Dominant firms and their alleged decline

Intemational Journal of Industrial 0

AlexisJACQIJ

There exists a long tradition in industrial organization thinking which argues that ‘dominant firms’ are unlikely to emerge from market processes and, more fundamentally, that if they do so, they will nevertheless rapidly decline and disappear. This survey examine: this proposition critically using recently developed mod& in which the ordering of movement in the market is crucial. It is found that the traditional argument involves a rather awkward conceptual&&on of ‘dominance’ and narrow conceptualizations of feasible strategic behaviour. By contrast, the exploration particularly of nonprice strategies open to firms in situations where there is some ordering of movement or lags in response suggests good reasons for expecting dominant firms to emerge and persist. A central fature of the argument that follows is the view that much of the variation in the outcome of market competition between rivals springs from variations in ‘initial conditions’ which, in turn, arise from strategic choices made in antecedent ‘games’ such as R&D, investment, location choice, and so on. Focusing attention on such ‘pre-play’ (i.e., all strategic manoeuvering prior to final output choice) enables one to endogenize (to some extent) the This research developed from joint work initiated with D. Encaoua whose contributions to of the sub&x2 have made themselves felt throughout this paper. We are obliged to H. Ergas, B. Ma&xi, E. Mansfield, P. Stoneman and A. Ulph for advice and conversation; useful remarks on an early draft were received with thanks from J. Cubbin, S. Sha&r, D. Mueller, . Waterson, and the ubiquitous A. Referee.The usual disc1 our understanding

0167-7187/84/$3.00 0 1984, Elsevier Science Publishers B.V. (No

and)

2

P.A. Geroski and A. Jaapemin,

Dominant ,‘irms’ alleged decline

initial conditions of the output game, and this has the happy effect of revealing the hidden strength of a number s-f conventionally made assumptions. One assumption of this sort which plays n important role in urn01 et al. many arguments [e.g., those of contestability theory; see of efficient (1982)] is the notion that there is always an infinite num he slightest deviation from zero profits. If, entrants waiting to p0UUCe be the case, one analyses the decisions rather than simply assumin by economic agents to joi

ueue (or not) and attempt entry in some

finds that the ‘infinite queue’ conin special cases (i.e., anly in certain generally, symmetric solutions involving considered as reasonable. Further, since initial conditions of output choice come wider sense of a sequence of inter-linked games, competition will take e form of a ‘race’ at one stage for a prize f subsequent stages. This points to the which afkcts the importance of a ‘racing order’ in determining the performance of markets, and one implication of analysing strategic positioning in such terms is that it

particular industry, one ceptualization is only rea

becomes diEcult to imq$me a conventional price leader as a dominant firm. At a somewhat broader lev& we emerge from this discussion with a point of view counter to that of the new ‘Neoclassical Institutional Economics’ which views outcomes as being generated by utility maximising agents overcoming transactions costs and other environmental annoyances, in the process creating various institutions to nelp handle such ‘market failures’ [e.g., di Alessi (1983) for a recent survey]. Applied to firms, that viewpoint sees firm size as an optimal xsponse to a somewhat untidy environment, and its persistence as the result of continuing successful adaptation to the vagari f a less than perfectly functioning market [e.g., Williamson (1975, that emerges born this survey environment in Q strategic fashion (in part faced by rivals) and there is sponses will be socially efficient arris and Mueller (1980)]. sider what a dominant firm is, where the source of its power lies, and how it can translate such advantages into a persistently dominant pos ion. In section 3, we shall digress somewhat from the main line of argument to analyse the process generating players. Part of any coherent story e arrival of entrants is a theory of who the first mover is, so this is equally a theory of the origins of dominance as of the seeds of its possible decline. Section 4 addresses itself looking at how d&rent explicitly to the persistence of do nance argment, tYPes of entrant mhd processes affect strategic competition and its long-run consequences. !%ncewe find ence not to be an unlikely event and since,

as mentioned above, there is very

competition t0 explicitly at licks with a few remarks on this subject in sectio 2

of

Dominance is a power relation dominator restricts the actions of the do ture of the game in his own interest.” spring from some asymmetry between (1960)] we focus on the ability of a firm to preco position which narrows the range of re ability to commit when one’s rival cannot a ‘differ advantage’ hereafter DMA; it might also be called a ‘pie-entry asymmetry advantage’ following Salop (1979a, p. 335)]. It is the ability to c resources which buttress the (implicit) threats characteristic of any rivalrous bargaining situation [such threats being a course of action condition what following players do; see Schelling (1960, especially p. 124)]. Such precommitments naturally take the character of investments ch alter the initial conditions of the game that commences when the D has expired and challengers arrive, giving the dominant firm ‘absolute cost’, ‘pr differentiation’ and ‘economies of scale’ barriers to entry and mobility (1956)]. In looking at games in which the order of movement is important, it is worth stressing that dominance ought not necessariIy to be equated with first movement, i.e., that certain types of games give for’ioweradvantages anld not jirst nwxment advantages [e.g., Baldwin and Childs (1969)]. Games with first movement advantages are those which numw the choice open to the follower, while games with follower advantages involve movement by the first firm which expands the choice set of the second mover. Examples of the latter occur when early movement creates a non-exclusionary public good for subsequent movers, and in such gaqes the ability to post one movement or force another firm to go firs! is the source Mence, a dominant firm (hereafter DF) able (in a situation in vvhich it is not indifferent to *beingthe first or secon ove accord@ to its preferences and exploit t at advantage through commitments w the choices open to rivals relative to what they would ‘The measurement of power should naturally concentrate on this expansion or contraction of rivals’ strategy spaces or their payoffs. If, without a dominant firm, some firm Ts choice set is Fi, while under pi dominant firm its choice set is Ri cFi, then the extent of power assymetry is reflected by the complement of Ri in Fi. Alternatively, If the highest returns that i could earn with and without a dominant firm were Ri 5Fi respectively, then (Fi - Ri) is a natural measure of the constraints imposed in being dominated.

