Incumbent Repositioning Against Entry in a Vertically Differentiated Market

This paper presents an analytical model to elucidate the incumbent’s optimal strategy on “vertical repositioning” as a countermeasure against entry. A vertically differentiated market is considered: An entrant establishes its product quality upon entry while incurring quality-establishing costs, and then the incumbent responds by adjusting—increasing or decreasing—its product quality from the original one while bearing some repositioning costs: quality-adjusting costs. Analyses show that the incumbent’s optimal vertical repositioning strategy is determined not only by its initial quality level but also by the cost differential in establishing and adjusting product quality in comparison to the entrant. Results provide the following insights into the dynamic vertical (re)positioning competition: First, an increase in the repositioning costs leads to a decrease in product differentiation (quality difference) between competing firms, which can harm not only the incumbent itself but also the entrant, and ultimately can deter the entry itself. Thus, sufficiently high repositioning costs can serve as an entry-deterrence device. Second, the incumbent would prefer competition of a superior entrant with low costs (if entry is unavoidable), as this can significantly increase vertical product differentiation to benefit the inferior incumbent. Third, higher repositioning costs in reducing the product quality—downward inflexibility—can function as a commitment device for the incumbent to secure a more profitable position by hindering the entrant from challenging the superior position.