Fixed costs, market power and revenue shares of the asymmetric firms

A startup firm often worries that entry into an industry with incumbents having power in both the input and output markets guarantees no success for its investments. I analyze how firms’ asymmetries, on the basis of the residual demand for their outputs, fixed demand-increasing costs and power in the input market, affect their revenue shares. Results are counterintuitive in that the incumbent firms’ market power in both the input and output markets can go against their revenue shares. The reason is that the profit-maximizing incumbents buy inputs at low prices but sell at high oligopolistic prices; this will entice the entry of new firms benefitting from (or paying just a little above) the low oligopsonistic input price and selling its differentiated products at a more competitive (i.e., lower than oligopolistic) price. The revenue share of a new entrant increases with (1) the ratio of its own fixed cost to the incumbents’ fixed cost, (2) the ratio of the price elasticity of its residual demand to that of the incumbents, and (3) the interaction between the incumbents’ level of market power in the input market, and the ratio of their variable costs to their fixed costs. Trade analyses of US import demand for semi-processed cocoa and coffee provide evidence supporting these findings. The main implications are that the incumbents’ double market power is a blessing in disguise for a new entrant and that the new entrant can differentiate its product and expand its revenue share by investing in fixed demand-increasing costs.