P.A. Geroski and A. Jacquemin, Dominants

al

decline

differential movement advantages had existed. Lei ‘uscompare this notion to other possible definitions. One can, of course, define a DF in terms of SQ~ specific advantage (such as control of a natural resource base, a distribution network, a patent, and so on); this is perfectly consistent with our definition when one realises that such advantages could only have come ffom a D ts to such advantages. ame which allocates the property ss satisfactory is the ratker common dominance in terms of relative firm size [e,g., Scherer (1 % or more of its industry output’ as a trite F is likely to achieve a larger market sh (relative to what it would have gotten absent a DMA aud assenting that achievement of dominance does not affect a &III’s goals by, for YUII~~~, making it more risk averse) and so defining dominar x in terms of size is to define it in terms of one of its likely consequences. n of a DF is in terms of a particular sort 1952), Worcester (1957), neral discussion and alte about price leadershi see Scherer (1980, pp. 176-184), M er (1957, p. 388) writes: ‘.. . the dominant firm Lanzillotti (1958)]. situation is one in e p&e leader has control over the industry price and its own output, but not over rivals’ output. The Dominant Firm behaves passively in regard to the output of small firms . . . (isolating) its own demand curve by subtracting from the industry demand curve the estimated total quantity supplied by all rivals at each price.. .’ Such a situation tiught to be contrasted with barometrie and collusive price leadership in hich the burdens of restricting output are shouldered by all firms; indeed, it is clear that the price leader in this model would rather that someone else took the leadership, although he prefers a situation in which there is at least one leader to one where no leaders produce a Coumot-Nash equilibrium [Ono (1981), Friedman (1977, p. 80) also notes the problem of who will be leader]. The problem with calling such a price leader ‘the dominant Erm’ is that, while it appears to be in a position of power because it knows the reaction function of rivals, it is actually the follower who has the less constrained choice; the desirable position of followership is ths fruit of successful exploitation of a DMA in pre-play in which firms ‘choose’reaction functions, and it is the price leader who lost the commitment race. To paraphrase Schelling (1960, p. 23): price leadership is ‘an unprofitable distinction evaded by the apparent follower and assumed perforce by the apparent leader’.2 2The empirical literataure [e.g., Scherer (1980, pp.M-56), Pascoe and Weiss (1983), Caves et al. ueller (1977,1982)] on the persistence of large lirms is not ideally constructed‘ to cast light on our de&&ion of persistence, interesting as it is in other respects. It tends o sufkr somewhat by cl ’ * to test the decline of price leaders using relative or size as a criterion for id g price leadership, but this is by no means the only interpretation one can put on these numbers.

persistence of power is inex to its successful exe natural to say that a position of dominance persists (or is sustain

generates for the Grm a

prepare tfi~edefat of firm 3, by manipulating its arrival time and/or the initial conditions of the game it will play. The most obvious fashion in which this can occur is if the defeat of firm 2 discourages firm 3. Labelling matters because a situation in which some &m i ‘wins’ in T, T+l, T+2,... is difkrent from a situation in which a single dif&rent firm wins each time. The basic method of ensuring persistence is to make a commitment [see Salop (1979a,b, 1981), Dixit (1982), Spence (198la), Encaoua et al. (1983)]; its force depends both on the context of the game, the nature of rivals, and on the precise ‘interdependence of expectations’: ‘the game of strategy.. .is a behaviour situation in which each player’s best choice of action depends on the action he expects the other to take, which he knows depends, in turn, on the other’s expectations of his own’ [Schelling (1960, p. 86)]. In the context of a e~rtuin environment with rational opponents, the making of commitments is relatively straightforward (at least conceptually), for in this case the leader can compute the challenger’s best reply contingent on his commitment decision clearly, and so can make the mQst advantageous commitment choice. Such a commitment, to be credible, must be irreversible, locking the leader into ‘a course of reaction’ vis-&is moves of the challenger. Since irreversibility is not an inherent characteristic of investments, the degree of irreversibility is a expectation by the challenger that, no retreat from the position taken. In the context of ts that assumes great time, AT, in which a co osec! by firm 2 a e. interdependence of ex

6

P.A. Geroski and A. Jacqumin, Dominant jhd

ddine

emptied of much of its character and force with certainty and rational opponents. In more realistic game contexts where

