Divisionalization and Entry Deterrence

Abstract

This paper assumes that incumbent firms can create new independent divisions more cheaply than potential entrants, who must incur the additional overhead costs of new entry. The main theoretical result is that such divisionalization ability leads perfectly informed incumbents to preempt all rational entry into their industries. In contrast, existing models of entry deterrence imply that informed incumbents, even those with steadily decreasing average costs, will often allow rational entry. Our result may explain why successful, large-scale entry by firms with no informational advantage is extremely rare. The use of divisions to preempt entry may also explain why large firms in high-profit oligopolies often divisionalize, allowing their divisions to compete freely despite the negative pecuniary externality that each division imposes on others.

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