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

This paper examines conditions under which one firm’s product-line expansion can cause all firms to be more profitable in horizontally-differentiated markets. While one may expect that a firm’s profits would 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. We first provide an example using the Hotelling model that demonstrates the possibility and mechanism of profit-increasing competitor entry. We then present conditions under which a competitor’s product-line expansion increases profits under the mixed-logit model. We find 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 of the rival’s products appeal to similar sets of customers. As extensions, we demonstrate 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.