Is’ conditional behaviour is not easily predicted, ir *lit and slow, the great problem with commitmen p=c&ed to have force. It would balance of power a muddy the waters initiatives taken by the DE’.Any st rival to attempt commi which two firms are locked into mutually incompatible other hand, entry deterrence in an unce y deterring behaviour will be ex the probability (perceived by rivals) that post optimal is rai&, it does not actually have to be ex The point is that the more like a straight race the co the easier the exercise of leadership and the more sustainable is the resulting position of dominance. Between t o ident& firms in conditions of complete certainty the commitment process takes the form of a straight no&andicap race, and so a DMA naturally has the dimension of time - a heodstart, If the race can be run at different speeds [because’of timHost trade-offs or adjustment costs: see Scherer (1967), Penrose (1959), Eisner and Strotz (1963), Nickel1 j1978, ch. 3)], then a DMA &es two dimensions - initial head-start and speed or acceleration aqmnetiies (in the limit one firm can run faster than the: other, there need be no race at all).4 there is uncertainty, it is often not clear when the race began or what it exactly consists of, and here a DMA can occur deqite the lack of a headstart, and perhaps despite higher acceleration costs. Ir such contexts, it is perception asymmetriesthat count, although, in a wider dimension, these too can be thought of as a headstart? There are a number of types of commitzent available to DFs to turn a DMA into profitable and persistent preerlption, and they may be most %is is stmsed by &helling (1960, chs. 2, 4B5) and i ; an interesting feature of receat worlc on bargaining [see Crawford (1982)]. Note that with both %mscommitted to a market in a tie, the no-gain game of conflict is liable to be replaced by a mare accommodating game of cooperation and this completely undermines the notion of credible exclusionary commitments, for the rules e would now be to cooperate w th any en&a t who manages to make a commitment. If tments can be entered into seq~entia!ly (e.g. the development of a new product in discrete stages), then the race can be run with continuous monitoring 01 relative possibility th.;ata ‘fast second’ strategy will be Edopted a small rival does); the basis of this advantage is its ensive experience in similar areas. ‘If this hapms with

financial problems con

or Comanor and

such credible c

economies, creates conditions of crow

8

P.A. Geroski and A. hquewin,

Dominanz jhs’

deged

&dine

in his existing crowded location relative to ‘squeepng over’ and sting the entrant. The higher the proportion of such fixed costs the belief by an entrant that the , the more reasonable 1 noa move and hence e more credible is the incum commitment to its niche. c investment Qn the cost side, much the most commomy di Dixit (1979, is investment in capacity t and Harris (1983), 1980),Spence (1979), Fud on and Lipsey (1980, 1981),Kirman and Masson (1980)]. ice, what makes such commitments credible is the extent 01 and Willig (1981), Grossman (1981); see to which they are sunk notions of exit barriers, Caves and Porter also, for the not unrel (1976,1977) and Eaton and Lipsey (1980); on the reasonableness of entrants’ wnjectures reg capital tieversibility, see Baumol et al. (1982, pp. 296 ds on their product specificity, the existence of second301)]pand this tenance costs, PO the extent that they are hand markets, and so on. at the owner’s discretion, undermine the necessary and made volun irreversibihiy of the commitment. Other strategies aim at changing cost functions by technical research, learning, and various input market strategies. To be a credible deterrent, the aclmentation of knowledge which a DF ec bodies in cost functions must be bo ,.&appropriable and perceived by rivals (who must appreciate its effects on their decisions), and since it is dBicult to imagine these two conditions frequently being satisfied, one is naturally drawn towards patents which do satisfy those two conditions [Gilbert (1981), Gilbert and Newberry (1982), Fudenberg et al. (1983); see also the critical remarks of Scherer (1981)]. In a world of certainty and perfect observation, learning [Spence (1981b), Gilbert and Harris (1981), Hall (1982), Lee (1975), Porter (1981); see also investment in R&D in conditions where ‘success breeds success9,e.g., Grabowski (1968), Phillips (1971)] is a somewhat artificial notion; in the context of uncertainty it may be as much a question of reputation as of substantial achievement in lowering costs which deters competitors? More generally, there is a broad range of non-price policies and input market strategies (including vertical ation and contractual commitments)s which can be used to create cost s. oneU&t naturallyask whether learning is important txzause the Boston consdthg Group (1972) has widely pubkizedand popularized the notion, or because it is actually an important of new technology [if, of course, it is important iirm enjo_yinglearning by doing and one preten context, only be apparent to another firm using rence between pretence and reality is liable to be perceived clearly only by well established firms in technologically stable or mature industries, Which is to say that the reputation of having learned is probably enough to acts are only crtible when the party holding the contract restriction plus the dubious legality of many strategically bt on how important such contracts will

P.A. Getoski ad A. J

differentials in favour of a it is &ten relatively in

labour and mana and so on. The vario commitment to certain output levels by the firm, the generation of skilled workers willing to pass on knowledge cpiore and Doeringer (1972), Thuro (1975)], generslly higher wages, and increased job security. Rather more mutual common interest may be expected between large Ernts and their principai creditors, the large financial institutions who maintain a large st (and thus a lively interest) in the financial wellbeing of those to whom they are committed [Shepherd, (1975,1976)]. The poorer the market value of the collateral for their loans, and the more ‘sunk’ they are in existing firms, the less willing they will be to lend to high risk entry ventures which threaten the security of such commitments. Thus, we defined a DF as a firm which has access to a DMA which can be exploited by making some credible commitment which preempts rivals, and thus restricts the scope of their actions. In this context, initial asymmetries between firms in output games can be thought of naturally in terms of DMAs in an antecedent game. A DF persists if it can use its DMA against a sequel;= of would-be challengers, and it is clear that only certain weapons and certain game contexts will ensure such a result; in particular, the longer lived, more product specific the weapon, and the more like a straight race the commitment process actually is, the more likely is an initial position of dominance to persist. The process of creating a dominant position is summa&d in fig. 1. 3. The

of

37ers

Obviously the notion of a DMA is bound up in questions of s and, to make precise what this involves, it is worth in move structure’ from ‘symmetry in payoffs’ [see S The latter is a articular outcome of a game, g characterize situ ns where active players have ide symmetry in move structure can be taken to descri y active identical player which all firms arrive as

