Are start-Up acquisitions by dominant firms driving innovation or killing competition?

This paper develops a sequential model to examine start-up acquisitions in markets with network externalities, incorporating a pre-entry strategic buyout option that allows the incumbent to integrate the start-up's innovation, followed by post-entry expenditure on coordination advertising, and defensive pricing strategies. We introduce asymmetric advertising efficiency combined with a stochastic success function to show that incumbents can utilise buyouts as a strategic entry-deterrence mechanism. When a buyout occurs, dominant incumbents optimally integrate the acquired innovation to sell a superior product rather than executing a ‘killer acquisition’. Furthermore, our model demonstrates that strategic buyouts are most likely when start-ups face moderate entry costs but offer highly valuable innovations. If entry is accommodated, the incumbent's superior advertising efficiency grants it a strictly higher probability of securing the coordinated demand without requiring a larger advertising budget. Our findings suggest that an incumbent's ability to maintain market dominance is sensitive to the size of the fixed cost of entry and the strength of the network externality. While buyouts eliminate fixed entry costs and expenditure on coordination advertising, they prevent post-entry price competition, and the distinct utility consumers derive from product variety. Notably, we prove that the more dominant an incumbent is before an acquisition, the greater the technological upgrade it must provide for the buyout to be strictly welfare enhancing. Consequently, our findings provide strong theoretical support for expanded, case-by-case antitrust scrutiny of start-up acquisitions in markets with network externalities.