We investigate the entrant's dilemma created by penetration pricing. Penetration pricing is a common strategy where firms enter into a market with relatively low prices. Setting a low price offers several advantages for entrants. For example, beating competitor's prices reduces consumers' risk of trial and gives consumers a monetary incentive to switch brands (Blattberg andNeslin 1990). Low prices thus help entrants to gain a foothold in the market and to build scale, especially when demand is price elastic (Moore 1992). However, there are also drawbacks of low price market entry. Low prices send an obvious signal of aggressiveness and can pose a substantial threat to incumbent firms (e.g., Ailawadi, Lehmann, and Neslin 2001). Consequently, low entry prices likely trigger hostile pricing responses by incumbents (Leeflang and Wittink 1992).
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