P.A. Gemski and A. hquemin,

Dominant firms’ alieged decline

P.A. Gerodti and A. Jacquemin, Dominant w

deged decline

11

same date. To understand the c iltext in which symmetry in move structure can appear, it’s ecessar-yto und d how players are attracted to markets. TQ be more precise, we conceive of the entry process (i.e., that process at each e f) as composed of three which generates e first place, agents must be attracted to the successive primal market, and be@ to seek the information necessary to make a challenge. This process we callsthe genetation ofpZaye~s fromagents and it summarizes the sending of s s from the market, the receiving and processing of such information by e agents, the arousal of interest, and the decision to respond to it through the initiation and collection of market specific information. At the end of this information processing stage, players face a second set of decisions; viz., if and, if so, how and when to attempt entry.g This translation of interested active players into active challengers we term the generation of trials porn players. With the onslaught of a challenger, the stories of static entry theory describe the generation of successjbl s from trials. The exploitation of DMAs affects the generation of outcomeq DMAs ‘hemselves arise from the prm generating trials. Evidentially, asymmetry in move structure arises in conditions of un&rtainty when there are several reasonable ways (ex ante) of perceiving and responding to signals; such Merences produce different evaluations by agents and players, and the action they take consequent on these will occur at different times and take somewhat different forms? To model the arrival and characteristics of players, then, involves looking at what happens at different stap in the entry process. The most important general observation to be made is that decisions made at the stage of player generation are quaiitatively different from those made at the trial stage, primarily because of the different types of uncertainty which characterize the different stages. en players know all that can reasonably be known about a market (save some residual uncertainty), they can be expected to form a trial decision on substantioely rational grounds; the decision to become a player is, however, a decision to follow a hunch, to collect information, and, above all, to decide to make a decision (about mounting a trial) later and, at ‘One of the obvious risks of mounting a trial is that other fbms may also be mounting a trial at the same time [Sherman and Wiiet (1 irao (l973), Kalish et al. (1978)], and this poses many problems. Suppose vironment and an infinite queue of players contemplating entry; suppose also that there is room only for one entrant in the market. In this case, it is diflicult to imagine an uilibrium in which just one player attempts entry, if the efforts of each interfere with those val aspirants, it is also diflicult to imagine successful entry occurring at all. Competition amongst would-be competitors would seem to involve (if possible) commitments to attempt an entry trial (a) under the threat posed by agents or not yet converted into players, and (b) in view of the threat posed by incumbents. ‘@Ihe literature on diffusion emphasizes the importance of asymmetry in move structure in practice; see (amongst others) Mansfield et al. (1977), Davies (1979), Nabseth and Ray (1974), Gort and Kkpper 82), Gort and Konakayama (1982), Stoneman (1983), Nelson (1981) and, on imitation costs, ansfield et al. (1981).

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P.A. Geroski and A.Jocquemin, Domimt @ms’ allaged decline

best, we can only expect agents to make procedurallyrationaldecisions [gee Simon (1978a,b)]. It is natural to think of such procedures as corporate spategjes, and to characterize entrants and their arrival tim in terms of one of several ex ante viable ‘corporate philosophies’ which determine information acquisition and evaluation procedures. PO some general remarks,see Spence (1981a), Porter (1980, 1981); Freeman (19% ch, 7) &cus~s various corporate strategies vi&vis innovation and shows clearly the effect of their adoption on an entry process.] Consider 'gr~ah oriented’ e generally take one of two generic forms: monitoring the strategies. pe and the market for corporate control if such strategies corporate are ‘acquisition oriented’, or monitoring basic scientific market developments if they are ‘internal growth oriented’. Clearly, the former strategy will never ir -olve entry (in the sense of Bain), since such corporate raiders enter industries only by taking over ongoing enterprises; the latter strategy involves earlier or later entry according, as the monitoring process stresses, innovation or imitation. Clearly, the existence of a variety of ante viable corporate strategies is liable to create DMAs; what is more, it is liable to bias the generation of players, creating forces which cause certain types of firms to go first and others to move later [Hines (1954), Farrar and Phillips (1959), Penrose (1959), Jacquemin (1967); see also Freeman (1974, ch. 5) on the characteristics of successful innovating hs]. This, in turn, implies that entry trials over time are unlikely to be independent. For example, if the trial generating process is such as to throw up less and less able players as time goes on, then all successful entries will be bunched into the early phases of the industry’s history and, much more importantly, a substantive preemptive commitment which successfully defeats early players will, perforce, defeat all subsequent players and ensure the persistence of a DF. By contrast, should the trail process throw up more and more able players over time, then preemption at any time Thas naturally only a limited life, and must be renewed in a more and more substantive form as time goes on? In any game where the order of movement is important, it is necessary to understand why the order takes the form it does, and whether the forces which ‘racing order’ also affect the characteristics of the ‘runners’ themse satisfactory explanation of ‘racing ordee-’must commence by examination of the decisions of agents to enter the race, and t the notion that agents will ‘choose’ to enter sequen important uncertainties in the market, and differing a to exploit them. “The first trial process described in the text might ark if the probability of perception of an opportunity were positively correlated to the ability to exploit it, so that the earliest trials come fkom the most alert and most able players. The second process (which gives rise to suspicion of follower advantages) co ch the more careMy and slowly a trial is prepared by a player, t ely to be; such effects are also liable to be assoc%tti with product Tilton (1969)-j.

