Competition within and across market positions: Strategic responses to entry threats

This paper unites the literature on market positions and competitive interactions to examine incumbent responses to the entry threat of a low-cost firm. We adapt a theoretical model of capacity expansion to show that the cost of the incumbent’s competitive response and the entrant’s cost of entry influence the incumbent’s response. We argue that both these costs vary with the prior choices (i.e., market positions) of incumbents and entrants. Using data on incumbent responses to entry threats from Southwest Airlines between 2003 and 2012, we find that: (1) full-service carriers expanded capacity while low-cost carriers avoided competition, and (2) full-service carriers expanded capacity less aggressively in markets that had less substitutive customer segments.