Academic journal article Journal of Business Strategies

The Value of Cheap-Talk and Costly Signals in Coordinating Market Entry Decisions

Academic journal article Journal of Business Strategies

The Value of Cheap-Talk and Costly Signals in Coordinating Market Entry Decisions

Article excerpt

Abstract

Signaling occurs when a firm attempts to indicate, truthfully or not, its intended course of action. Competitors often use signaling in market entry situations to coordinate actions, or possibly to deter entry by other firms. This paper examines the value of cheap talk and costly signaling in a large group market entry game. Eighty subjects, twenty in each of four groups, participated in a computer-controlled decision making experiment. After learning the capacity of the market, subjects were given an opportunity to signal their intentions to enter or stay out. Following feedback of aggregate signals, subjects were asked to estimate the aggregate number of entry decisions they anticipated. Following the estimation task, subjects had to decide whether or not to enter the market, which varied in size from trial to trial. Results suggest that when no cost was imposed on signals (cheap talk), players significantly exaggerated their intentions to enter the market. When signals were costly, signaling behavior was more consistent with subsequent entry decisions. Overall, however, neither cheap talk nor costly signaling had much effect on actual market coordination, and aggregate results generally are consistent with Nash equilibrium predictions. The study concludes with a discussion of insights for researchers and management practitioners. Title: The Value of Cheap-talk and Costly Signals in Coordinating Market Entry Decisions

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Decisions to enter or not to enter markets are among the most important strategic choices firms face. These decisions often involve significant investments of capital and human resources, and questions of market positioning, which some researchers view as the "essence of strategy" (Porter, 1996). Though the economic solution to the problem of market entry is often overly simplified, indicating that a risk-neutral, profit maximizing firm should base its entry decision on the net present value of expected profits (Oster, 1994), the strategy literature indicates there are countless ways a potential entrant might think about this type of decision and a myriad of variables or factors that may impact a firm's entry decision.

Given the diversity and inconsistency in market entry research, we have chosen to study a simple but fundamental problem that has not been addressed adequately in the literature: aggregate market entry coordination. Aggregate entry decisions that are coordinated poorly may result in situations of over-entry or under-entry. If over-entry occurs, the market may be served, but firms choosing entry face significant competitive pressures and lower profits. If under-entry takes place, the market may not be fully served, and firms choosing entry face negligible competition and higher profits. We also have chosen to study a factor that might affect aggregate market entry coordination: signaling.

Signaling occurs when a firm or decision maker attempts to indicate, truthfully or not, its intended course of action (Spence, 1974). Signals often manifest in market entry situations that involve strategic interdependence (Seale & Sundali, 1999)--where the outcomes or payoffs to the firm depend not only on its decision, but also on the decisions of its competitors. In these situations, signaling may be a valuable tool to either coordinate actions, or possibly to deter entry by other competitors. To be effective, signals, which may take the form of verbal or written communication, or overt action, must be easily observable and made well in advance of the decisions and actions of rival firms.

Firms routinely make market entry decisions, decide between types of signaling activities, and attempt to interpret the signals they receive from their competitors. Considering this iterative process, several research questions are paramount. First. do decision makers use signaling, and, if so, do they use it strategically or truthfully? Second, how do decision makers interpret and use the signals made by competitors? …

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