It f0Ilows immediately that systematic ‘biases’ to order of mouemezk entrants wai al cost’ or 0utcQmesof only

At the simplest level, a D

t of in terms of the order

movememt and thus, as we have seen, as the outcome of a

generating process,I2 Whatever the details of that process particular cause of the DMA), it contains the seeds of dominance within its workings. To establish this, it is helpful to commence entry generating process which throws up identical players In particular, focus upon a situation in which a set of M equal chance to commit themselves to the market and suppose that the game is played under certainty. If the market is large enough to support several firms, then a Nash equilibrium in almost any antecedent commitment game will produce symmetric and probably perfectly co ve payoffs (depending, of course, on entry barriers) in the subsequent game Ce-ga, Grossman (1981)]. The reasoning is &ar: as there is no commitment involved in making commitments, all players make the same commitment at the same time and so enter the output game on an equal footing further, lack of obstacles to commitment plus Nash beliefs ensure that a sufficient number ultimately enter the output game and so render it relatively competitive. Suppose now that we allow the commitment game to put a natural limit on the numbersentering the output game; e.g., imagine it to be an R&D race with a winner-take-all outcome. Under conditions of certainty, Nash behaviour in choice of R&D programmes leads to matching behaviour and so to problems with the existence of equilibrium [Reinganum (1982, p. 687), Dasgupta and Stiglitz (198Oa,p. 9)]. The key to surmounting this existence problem is to assume wamien and Schwartz (1982, pp. 176-177)] ‘.. . that no one be assured of being first or at least tying for first’, and the simplest way to do this is to introduce technological uncertainty into the context of the game, i.e., to make the link between commitment and outcome of the ra stochastic and less than perfectly correlated across firms [the importance of 12Afurther and more subtle manner in which asymmetry in move

structure can be tran etries in into asymmetry in payoffs arises if the order of movement induces as conjectures and q~~Uons. This will occur if learning by observing’ is an important source of information to late-comers, for this enables early movers to mould their rivals’ expectations by appropriate actions.

14

P.A. Get&i

is stressed

and A. Jacq

in, Dominantfhs’

alleged decline

d Stiglitz (1980a)].13 The winner is, of course, sto&astic (the major question of interest thus being how the race was run)14 but is in no sense a DF: since the running of the race does not depend financial capability, and so on), there on any characteristics of the firm in some antecedent game, reduce the is no way a firm could, by playin tself of a favourable outcome? choices open to rivals and so ass is clear. When the context of the The implication of these n, then there will be many players ccmmitment and output games The entry generating process able to imitate each other and so the outcome of the entire throws up identical firms with n produce a DF. Even if there is some process will be competitive he commitment process, the fact that artificial limitation on the of any of the characteristics of the the running of the race is ind there is no restriction on players’ runners (or, alternative1y, the cteristics) ensures the dissipation of any abilities to acquire the necessary c commitment game. It is rents in the output game by tie then a matter of perfect ind8eren generating process As a benchmark, these stories which at bottom drives the resultsVcorresponds roughly to a situation in out and promptly received by which clear, unambiguous signals numerous agents who, guided by tb all act in much the same manner to acquire characteristics and mount entry trials. Naturally, they arrive simultaneously and are identical. There is simply no general workable alternative to this process in the literature; among various special cases, there are four types of DMAs that one might wish to distinguish. First is the case of a fixed jirst mwe in which one firm is allowed to go first and establish itself, and then all the others arrive (simultaneously) later when it is as fully established as it can be. This is the type of model characteristic of static entry theory, and it corresponds to a bias in the generation of players in which

by

Dasgupta

‘3Thiswould also occur if there were ‘u man and Rumelt (1982)]. For some models which mix first and generate a diffusion of innovation or invention dates, see Reingan Jensen (1982). Rao and Rutenberg (1979) consider a plant capacity stallation race, while Jdviulovic (1981) considers location decisions which reveal private ‘ws is in fact the driving force behind of the literature which has concentrated on ‘Schumpeterian’hypotheses about how the e f rivahy, the fixity of costs, the value of prixe, alterations in the degree of uncertainty, and affect the speed at which the race is run. See Scherer (1%7), Loury (1979) Lee and Wilde Reinganum (1981a, b), Dasgupta and Stiglitz (198Oa,b); for general surveys, see Dasgupta (1983) and Kamien and Schwartz (1982), the latter of which extensively discusses the older decision theoretic approach to this problem. “This applies to most of the work referenced in footnote 14. Scherer (1967) and Rao and Rutenberg (1979) are interesting exceptions. Scherer concludes that small firms may have an incentive to innovate while large ones have one to innovate Cpp.383-384; see also &mien and Schwartz (1982, pp. 137-140) for some r s along these lines], while Rao and Rutenberg of &vantages in their race fia with fims (1979) establish some presumption that t which have already achieved large size.

