pro-

vides data on new consumer magazines sold in

the United States, categorized by type of maga-

zine.

Variables

Dependent variable

The dependent variable is the log of the per-

issue price for a 1-year subscription.5 The per-issue

price is the listed price for a 1-year subscrip-

tion divided by the number of issues. I use the

per-issue price rather than the total subscription

price to facilitate analysis across magazines with

different numbers of issues. I focus on subscrip-

tion prices rather than single-copy prices becausesingle-copy prices have been shown to be very

sticky (Cecchetti, 1986; Round and Bentick,

1997), and because subscriptions generally account

for roughly three times more revenue than single-

copy sales (Papazian, 1997). In addition, sub-

scribers tend to be more price sensitive than

single-copy buyers (Round and Bentick, 1997),

while single-copy buyers are much more influ-

enced by non-price factors such as the magazine

cover (Daly, Henry, and Ryder, 1997). As a result,

publishers are more likely to emphasize non-price

dimensions such as the magazine cover in compet-

ing for single-copy readers, while price is a more

important competitive weapon in the subscription

market. Finally, this study analyzes subscription

prices rather than advertising rates because incum-

bents have a greater incentive to reduce subscrip-

tion prices due to the positive effect that this

has on advertising revenues (by increasing circu-

lation the magazine is able to charge higher ad

rates).

5 I use log price because of skewness in price, and to beconsistent with prior firm pricing studies.

Independent and control variables

I measure entry with a dummy variable that takesa value of one for a particular incumbent maga-

zine if at least one new rival magazine enters the

market during the current year, and zero other-

wise. In order to measure entry it is necessary to

determine what constitutes a new entrant. For the

purposes of this study, I include all new maga-

zines listed in Samir Husnis annual Guides to New

Consumer Magazines that were published at least

four times per year in that year.6 In a very small

number of cases, I find magazines listed as new

entrants in the incumbent dataset for at least one

prior year. These magazines are not considered to

be new entrants. I also consider the identity of the

publisher of the new entrants. If the publisher of

an incumbent magazine introduces a new entrant

into the same market, then the new magazine is not

treated as a new entrant because it is not a rival.

Therefore, I define entry specific to each incum-

bent magazine. Only new magazines introduced

by rival publishers are considered new entrants.

The incumbents age is the logarithm of the

number of years since it was founded (since it

entered the market). I use log of age because

the effect of age is likely to diminish at higher

levels. Similarly, I use the log of the number ofmarkets in which it sells magazines to measure the

publishers corporate scope. A Herfindahl index

measures market structure.

In addition to these variables, I include sev-

eral control variables. The aggregate circulation of

rival magazines controls for market demand. To

further control for market structure, I include the

number of rival incumbent magazines.7 Similarly,

I include a dummy variable to indicate whether

or not any rival magazines exited the market dur-

ing the current year.8 This allows me to control

for the effect of exit, which tends to be correlated

with entry (Evans and Sigfried, 1994). Finally, to

control for the publishers experience with entry, I

include the percentage of entrants that a publisher

has faced since 1990 that have survived to the

current year. In addition, I control for unobserv-

able magazine, publisher, and year fixed effects,

as described below.

6 I exclude new magazines with an unknown number of issues.7 This variable excludes rival new entrants.8 A magazine is defined as exiting the market if it no longerappears in the dataset and if it does not appear in that yearsedition of the Standard Periodical Directory.



9/20


Model

To test the hypotheses, I estimate the followingfixed-effects model:

ln(PRICEijkt) = b1Xijkt+ ui + vj + wt+ eijkt

where i indexes magazines, j indexes publish-

ers, k indexes markets, and t indexes years. In

this model, PRICEijkt is the per-issue subscrip-

tion price of incumbent magazine i, owned by

incumbent publisher j , competing in market k, in

year t. Xijkt is the set of independent and con-

trol variables described above. The ui is a setof magazine-specific dummy variables (magazine

fixed effects), vj are publisher-specific dummy

variables (publisher fixed effects), and wt are year-

specific dummy variables (year fixed effects).

In the fixed-effects specification, only within-

magazine variation is used. In this model, the

coefficient on entry compares a magazines price

in those years in which it faces entry with its price

in those years in which it does not face entry,

averaging this difference across all magazines in

the sample. A statistically significant coefficient

on entry would indicate that incumbent magazines

charge different prices in years when they faceentry compared to years in which they do not face

entry.9

I use a fixed-effects specification to control for

unobserved differences across magazines, publish-

ers, and time. Because each magazine only com-

petes in one market, the magazine fixed effects also

control for time-invariant differences in supply and

demand conditions across markets. Moreover, pub-

lisher fixed effects control for the fact that some

publishers may have already established reputa-

tions for fighting entry.

