Seeking an Expanding Competitor: How Product Line Expansion Can Increase All Firms' Profits

Abstract

The author examines conditions under which one firm's product line expansion can cause all firms to be more profitable in horizontally differentiated markets. Although a firm's profits might be expected to decrease when a competitor expands its product line because the firm loses some sales to the new product, this intuition is incomplete because a competitor's product line expansion can also soften price competition. The author first provides an example using the Hotelling model that demonstrates the possibility and mechanism of profit-increasing competitor entry. He then presents conditions under which a competitor's product line expansion increases profits under the mixed-logit model. The study demonstrates that firms benefit from a rival's entry most when a moderate number of customers are unserved before the new-product introduction and when the new product is positioned such that both the rivals' products appeal to similar sets of customers. With regard to extensions, this study demonstrates that the result continues to hold when firms choose product attributes endogenously and that a manufacturer's profits can increase from a rival's product line expansion even when the firms sell through a retailer.