which one (or a sm they can establis potential players learn of the 0 itself, the fh-stmover attempt to reduce i technology, and so firm with a tied persistently as f;eu differentiation advan combination of these challengers at the privileged of these (it is clear why they would not all answered at the same time as the question of its persistence. The main conceptual problem with tied Ezt move D As lies in the implicit entry generating process. One Grm is allowed to move first and is also allowed to operate until such time as it can no longer improve its position (knotig that eventually it will be challenged), a covering is cast off the market and all agents potentially simultaneously alerted and approached. What is particularly weird in this story is that there is no potential competition during the commitment process. The simplest extension to consider is a fixed sepnce of ar~&rolsin which one player ‘per period’ arrives to mount a trial. To be course, the rate of arrival of players must be more rapid than the speed at which initial entrants try to pre-empt the market;;’ natural preemptive weapons include location or product choice may (WE), Prescott and Visscher (1977), Lane (1980)] or capacity [Spence (1979)]. Rather than on instantaneous diffusion of information about market opportunities after the initial firm has established itself this entry generating process rests on a continuous &ffusion at a constant rate from the outset. As before, the character of the diffusion process is entirely independent of the actions of the DF, and so competition still takes the form of a straight race with exogenously determined handicaps; whether or not an early firm achieves a position of dominance is in some sense a matter of good luck or alertness at the birth of the market, and there is very little strategic skill involved in establishing as dominant a position as the exogenous handicaps allow. The somewhat richer potential of this model lies in the notion that, since different arrival &es must spring from asymmetries amongst agenti and their ability to perceive market opportunities, then it is clearly reasonable to suppose some systematic differences in the characteristics of the players who, period by period, come to mount a challenge. In this latter case, whether and how ‘6These modelsusuallyartiiicially constrain the extent to which a first mover can (e.g., confine it to one plant or to one location) and then trace the orderly filling up of space; Prescott and Visscher (1977, sect. 3) are fairly clear on this point, and the problems it raises.

16

P.A. Geroski and A. Jacpemin, Dominantfirms’ alleged decline

long a dominant position persists depends on this variation in challengers’ characteristics. 0th preceding two D As ultimately spring from an asymmetry in the yers; and they stand in perception and acting upon of opportunities s. However, some of the clear contrast to models where there are no models discussed in the beginning of this section also had a second characteristic and that was that the ability to run the race was astamed not to depend on any characteristic of the runners. This is, of course, not a difficult assumption to remove, and one particularly simple extension involves what might be called an implicit first mover DMA in which the entry generating process is such that no lags of information about or response to new events occur, and the only diEeience between the firms is that one is an incumbent. It does not matter whether that incumbency is the stochastic outcome of some prior move or not (and hence the fixed first move is implicit) or whether the incumbent is more efficient in any sense; what matters is that some exogenous change occurs to allow a second firm to enter an adjacent market (the original market is as safe as it was before). If post-entry profits are less than the joint maximum, the simple fact of incumbency gives t!ie initial firm an incentive to pre-empt because the incumbent’s loss (monopoly profits less its share of the duopoly joint profits) in the event of entry exceeds the payoff to the successful entrant when monopoly profits exceed duopoly joint profits [Eaton and Lipsey (1979), Schmalensee (1978), Gilbert (1981), Gilbert and Newberry (1982), Salop (1979a, 1981)]. It is a DF because its exogenously protected original market restricts subsequent rivals’ choices. Of course we need not invoke such strong assumptions; a very related kind of result can emerge from very different kinds of considerations. Suppose now that the entry generating process is such that any exogenous changes or developments in the market area are most easily perceived by an incumbent, but that no part of the market is necessarily safe after entry. Once again, pre-emption by the incumbent is likely, and it is based on the implicit first move which originally established it in the market (whatever character it might have taken); now, however, the result hinges entirely on endogenous differences in perception by agents. In all the entry processes thus far discussed, DFs play .essentially a game against nature, since their acti lay no role except in the process of converting trials into outcomes. e there are no doubt many situations in which pre-commitment is this s much more interesting is the case where actual exploitation of a attracts agents, giving them the information to convert themselves into players and to mount effective trials re incumbents are ready. It is natural to consider such a to be one with an endogenous sequence of arrivals. The basic problem raised in such models is to analyse what kinds of signals can be expected to attract the attention. of agents [see Caves and Porter (1977), for