9 I also considered several different model specifications: (1)first-difference models; (2) models with a lagged dependentvariable (DV); (3) models with entry as the DV and price (orlagged price) as an independent variable, in order to furtherexplore the possibility of reverse causality; and (4) a modelusing 3-year moving averages, composed of the current yearand the two previous years. In each of these four approaches, Iexamined a model without any interaction terms (comparable toModel 1 in the paper), and a model with all three interactionterms (comparable to Model 5 in the paper). Generally, theresults are quite consistent across model specifications, and arequite consistent with those reported in the paper. There is littleevidence of reverse causality, and the results are quite robust todifferent specifications.

RESULTS

Table 3 provides descriptive statistics and a corre-lation matrix. Looking at the sample means, there

is an entry in 92 percent of the observations. While

this is a high percentage, reflecting the low barri-

ers to entry in the magazine industry, there are 284

observations spanning 21 different markets which

experience at least 1 year without entry.

The correlation matrix in Table 3 is a within

correlation matrix. That is, the correlations reflect

only the variation within each magazine over time.

This corresponds to the fixed-effects model which

only exploits the variation within each panel (mag-

azine). Despite the fact that the variables are cen-tered around the magazine mean, in several cases

the correlation between an interaction term and its

components is very high. For example, the correla-

tion between the incumbent ageentry interaction

and incumbent age is 0.93, and the correlation

between the marketsentry interaction and markets

is 0.83. As I discuss below, these high correlations

do not appear to cause multicollinearity.

Table 4 reports results for the models used to

test Hypotheses 1 4. Model 1 does not include

any interaction terms. In this model, incumbent age

has a negative and statistically significant effect

on incumbent price, while the effects of corpo-

rate scope and market structure are statistically

insignificant. Entry has a negative but statistically

insignificant effect. This result fails to provide sup-

port for Hypothesis 1, suggesting that, on average,

incumbent magazines do not cut prices in the face

of entry.

Model 2 includes the interaction of entry and

incumbent age. In this model, the effect of incum-

bent age remains negative and statistically sig-

nificant. The effect of entry is also negative and

statistically significant, while the interaction of age

and entry has a positive and statistically significanteffect. These results provide support for Hypothe-

sis 2, indicating that newer incumbents cut prices

more in response to entry.


incumbent corporate scope. In this model, the

effect of incumbent corporate scope becomes posi-

tive, but remains statistically insignificant, as does

the effect of entry. The effect of the interaction

term is negative and statistically significant, pro-

viding support for Hypothesis 3, and suggesting

that multi-market incumbents cut prices more in

response to entry.



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1238 D. Simon

Table 3. Descriptive statistics and within-magazine correlation matrix

Variable Mean S.D. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

1. Pricea 0.66 0.502. Entry 0.92 0.27 0.013. Incumbent

agea3.14 0.95 0.06 0.08

4. Marketsa 0.92 0.91 0.06 0.03 0.285. Herfindahl 0.23 0.16 0.05 0.01 0.07 0.006. Market

circulation(millions)

12.11 1 6.69 0.15 0.01 0.24 0.04 0.21

7. Rivalmagazines

19.71 1 4.00 0.19 0.00 0.26 0.08 0.27 0.65

8. Rival exit 0.12 0.32 0.01 0.01 0.17 0.08 0.02 0.08 0.039. Experience

with entry

0.02 0.03 0.03 0.02 0.22 0.17 0.05 0.17 0.05 0.07

10. Incumbentagea Entry

2.89 1.23 0.04 0.93 0.31 0.10 0.01 0.08 0.07 0.03 0.07

11. Marketsa Entry

0.87 0.91 0.03 0.39 0.27 0.83 0.01 0.04 0.07 0.07 0.16 0.41

12. Herfindahl Entry

0.20 0.16 0.03 0.77 0.07 0.03 0.39 0.11 0.13 0.01 0.00 0.70 0.30

13. Experiencewith entry Entry

0.02 0.03 0.03 0.13 0.20 0.16 0.04 0.17 0.05 0.07 0.94 0.07 0.05 0.11

a Logarithm. For correlations with absolute values greater than 0.04, p < 0.05.


market structure. Here, both entry and marketstructure have positive and statistically significant

effects. The interaction effect is negative and sta-

tistically significant, providing support for Hypoth-

esis 4. This result suggests that incumbents in con-

centrated markets cut prices more following entry.

Model 5 includes all three interaction terms.

Of the main effects, incumbent age continues to

exert a negative effect on incumbent price, while

the effect of market concentration remains posi-

tive and statistically significant. The positive effect

of corporate scope is statistically insignificant, as

is the negative effect of entry. All three interac-tion terms continue to have statistically significant

effects, and in the hypothesized directions. Taken

together, these results provide strong support for

Hypotheses 24.

While the interaction effects in Models 25 are

statistically significant, the R2 in the interaction

models is not much larger than in the basic model.

