Working Paper: NBER ID: w27146
Authors: Sai Krishna Kamepalli; Raghuram Rajan; Luigi Zingales
Abstract: Venture capitalists suggest that incumbent internet platforms create a kill zone around themselves, where any competing entrant is acquired quickly. Consequently, financing new startups becomes unprofitable. We construct a simple model that rationalizes the existence of a kill zone. The price at which an acquisition is done depends on the number of customers the entrant platform can attract if it remains independent, which in turn depends on the number of apps that have adapted to the platform. The prospect of a quick acquisition by the incumbent platform, however, reduces the app designers’ benefits from adaptation, making it harder for a technological superior entrant to acquire customers. This reduces the stand-alone price of the new entrant, decreasing the price at which they will be acquired, and thus reducing the incentives of VCs to finance their entry. We discuss the policy implications of this model.
Keywords: Venture Capital; Digital Platforms; Innovation; Acquisitions
JEL Codes: G31; G34; L41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expectation of acquisition (D84) | reduced adaptation by app designers (L15) |
| reduced adaptation by app designers (L15) | decreased customer attraction to the new platform (D16) |
| decreased customer attraction to the new platform (D16) | lower acquisition prices (G19) |
| expectation of acquisition (D84) | lower standalone market value for the new entrant (D41) |
| lower standalone market value for the new entrant (D41) | decreased acquisition price (G34) |
| decreased acquisition price (G34) | disincentivizes venture capitalists from financing new startups (G24) |