SITUATION: ENTRY INTO A MARKET
During the dot-com boom of the late 1990s, the online retailing scene was growing by leaps and bounds. More and more consumers were going online, and at the same time, new online services were popping up. Representative of these dynamics is FIGURE 5.7, which reports the growth in the number of B2B exchanges (i.e., sites that acted as an intermediary between businesses want- ing to buy and businesses wanting to sell products or services).8 Initially, the number of exchanges rose at an increasing rate. Then, beginning around 2001, there was a sharp downturn in the number of B2B exchanges. This pattern is quite typical for an industry in its incipiency. FIGURE 5.8 shows the same pat- tern among automobile manufacturers in the early part of the 20th century— a sharp rise and then a decline.9
Although explaining why the number of companies rises and then falls re- quires a model too complicated for this book, we can at least explore the de- cision to enter a market and the determination of how many sellers there are once all of the entry and exit settles down.
5.3 Asymmetric Games 131
Consider a new market that has just opened up—for example, the online book market in the mid-1990s. (Amazon.com began selling books online in July 1995.) Assume that there are five firms that might enter the market; let us uncreatively label them companies 1, 2, 3, 4, and Jeff (okay, actually 5). To operate in this mar- ket, a firm must incur the cost of entry, which you can think of as the cost of cre- ating a website, putting together a fulfillment structure, and advertising the site.
FIGURE 5.7 B2B Online Exchanges, 1993–2004 N
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0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Years
FIGURE 5.8 Automobile Manufacturers, 1895–1938
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0 1895 1900 1905 1910 1915 1920
Years 1925 1930 1935 1940
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132 CHAPTER 5: STABLE PLAY: NASH EQUILIBRIA IN DISCRETE n-PLAYER GAMES
As shown in TABLE 5.4, the prospective entrants face different costs of entry. Company 1 is the most efficient, in that its entry cost is only 100,* while company 5 is the least efficient, with an entry cost of 210. A company may have a lower entry cost because the owner can do his own programming or the company is a subsidiary to a conventional retailer (like bn.com, which entered as part of Barnes & Noble), allowing it to draw on some of the fulfillment technology already in place.
Having described the cost of entry, let’s now consider the benefit of entering the market. Each retailer anticipates earning a profit upon entry. However, that profit is lower when there are more com- peting sites. Assume that all retailers would earn the same gross
profit (i.e., the profit before netting out the cost of entry). TABLE 5.5 reports the gross profit that each would earn and shows how it depends on how many retailers there are. If only one company enters the market, then that company has a monopoly (“mono” from Latin for “alone” or “single”) and earns a profit of 1,000. If, instead, two companies enter (so that we have a duopoly), then each earns 400. Note that total industry profit has declined from 1,000 to 800 with the pres- ence of a second retailer. This is because, not only do two retailers have to share the market, but competing for con- sumers will lead them to reduce their prices and, with it, their profit. If there are three retailers (a “triopoly”), then each company earns 250, and so forth.
As these firms simultaneously decide whether to enter the market, each company’s strategy set is composed of enter and do not enter. A company’s pay- off is zero if it does not enter and is its net profit (gross profit minus the cost of entry) if it enters. For example, if company 2 enters and, say, two other com- panies enter, then company 2’s payoff is Using the informa- tion in Tables 5.4 and 5.5, TABLE 5.6 reports the various payoffs.
Note that no strategy is strictly dominated, although, for company 1, enter weakly dominates do not enter. The former strategy delivers a strictly higher payoff when three or fewer other companies enter and the same payoff when
90(� 250 � 160).
*Never mind the units—they could be thousands of dollars, millions of shekels, billions of lekë.