However, a test for the joint significance of the

three interaction terms in Model 5 yields an F-

statistic of 6.66, (significant at 0.0002). Although

adding the interaction terms does not explain a

lot of additional variance in incumbents pricing

responses, the interaction terms do illuminate the

relationships between the individual variables. Tosee this, compare the coefficient on entry in Mod-

els 1 and 2. In Model 1, the coefficient is 0.003,

and is statistically insignificant, while in Model2 the coefficient on entry is 0.125 and statisti-

cally significant. In other words, on average, anincumbent with 1 year of experience (i.e., where

log incumbent age equals zero) reduces price by

12.5 percent in response to entry. Controlling for

the differing incentives of old and new incumbents

reveals the effect of entry on new incumbent pricesto be substantial.

Looking more closely at the magnitudes of theseeffects, the results of Model 2 indicate that whilean incumbent magazine with 1 year of experi-

ence cuts price by 12.5 percent following entry, an

incumbent with 11 years experience cuts its price

by less than 4 percent when facing new entry,10

and a magazine with 21 years experience cuts itsprice by about 1 percent. Similarly, in Model 3,

single-market incumbents do not reduce price post

10 I arrive at this number by taking ln(11) = 2.398 and multi-plying this by the coefficient on the interaction term (0.037),and adding the product to the coefficient on entry, i.e., (2.398 0.037) 0.125 = 0.036.



11/20


Table 4. Regression models for hypothesis tests

Model 1b

Model 2b

Model 3b

Model 4b

Model 5b

Model 6b

Entry 0.003 0.125 0.023 0.036 0.038 0.039(0.011) (0.030) (0.015) (0.020) (0.049) (0.048)

Incumbent agea 0.110 0.141 0.110 0.108 0.132 0.055

(0.017) (0.020) (0.017) (0.017) (0.020) (0.021)Marketsa 0.013 0.015 0.021 0.014 0.015 0.007

(0.013) (0.013) (0.018) (0.013) (0.018) (0.018)Herfindahl 0.076 0.075 0.075 0.164 0.152 0.159

(0.055) (0.055) (0.055) (0.066) (0.066) (0.066)Market circulation 0.011 0.010 0.011 0.010 0.010 0.009

(0.003) (0.003) (0.003) (0.003) (0.003) (0.003)Rival magazines 0.003 0.003 0.003 0.003 0.003 0.001

(0.001) (0.001) (0.001) (0.001) (0.001) (0.001)Incumbent agea Entry 0.037 0.028 0.025

(0.011) (0.012) (0.011)Marketsa Entry 0.036 0.032 0.029

(0.013) (0.013) (0.013)Herfindahl Entry 0.119 0.103 0.080

(0.049) (0.050) (0.046)Rival exit 0.009

(0.009)Experience with entry 0.042

(0.374)Experience with entry Entry 0.057

(0.375)N 3715 3715 3715 3715 3715 3335Within R2 0.229 0.232 0.231 0.230 0.234 0.238

a Logarithmb Includes magazine, publisher, and year fixed effectsStandard errors are reported in parentheses. Significant at 0.10; significant at 0.05; significant at 0.01

entry, but an incumbent publisher competing in

five markets cuts its price by 3.4 percent. In Model

4, a 10-percentage point increase in the Herfindahl

index (on a 01 scale) results in incumbents cut-

ting prices by an additional 1.2 percent post entry.

In Model 6, I add additional control variables not

included in the previous models: a dummy vari-

able for rival exit, a measure of the incumbents

experience with past entry, and its interaction with

the entry dummy. The interaction term reflects theinfluence of the incumbents experience with entry

on its response to entry. I include these variables

separately because they each have missing values

for each magazines first observation.11

The results of Model 6 are very similar to those

of Model 5. Entry has a statistically insignificant

11 The exit variable takes missing values for the first year becauseit counts rival magazines that were in the dataset in the previousyear that no longer appear. Incumbents experience with entryis missing for the first year because this variable measuresexperience up to, but not including the current year.

effect, while all three interaction effects are sta-

tistically significant. The effect of rival exit is

negative, but statistically insignificant.12 Similarly,

incumbent experience with entry has a statistically

insignificant effect, as does its interaction with

entry.

Because of the high correlations between the

interaction terms and the variables that make up

the interactions, along with the modest increases in

R2

when the interaction terms are added, one mightbe concerned that multicollinearity is making the

results in Table 4 unstable. To consider this, I split

the sample at the median value of each of the three

variables that I interact with entry and examine the

effect of entry in each half of the sample. I report

these results in Table 5.

12 I also consider a continuous measure of exit: the number ofrivals that exit in the current year. The effect of number ofrival exits is negative and statistically significant, suggestingthat rival exits is picking up the effect of some unobservedchange in market demand. The other results do not change in ameaningful way.



