The manager of a firm is considering the possibility of entering a new market, where there is only one other firm operating. The manager’s decision will be based on the profitability of the market, which in turn heavily depends on how the incumbent firm will react to the entry. The incumbent firm could be accommodating and let the entrant grab his share of the market or she could respond aggressively, meeting the entrant with a cut-throat price war. Another factor that affects the revenue stream is the investment level of the entering firm. The manager of the firm may invest to the latest technology and lower his operating costs (low cost case) or he may
go ahead with the existing technology and have higher operating costs (high cost case). The manager estimates that if his firm enters the market and the incumbent reacts aggressively, the total losses will be $7 million in low cost case and $10 million in high cost case. If the incumbent accommodates, however, the firm will enjoy a profit of $6 million in low cost case and $4 million in high cost case.
Given that the incumbent will act in their own best interest, what should the manager of the firm do?