Mergers, Innovation, and Entry-Exit Dynamics: Consolidation of the Hard Disk Drive Industry, 1996—2015 Mitsuru Igamiy Kosuke Uetakez July 28, 2016 Abstract How far should an industry be allowed to consolidate when competition and inno- vation are endogenous? We extend Rust’s(1987) framework to incorporate a stochas- tically alternating-move game of dynamic oligopoly, and estimate it using data from the hard disk drive industry, in which a dozen global players consolidated into only three in the last 20 years. We find plateau-shaped equilibrium relationships between competition and innovation, with systematic heterogeneity across time and productiv- ity. Our counterfactual simulations suggest the optimal policy should stop mergers when five or fewer firms exist, highlighting a dynamic welfare tradeoff between ex-post pro-competitive effects and ex-ante value-destruction side effects. Keywords: Antitrust, Competition and innovation, Dynamic oligopoly, Dynamic wel- fare tradeoff, Entry and exit, Horizontal mergers, Industry consolidation. JEL classifications: L13, L41, L63, O31. For comments, we thank John Rust, Paul Ellickson, April Franco, Joshua Gans, and Allan Collard- Wexler, who discussed earlier versions of the paper, as well as participants at various seminars and con- ferences. For inside stories and insights, we thank Jeff Burke, Tu Chen, Finis Conner, MyungChan Jeong, Peter Knight, Currie Munce, Reggie Murray, Orie Shelef, and Lawrence Wu, as well as Mark Geenen and his team at TRENDFOCUS, including John Chen, Don Jeanette, John Kim, and Tim Luehmann. Financial support from the Yale Center for Customer Insights is gratefully acknowledged. yYale Department of Economics. E-mail:
[email protected]. zYale School of Management.