12/20

1240 D. Simon

Table 5. Split sample regressions

Model 7ab

Low incumbentage (2)

Model 9ab

Low Herfindahl(0.187)

Model 9bb

HighHerfindahl(>0.187)

Entry 0.036 0.023 0.017 0.032 0.016 0.003(0.017) (0.015) (0.016) (0.014) (0.027) (0.012)

Incumbent Agea 0.141 0.280 0.128 0.092 0.056 0.201

(0.025) (0.144) (0.029) (0.019) (0.026) (0.025)Marketsa 0.015 0.060 0.026 0.014 0.043 0.002

(0.018) (0.020) (0.035) (0.016) (0.021) (0.016)Herfindahl 0.245 0.123 0.129 0.069 0.014 0.113

(0.081) (0.077) (0.076) (0.085) (0.377) (0.057)Market circulation 0.012 0.008 0.005 0.013 0.001 0.009

(0.004) (0.005) (0.006) (0.004) (0.005) (0.007)

Rival magazines 0.002 0.005 0.004 0.002 0.001 0.001(0.002) (0.002) (0.002) (0.002) (0.002) (0.002)

N 1857 1858 2033 1682 1852 1863

Within R2

0.293 0.192 0.135 0.361 0.200 0.302


For example, I first re-estimate Model 1 for

those observations where incumbent age is less

than the median value of 24. For these newer firms,

the effect of entry is negative and statistically sig-

nificant. By contrast, for those observations where

incumbent age is greater than or equal to 24, theeffect of entry is positive and statistically insignif-

icant. These results parallel the results reported

in Model 2, where the interaction of entry and

incumbent age has a negative effect on incumbent

price.

Similarly, I split the sample at the median

value of corporate scope. For focused publishers,

those competing in one or two markets, the effect

of entry is positive and statistically insignificant,

while for broad publishers who compete in more

than two markets the effect of entry is negative

and statistically significant. These results parallelthe results of Model 3; publishers competing in

more markets cut prices more following entry.

Finally, I split the sample at the median Herfin-

dahl value (0.187). For those observations in con-

centrated markets, where the Herfindahl index is

above the median value, the effect of entry is

negative and statistically insignificant. But in com-

petitive markets, where the Herfindahl index is

less than or equal to the median value, the effect

of entry is positive and statistically insignificant.

Despite the statistical insignificance, the pattern of

results is consistent with the results of Model 4;

incumbent pricing responses are less negative in

competitive markets.

Taken together, the results in Table 5 are highly

consistent with those reported in Table 4, revealing

the interaction effects to indeed capture important

differences in how incumbents respond to entry. Tobetter explain these results, Figure 1(a c) provides

graphical illustrations of the split sample results. I

take the average price for each type of incumbent

(old and new incumbents, incumbents owned by

focused and broad publishers, and incumbents in

competitive and concentrated markets), for those

observations without entry. I then use the corre-

sponding entry coefficient to compute the expected

price when each type of incumbent faces entry.

These figures show that new incumbents, incum-

bents owned by broad publishers, and incumbents

competing in more concentrated markets all reduceprice more than their respective comparison group,

in response to entry.

Additional analyses

Along with the incumbent and market charac-

teristics discussed here, entrants characteristics

may also influence incumbent pricing responses.

Lieberman (1987b) and Thomas (1999) find some

evidence that incumbents respond more aggres-

sively to de novo entry than to incumbents that



13/20


Old

New

2.20

2.30

2.40

2.50

2.60

2.70

No Entry Entry

Price

(a)

Focused

Broad

2.30

2.40

2.50

2.60

No Entry Entry

Price

(b)

(c)

Competitive

Concentrated

2.20

2.30

2.40

2.50

No Entry Entry

Price

Figure 1. Entry response by incumbent type (graphs of split sample results). (a) Old and new incumbents. (b) Focusedand broad publishers. (c) Competitive and concentrated markets

expand existing operations or introduce new prod-

ucts.

To consider whether incumbents respond more

aggressively to de novo entrants than to incumbent

entrants, I separate entry into two components: de

novo entry and incumbent entry. De novo entryindicates entry by a publisher with no incumbent

magazines, while incumbent entry refers to a new

magazine offered by a publisher that offers at least

one incumbent magazine. Table 6 reports these

results.

In Model 10, the effect of incumbent entry is

negative, but statistically insignificant, as is the

effect of de novo entry. In Model 11, I include a

dummy variable for whether the incumbent com-

petes in more than one market. In addition, I

interact this variable with the two types of entry.

The results indicate that multi-market incumbents

cut prices in response to de novo entry by sig-

nificantly more than single-market incumbents.

On the other hand, multi-market incumbents did

not respond differently to incumbent entry. Taken

together, these results suggest that the type of entry

moderates the negative effect of incumbent corpo-rate scope on incumbent pricing responses; multi-

market incumbents seek to build a reputation for

fighting de novo entry but not incumbent entry.

