Working Paper: CEPR ID: DP14709
Authors: Luigi Zingales; Sai Krishna Kamepalli; Raghuram G. Rajan
Abstract: We study why acquisitions of entrant firms by an incumbent can deter innovation and entry in the digital platform industry, where there are strong network externalities and some customers face switching costs. A high probability of an acquisition induces some potential early adopters to wait for the entrant's product to be integrated into the incumbent's product instead of switching to the entrant. Because of this, the incumbent is able to acquire the entrant for a lower price. Even if the incumbent platform does not undertake any traditional anti-competitive action, the reduction in prospective payoffs to entrants creates a “kill zone” in the space of startups, as described by venture capitalists, where entry is hard to finance. The drop-off in venture capital investment in startups in sectors where Facebook and Google make major acquisitions suggests this is more than just a theoretical possibility.
Keywords: digital platforms; acquisitions; kill zone
JEL Codes: G34; G31; L41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Prohibiting acquisitions (G34) | Enhance innovation (O35) |
| Acquisitions by incumbents (G34) | Deter innovation (O39) |
| Acquisitions by incumbents (G34) | Create a 'kill zone' for startups (L26) |
| Creation of a 'kill zone' (H56) | Reduced investment opportunities for potential entrants (L19) |
| Expectation of acquisition (D84) | Reduces app designers' incentives to adopt new platforms (D49) |
| Reduced incentives to adopt new platforms (L15) | Diminishes likelihood of customer adoption (L15) |