P.A. Gem-ski

1

price-cost margins, the other si

is static or growing [e.g., Ireland (1972)] and as long as the price lead& enjoys no cost advantages, the output of the competitive fringe will asymptotically approach total industry output, and the price leader declines. §ince this is the first argument we have encountered which suggests the decline of ‘dominant firms’, it is worth examinin g it closely. It contains two crippring weaknesses. The first problem lies in the linking of price leadership to dominance: it is not obvious how the dubious distinction ot bearing the entire burden of industry output restriction can be seen as a pse-emption which lessens the choice set open to rivals. The decline of the ~5ce P4er is thus no more than the disappearance of the already weak. 3%~ r;scond problem is that it is difficult to see how a firm restricted to x&g only price as a competitive weapon when there is cedainty and OS;lags in response to price can ever successfully pre-empt rivals. It is ck%z, kvi; zver, that weapons which create cost asymmetri~ product diEermtiatim zdvantages, or contexts in which scale economies are important [see RufEn (19X), Jacquemin (1972), Kamien and Schwartz (1979, Lee (19?5), de Bondt (19761, Encaoua and Jacquemin (198(I), Flaherty (1980), Norman and Nicholls (1982)] would all allow the price leader to exploit a DMA and persist despite its-handicap? For both reasons, it is hard to take such models as serious arguments for the decline of DFs.

“Encaoua et al. (1981) describe a model in which the priceleader eventually abandor;s his burden. The k~troduction of stochastic arrival dates does not seem to have altered the ese models much [see Kamiers and Schwartz ( 1971,1972,1975), conclusiofIs of !I975 1933), L&pan (1980)]. For general surveys of control theory applied to sxh models, see Jaapemh and Thisse (1972) and Leban and Lesoume (1982).

18

. Geroski and A. Jacq

A much more reaso able model in which profits act as a signal and attract pricing behaviour and tha: generation entrants would cou rtheir use in erecting e-emptive defenses against the entrants. le, that capacity is the weapon used to deft?nd a that such capacity increments must be self profits to fin== a s incentive to raise prices and reap .

omes an interes risk strategies and low profile strategies. means the clearest or only signal that co weak point in a DFs de be renewed [as for ex ments of Eaton and kipsey (1980, 1981)], for it is exactly this point an alert player can be e ed to attempt to nnount a trial [on a related theme, see Moran (197 r such critical times to be the subject to the -reception of and rapid response to certain entry trials requires eithe types of signals (such as e ordering of new equipment by the DF) or else the ability of potential entrants to wait patiently on the sidelines until a ’ weakness appears. Either way, there is a presumption that the DF will survive by mo g earlier than such entrants (with th r result that the market may characterized by excess capacity) part of these commitments are being renewed (for essentially the reasons discussed above). To summarize, it is faivly clear that the persistence of dominance is more assured the more exogenous and slow moving is the process generating entrants. There are a variety of ways of conceptualizing this, and we have considered here four classes of DMAs which (together with the case where no DMAs exist) illustrate this point, When DMAs are based on exogenous arrival processes, they are easy to exploit and a DF will be succes&l if the arrival rate is slow and if it has sufficient competitive weapons at hand en arrival rates are endogenous, DFs are constrained in the making of d the outcome depends on a myriad of factors ranging from als to the context of the game. In the limit when there are behaviour occurs at all, and so dominance very little strate ar. Any reasonable examination of actual markets reveals that there are many instruments at the disposal of a firm holding a DMA. It can m commitments which can only be liquidated gradually, it can sink industry or rivals arrive, and it an use non-p&e specific investments be uments (such as produc egration, ergers, and various contra tions. What is more, rfeCt i rmation pNil.riamson

s

is much

exa

uestions. A first prob

a second or third best efficient rules for policy makers interested inkciency and the temptation to throsr the baby out with the bath water is accordingly increased. The ability to improting’ irn a second or rationalize various restrictive practices 3s y providing Zlustrations or third best sense, and to cloud the general counter-examples of how different types of conduct can be ‘welfare improving’ in certain and more or less contrived situations seems frequently osticism. A second [email protected] is that to lead only to impotent policy the policy. problem raised by pockets of persistent cowrate power depends very much on the goa!s of such poIicy initiatives. We shoul r by discussing why the rsistence of dominance o antitrust activity even

en such dominance is

‘Wne prOi&lD we have not consider-xlhere is whether a singIe DF persist than a group of fmns cooperative behaviour among

and Porter (1977).

20

P.A. Gemski and A. Jacquemin,Dominantjhs’

allegeddecline

fined socially valuable sense. In particular, it seems of for antitrust is a classical affirmation of the of markets. That tradition emphasizes the of rivals freely operating in markets: it combines market power with a solid presumption that its will, in general, not increase welfare. The ned here shows the lac n economrc theory for the view that spontaneo s market forces infrequently that positions of power achieved, are no more than short-run phenomena. It seems to us, then, that this calls for a vigorous antitrust policy to be appd particularly to dominant Erms and their strategic behaviour in order to ensure the kind of results that Ereemarkets promise to produce in theory. If antitrust policy is to be vigorously applied to dominant firms, these must be identifiable. In U.S. courts, the word ‘dominance’ has no legal meaning since it is not used in antitrust statutes [for an analysis of the wOMon OfU.T.S. mtitmst km, see Fox (WO)]. In the language of the U.S. courts, the term dominance is often utilized to describe a company that is in a monopoly position within the meaning of Section II of the Sherman Act; as defined by the Supreme Court, this means having (U.S. v. Grinnell Corp., 1966)19L. the power to control market prices or exclude competition’. Most European le ation applies similar conceptions, using broad evaluations of the relative size and strength of competitors, the stability of factors such market position, the frequency of entry, and so on, to infer the existence of dominance [see Jacquemin and de Jong (1977, ch. 7)]. This appears to be at some disttice from our definition of dominance based on differential mover advantages. Such advantages are, however, extremely difficult to measure satisfactorily even with the benefit of hindsight, and, by consequence, one is left with very little option but to try to infer the nature and existence of such DMAs by their most likely consequencle~.This is a sensible scientific practice, for which there are well established S. Such ‘backward inference’ from consequences (like large, &et shares) to causes (such as differential movement advantages trategic practices of dubious or, at best, unclear welfare status) leads then naturally to the kinds of ready-made criteria now employed by the courts of various advanced “tiestem economies. In this sense, the notions that rsistent positions of dominance are strcrtegically created, and that there is no presumption that those firms who minimize the use of scare so&l ‘gCompare this to Kaysen and Turner (11965,p. 8): ‘When fkns can persistently behave over substantial periods of time in a manner which differs from the behaviour that the competitive titive firms facing similar cost and demand conditions, they can wer.’ This statement rightly places persistence in the centre that temporary moglopoly is of much less importance.