Along with the type of entry, multi-market con-

tact between entrants and incumbents may also

moderate the negative effect of corporate scope

on incumbent pricing responses. To consider this,

I construct a measure of multi-market contact

between incumbents and entrants which counts

the number of times in which the entrants into

a market meet the markets incumbents, across

all markets other than the focal market. If either



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1242 D. Simon

Table 6. Additional analyses

Model 10b

Model 11b

Model 12b

Model13b+

Ad rate

Model 14b

Ad rate

Entry 0.027 0.001 0.082(0.016) (0.012) (0.052)

Incumbent Agea 0.110 0.109 0.108 0.111 0.094

(0.017) (0.017) (0.017) (0.019) (0.022)Marketsa 0.013 0.017 0.017 0.001 0.005

(0.013) (0.016) (0.016) (0.013) (0.019)Herfindahl 0.076 0.075 0.073 0.064 0.100

(0.055) (0.055) (0.055) (0.059) (0.071)Market circulation 0.011 0.011 0.010 0.001 0.001

(0.003) (0.003) (0.003) (0.003) (0.003)Rival magazines 0.003 0.003 0.003 0.0004 0.0004

(0.001) (0.001) (0.006) (0.0015) (0.0015)Incumbent agea Entry 0.019

(0.012)Marketsa Entry 0.005

(0.014)Herfindahl Entry 0.047

(0.053)De novo entry 0.005 0.025

(0.011) (0.016)Incumbent entry 0.0004 0.010

(0.0068) (0.010)Multi-market incumbent 0.053 0.058

(0.031) (0.031)Multi-market incumbent De novo entry 0.058

(0.022)

Multi-market incumbent Incumbent entry 0.015(0.013)

Multi-market incumbent Entry 0.058

(0.022)Multi-market contact 10 0.004

(0.002)Multi-market incumbent Multi-market contact 10 0.004

(0.003)Circulationa 0.592 0.591

(0.018) (0.018)N 3715 3715 3715 3638 3638Within R2 0.229 0.231 0.231 0.686 0.686


the entrants into a market or the incumbents in

that market do not compete in any other mar-

kets, then the multi-market contact variable takes a

value of zero. But, if one magazine enters into the

womens market, and its publisher also competes

in the sports market, where one of the incumbent

womens magazine publishers also competes, then

multi-market contact in the womens market will

be one (because an entrant and an incumbent meet

once outside the focal market).

To examine the moderating effect of multi-

market contact, I interact multi-market contact

with the multi-market incumbent dummy. The

results of Model 12 show that multi-market incum-

bents cut prices by significantly more than single-

market incumbents in response to entry. More-

over, there is weak evidence that multi-market

contact moderates the aggressive pricing response

of multi-market incumbents; the interaction of

multi-market contact and multi-market incumbent



15/20


Table 7. Frequency of price cuts and advertising rate cuts in response to entry

Observations Ad rate: cut Ad rate: no changeor raise

Total

Magazine price: cut 848 1610 2458 (73%)Magazine price: no change or raise 190 711 901 (27%)Totals 1038 (31%) 2321 (69%) 3359 (100%)

has a positive effect that approaches conventional

significance levels (p = 0.125).

While this study focuses on incumbents sub-

scription prices, one might suspect that incumbents

also respond to entry by reducing advertising rates.

Although I argue above that incumbents have a

greater incentive to cut subscription prices due to

the effect that this has on ad revenues, advertising

space is a more homogeneous product than maga-

zine subscriptions, and therefore demand is likely

more elastic with respect to price. As a result, pub-

lishers may also reduce ad rates in response to

entry.

To consider this possibility, I estimate a basic

model and an interaction model of the maga-

zines advertising rate. In both models I control

for the magazines circulation. Models 13 and 14

in Table 6 report the results. In the basic model,

the effect of entry is statistically insignificant, asare the effects of market concentration and corpo-

rate scope. The effect of incumbent age is positive

and statistically significant. This may reflect older

magazines ability to attract readers that are more

valued by advertisers. It may also indicate that

advertisers will pay more to advertise in older mag-

azines because they have more information about

the characteristics of the readers of older maga-

zines.

When I include the interaction terms, the neg-

ative effect of entry (p = 0.11) and the positive

effect of the entryincumbent age interaction (p=

0.12) both approach conventional levels of statisti-

cal significance, suggesting that newer incumbents

respond to entry more aggressively than older

incumbents. The other two interaction effects are

statistically insignificant.

To better understand these results, I examine

the frequency of price cutting and ad rate cutting

when facing entry.13 The results are reported in

Table 7. The results indicate that, out of 3359

cases, magazines cut prices 2458 times (73%)

13 I adjust nominal prices and ad rates for inflation.

when they faced entry, while they cut ad rates

in only 1038 of these cases (31%). Combined

with the results of Models 13 and 14, it appears

that magazines are more likely to cut subscription

prices in response to entry.

