Proliferation and Entry Deterrence in Vertically Differentiated Markets

We examine the profitability, entry deterrence and welfare effects of
proliferation offered by non-cooperative firms competing in quality and price. In
a market of one high quality firm and competitive low quality firms, we find that
the established high quality firm will not initiate proliferation but may have an
incentive to do so if facing entry threats. The proliferation quality is
endogenously determined and the industry profit decreases with such
proliferation. Moreover, we show that proliferation increases consumer surplus
in the same way as entry does. That is, while proliferation to deter entry is anticompetitive, it is not necessarily welfare-reducing.