than defendants who, in any c8se, merely

resenrations to such work in order to answer the case p The reason for this lies in the limitation of poby to

application of backward Serence based on the kind of economic th proposed by K!=vorick and Joskow (197911 generally impede choice or the Mom to compete in markets without involving plaintiffswith the necessity of proving 9 direct loss of efEciency.21It then remains for defendants to prove, either that the cause of a large, stable market share is truly di&rent Corn that alleged, or to show the existence of some welfare improving mitigating circumstances.22 Whatever the presumption one adopts about the allocative effects of dominance, it is’ hard to accept conventional Pareto welfiue analyses as forming the sole basis for antitrust intervention. It is well hewn that ‘OTherecent wave of US literature on predatory pricing presents an illustration of the problem [Arceda and Turner (1975), Schcrer (1976), Wiin (1977b,1979), Ordover and wiuig (1981);for ovcimim& see Salop (1981) and Hay (1981)]. Several rules and standards have been prom for enabling the courts to distinguish between predatory and non-predatory exit inducing behavior, a variety of examples in which pqdatory pricing defined by some standard amongst doesnotrcducc~haveebeenproduced;andthusa~~lackofconsensus theorists uncertainties, given also the difliculty of obtaining relevant data, and that or intent from such data, some are tempted to conclude that the best rule is no rule at all leg., Easterbrook (1981)]. 21A strong statement along these lines can be found in Williamson (1975, p. 220), who argues that section 2 of the Sherman Act should be interpreted by the courts to require a !indiug that: ‘. . qcrsistent dominance is presumptively unlawful, provided only that the industry can be stage of development’. t a dominant firm charged with rebut the presumption of result of economies 0 monopoly, of the exercise of an unexpired paten& or of a contmumg management su@ority’. It should be added, however, that practices ought to be condemned.

22

P.A. Geroski and A. .lacquemin, Dominantfirm.4 alleged decline

achievement of efficiency is neither necessary nor sufficient as a criterion Of ideal policy. For example, it could be argued [see Hirshleifer (1976, p* 443)] that the question of the means by which the social outcomes are achieved is more important than the social allocation outcome itself: for many, an allocation that is ineflicient but arrived at in a spirit of voluntary cooperation under law is far better than an ideal allocation established by dictatorial decree.23 It is also the case that the Schumpeterian competition arguments which are a familiar part of antitrust defenses sit very unea~if~ t that reto-type welfare calculations. These two points t distribution and equity ought to loom large in policy decisions: do would-be entrepreneurs have equal or ‘fair’ access to the means ~eoes~aryto attempt a creative breakthrough? Do successful competitors in innovative processes have a ‘fair’ return for their efforts, or access to a Wr’ mechanism for determining rewards? Reinforcing this, it is the ease that distribution and equity issues dominate the evaluation of the consequences of whatever competitive process is under consideration both because market power affects the distribution of economic rewards [e.g., Comanor and Wiley (1975)] and because market power affects the decision of what to produe which must be evaluated vi&is consumer tastes [e.g., Marris and Mueller (198011.All of these would be important considerations even if creatively destructive competition involved a regular turnover of winners; when, however, small asymmetries can be solidified into dominant positions that persist, then the inequities they create become institutionalised, creating longterm problems in the performance of the economic system which cry out for policy attention. Thus, vigorous antitrust policy is a political choice and is justifiable pdy on those grounds. In our view, it ought to be based on the fairly uncontroversial presumptions that large pockets of private power in a position to perpetuate themselves without public control are fundamentally undemocratic and thus generally undesirable whatever the outcome. 23A counterpart in antitrust policy is the view olten adopted by the U.S. Supreme Court that the Congress desires to promote competition through a high degree of decentralization and a large population of independent lirms, even at the expense of occasional higher ~sts and prices. This is very much a matter of forming social preferencesdiiy on the distribution of output across firms, supplementing welfare views based on conventional welfare loss values. See also Cowling (1982) for an anti-merger policy argument based on the lack of democratic control of large DFs.

Ale&, I. di, 1983, Property rights, transaction costs and x-efficiency, American Economic Review 73,&t-81. Allen, B., 1982, Some stochastic processes of interdependent demand and technological diffusion of an innovation exhibiting externalities among adopters, International Economic Review 23, 595408.

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