Of the 2458 cases in which magazines cut prices

in response to entry, they also cut advertising rates

848 times (34%). On the other hand, for the 901

cases where they did not cut prices in response

to entry, they cut advertising rates only 190 times

(21%). These results suggest that magazines do not

use ad rate reductions as substitutes for price cuts

in responding to entry. If anything, it appears that

magazines use these two types of prices as comple-

mentary entry response mechanisms, as suggested

by Gatignon and Hanssens (1987).

DISCUSSION

Economic theory suggests that incumbent firms

may cut prices after entry, either to deter future

entrants or to maximize current profits. But, despite

solid theoretical support, empirical research has

produced inconsistent results: some studies find a

negative relationship between entry and pricing,

while this study and others do not.

Regarding the direct effect of entry, the results

of this study indicate that entry does not have

a statistically significant effect on incumbents

pricing. One industry-specific explanation for thelack of incumbent response is the high rate of

entry in the magazine industry; the mean number

of new entrants into a market in the sample is

nine. Because entry is almost continuous, it may

be that the threat of entry keeps prices low, even in

the absence of entry (Hannan, 1979; Cool, Roller,

and Leleux, 1999). In other words, the magazine

industry may be a contestable market in which

incumbents set low prices in anticipation of entry,

regardless of whether or not it actually occurs.

Frank and Salkever (1992) offer another possible

answer to this question, but it is also somewhat



16/20

1244 D. Simon

industry specific. In explaining the positive cor-

relation between brand name prices and entry

by generic manufacturers, they argue that genericentry attracts price-sensitive consumers, making

the residual demand curve for brand name incum-

bents more price inelastic. This allows brand name

manufacturers to raise prices on the less price-

sensitive market. But, as the authors note, such

an explanation is only applicable in cases where

there is clear market segmentation. Yamawacki

(2002) argues that the heterogeneity in incumbent

response is a function of incumbents varying abil-

ity to respond to entry. Many in the marketing

literature argue that product differentiation moder-

ates incumbents pricing responses.This study offers a more general explanation for

the selective response to entry by incumbent firms:

incumbents vary in their incentive to respond

to entry. Incumbents with greater incentives to

respond to entry are more likely to respond aggres-

sively. To consider this explanation, this study

assesses the effect on incumbent pricing responses

of three factors that may influence the incumbents

incentive to respond to new entry: incumbent age,

incumbent corporate scope, and market concentra-

tion.

While the average effect of entry was not

statistically significant, these three factors were

found to significantly influence incumbents pric-

ing response to entry. The results indicate that

while incumbents reduce prices over time, an

incumbents time in the market weakens its pric-

ing response to entry; newer incumbents cut prices

more in response to entry than do older ones.

While the negative effect of incumbent age on

prices may suggest a liability of age, when con-

sidered jointly with the positive age entry interac-

tion effect, it appears that older incumbents have

greater know-how that allows them to cut costs

and in turn reduce prices below those of newerrivals. These lower costs and lower prices protect

older incumbents from the threat posed by new

entrants, and may explain both the negative impact

of incumbent age as well as the positive ageentry

interaction effect.

However, there are two alternative explanations

for the negative coefficient on incumbent age.

First, reflecting the fact that entry occurs almost

continuously in the consumer magazine industry,

incumbent age may capture the effect of past

entry. Therefore, incumbents may reduce prices

over time because they face entry in most years.

Other analysis suggests that age may also be pick-

ing up some of the effects of macroeconomic and

industry-specific time trends measured by the yeardummy variables.

While it is difficult to identify the direct effect

of age, the interaction effects along with the results

of the split-sample analysis appear to provide

robust evidence that older incumbents respond less

aggressively to entry than new incumbents. Com-

bined with theoretical arguments suggesting that

older incumbents may have accumulated greater

know-how, the results would seem to suggest that

older incumbents enjoy lower costs which they

exploit by reducing prices, thereby limiting their

need to reduce prices when facing new entry. Thisis also consistent with evidence from prior studies

that newer firms are more vulnerable to the threat

of entry (Geroski, 1995), as well as evidence that

the survival rate of new magazines is very low;

roughly 70 percent of all new magazines survive

less than 5 years (Husni, 1997). It appears that

entry threatens the survival of younger incumbents,

forcing them to respond aggressively by reducing

prices.

The results of this study also provide evidence

that multi-market incumbents fight entry in one

market as a way to deter entry in their othermarkets. The number of markets in which a pub-

lisher competes increases the amount by which it

cuts prices following entry. This is consistent with

game-theoretic models which argue that firms may

cut prices aggressively in response to entry, as

a way to develop a reputation for fighting entry.

Firms competing in multiple markets gain more

from developing such a reputation, as they can

deter potential entrants in all of the markets in

which they compete.

