Question

An incumbent firm is considering expanding its capacity. It can do so in one of two ways. It can purchase fungible, general purpose equipment and machinery that can be resold at close to its original value. Or it can invest in highly specialized machinery that, once it is put in place, has virtually no salvage value. Assuming that each choice results in the same production costs once installed, under which choice is the incumbent likely to encounter a greater likelihood of entry and why?

Answer 1

Investment can deter entry only when it is more understandable,visible and irreversible. Investment of significant amount in highly specialised asset yields a high commitment value as it has no other use. Exit barrier is increased when an investment by a firm has no outside option. Incentives for the firm can be reduced by exit barriers and the firms would stop producing if they had known about the prevailing conditions with certainty they would not have entered in the first place.During poor industry conditions it is given that the firms are less likely to exit, industry downfall leads to lower overall profits and entry seems less attractive the firms finds it profitable to redeploy their assets to various other uses. The firm has no other option than to utilise the plant as it has been built in its particular industry. So the competition behaves less aggressively and therefore the firm invests in fungible asset as there is a greater likelihood that entry would not be deterred