Entry and Acquisitions in Software Markets

How do acquisitions of young, innovative, venture capital-funded firms (startups) affect firms’ incentives to enter a market? In the paper presented in this ZEW Research Seminar, the author creates a product-level dataset of enterprise software, and uses textual analysis to identify competing firms. Motivated by new stylized facts on startup acquisitions in software, she builds and estimates a dynamic model of startups’ entry decisions in the face of these acquisitions. In the model, acquisitions can affect returns to entry (1) by affecting market structure, and (2) by providing an entry-for-buyout incentive to potential entrants. Using the parameter estimates, the author simulates how startup entry would evolve over time if merger control was tightened. The simulations reveal that, if all startup acquisitions were blocked, entry would decline on the order of 8-20% in some markets. In contrast, she finds suggestive evidence that blocking mergers between established industry players and more mature startups might increase entry. These findings indicate that case-by-case merger review can best foster sustained startup entry.