It should be noted that the ability to develop

a reputation in other markets assumes that themarkets are linked in some way (Milgrom and

Roberts, 1982b), such that potential entrants are

likely to be aware of the incumbents responses in

other markets, and such that entrants view behav-

ior in one market as predictive of behavior in other

markets. Therefore, while this relationship might

be expected to hold for geographically diversified

firms like airlines or banking, it would be less

likely to apply to firms that are diversified into dif-

ferent product markets. Entrants may not be aware

of the incumbents behavior in other product mar-

kets, or they may view the markets as sufficiently



17/20


different that incumbent behavior in one market

does not predict behavior in another market.

This relationship is counter-intuitive, challeng-ing the notion that firms competing in only one

market are more likely to fight because they have

fewer alternatives. As noted above, this argument

only applies if the cost of exit is greater for single-

market incumbents. For this to be true, there must

be costs associated with exiting the market, and/or

sunk costs associated with entering a new market,

which only the single-market incumbent would

need to incur (the multi-market incumbent having

already done so).

In the consumer magazine industry it appears

that the cost of exiting the market tends to be lowbecause most of a publishers critical resources

reside at the magazine level, in the form of the title

and magazine layout, along with the publisher and

editor. For this reason, publishing firms frequently

buy and sell individual magazines. This suggests

that exiting incumbents can sell their magazines to

existing rivals.

The cost of entering a market also seems to

be fairly low for an existing publisher. First, the

average publisher in the sample competes in four

markets. Second, in the entry data many publish-

ers enter multiple markets. Third, the fixed costs

of printing, distribution, marketing, and adminis-

tration can all be spread over titles and markets

(Round and Bentick, 1997). Taken together, this

suggests that the magazine industry has low mobil-

ity barriers, consistent with the high entry rates

described above. Under these conditions, single-

market incumbents incur little additional cost to

exit a market.

While the results indicate that multi-market

incumbents respond more aggressively to entry,

additional analysis suggests that this effect is mod-

erated by two factors: the type of entry and

multi-market contact. Multi-market incumbents cutprices more than single-market incumbents in

response to de novo entry, but less than single-

market incumbents in response to entry by incum-

bents. These results are consistent with Thomas

(1999), who finds that large incumbents cut price

in response to de novo entry while accommodating

entry by incumbents. These results suggest that it

is more difficult to deter incumbent entrants. Sim-

ilarly, it appears that multi-market incumbents cut

prices less in response to entry when they meet the

entrants in other markets. This finding is consistent

with the multi-market competition literature, which

stresses that firms competing against each other

in multiple markets are more likely to recognize

their mutual interdependence and avoid price wars(Gimeno and Woo, 1999).

Finally, the results indicate that incumbents in

concentrated markets respond more aggressively

to new entry, cutting prices by more than incum-

bents in competitive markets. While it may seem

counter-intuitive that firms respond more aggres-

sively in less competitive markets, these firms have

a greater incentive and a greater need to cut prices

in response to entry. Firms earning monopoly rents

have more to lose by not fighting entry, and more

to gain by deterring future entry. This result is con-

sistent with Hannan (1979), who finds that banks inconcentrated markets are more likely to cut prices

pre-entry to deter entrants, and with Lieberman

(1987b), who finds that incumbents in concentrated

markets increase capacity by a greater amount fol-

lowing entry

As noted above, incumbents face incentives to

cut price in response to entry both to maximize cur-

rent profits and to deter future entry. New entrants

threaten incumbents market share and reduce their

ability to coordinate pricing decisions. But incum-

bents also may consider future profitability and

determine that cutting prices, even beyond what

maximizes current profits, may be optimal if future

entrants are deterred. Previous studies have not dis-

tinguished between these two incentives for reduc-

ing prices following entry: Do firms cut prices in

response to entry to maximize current profits or to

deter future entry? This studys results shed some

light on this question.

Finding that newer incumbents cut prices by

more than older incumbents suggests that newer

incumbents reduce prices to maximize current

profits, because there is no reason to believe that

newer incumbents would be more concerned than

older incumbents with entry deterrence. Therefore,the marginal effect of entry on new incumbents

prices should be attributable to the current profit

maximization explanation. On the other hand, the

interaction effect of corporate scope and entry sug-

gests that multi-market firms cut prices to deter

future entrants. Thus, the results of this study sug-

gest that each incentive affects incumbent behavior

under certain circumstances.

Geroski (1995) comments that the absence of

a pricing response post entry could either indicate

accommodation by the incumbent or a limit-pricing

strategy in which prices are reduced pre-entry.



18/20

1246 D. Simon

Again, empirical studies have not distinguished

between these two explanations for the absence of

a pricing response found in many studies. Theseresults suggest that selective responses do not

reflect limit-pricing, but rather that incumbents

with weak incentives choose not to respond to

entry. Those incumbents with less incentive to cut

prices following entry also have weaker incentives

to limit price.

One concern with this study is that magazines

may respond to entry with non-price weapons. For

example, magazines may change the editorial for-

mat, or they may upgrade the quality of the paper

used, moving to a glossier finish. Similarly, they

may increase the number of pages per issue. Thesenon-price responses may tend to be cost increas-

ing, leading to price increases. As a result, these

non-price responses may cause a spurious, posi-

tive relationship between entry and price. This may

contribute to the absence of a direct relationship

between entry and incumbent prices.

Another concern in doing this study is the poten-

tial endogeneity of the entry variable. There are

two potential sources of endogeneity in the entry

variable. First, causality may work in the opposite

direction, as a potential entrants decision to enter a

market is likely to be influenced by the anticipatedresponse of incumbents. As discussed above, firms

may develop a reputation for aggressiveness that

deters entry (Kreps and Wilson, 1982; Milgrom

and Roberts, 1982b). Second, demand conditions

may be correlated with both entry and incumbent

prices. For example, if there is excess demand,

then incumbents may set high prices, which will

attract entry.

I partially control for both of these sources

of endogeneity. Fixed effects control for time-

invariant sources of endogeneity. Specifically,

magazine and publisher fixed effects control fordifferences across magazines and publishers in

their pricing behavior. Market circulation imper-

fectly controls for time-varying demand condi-

tions that may affect entry and pricing. However,

there may still be unobserved demand factors that

are correlated with both pricing and entry deci-

sions, creating a potential feedback from prices

to entry. In this case, these sources of endogene-

ity should bias the estimated coefficient on entry,

upwards, toward zero, perhaps helping to explain

the absence of a statistically negative entry coeffi-

cient in most models.

While the effect of entry may be biased, the

interaction effects will be unbiased as long as the

unobserved factors that are correlated with bothpricing and entry have an equal impact across dif-

ferent types of publishers. That is, even if the true

effect of entry is more negative than that reflected

in the estimated coefficients on entry, the interac-

tion coefficients should provide good estimates of

the differential effect of entry for different types

of incumbents, as long as the unobserved demand

shifters affect the different types of incumbents

equally.

One might also be concerned that changes in

supply conditions, for example a reduction in costs

due to a technological innovation, could induceentry and could also lead to lower prices, yielding

a downward bias in the coefficient on entry. But,

this is unlikely because factors that reduce produc-

tion costs would be likely to affect all magazine

publishers, regardless of the type of magazine that

they produce. This effect would be captured by

the year fixed effects. As a result, I do not believe

that unobserved supply conditions pose a substan-

tial threat to the qualitative nature of the findings

discussed above.14

As the above arguments suggest, there are ben-

efits to conducting this study in a single-industrysetting. Using an industry such as the consumer

magazine industry, which comprises many differ-

ent markets, allows me to assess the effects of

variation in market entry conditions, while con-

trolling for a variety of other factors that might be

correlated with both entry and pricing behavior,

such as supply conditions.

But, as with any single-industry study, there

are concerns about generalizability. This may be

a particular concern in this study due to the high

rates of entry in the consumer magazine industry.

Low entry barriers and the resulting high entry

rates may partially explain the absence of a pricing

response across all incumbents. On the other hand,

as noted above, publishers have an extra incentive

to cut magazine prices because of the positive

effect this has on advertising revenues.

14 Most studies of incumbent pricing response to entry estimatemodels similar to the ones that I estimate here, using fixedeffects, but ignoring any remaining endogeneity (Thomas, 1999;Marion, 1998; Hannan, 1979). Moreover, two studies that useinstrumental variables estimation to control for the remainingendogeneity find that the results are not greatly affected (Frankand Salkever, 1997; Yamawacki, 2002).



19/20


It would be interesting to see whether similar

results are found in other industries including air-

lines, banks, and mutual funds, which, like mag-azines comprise many different markets, but have

much lower entry rates. Anecdotal evidence from

the airline industry indicates that incumbents do

respond aggressively to entry (Carey, 2002).

CONCLUSION

A great deal of research, theoretical and empiri-

cal, has examined the use of prices to deter entry.

While theory suggests that firms often have incen-

tives to cut prices to deter entry, empirical resultshave generally failed to find evidence of price-

cutting after entry.

This study provides evidence that several fac-

tors influence the incumbents response to entry.

Results show that new incumbents respond more

aggressively to entry, as a way to survive. Sim-

ilarly, multi-market firms cut prices in response

to entry, as a way to deter entry in other mar-

kets. Finally, firms in concentrated markets have a

greater incentive to use price to deter entry, as a

way to protect oligopoly profits.

While this study examines the factors that influ-

ence incumbent pricing responses to entry, an

interesting opportunity for future research lies in

examining the effect of incumbents entry deter-

rence efforts. To what extent does price-cutting

actually deter potential entrants from entering?

To what extent does price-cutting prevent entrants

from stealing incumbents market share? And, how

successful are entrants in gaining market share in

the face of incumbent price-cutting? Understand-

ing the answers to these questions is important for

managers and policy-makers alike.

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Incumbent Pricing Responses to Entry