We study why high-priced acquisitions of entrants by an incumbent do not necessarily stimulate more innovation and entry in an industry (like that of digital platforms) where customers face switching costs and enjoy network externalities. The prospect of an acquisition by the incumbent platform undermines early adoption by customers, reducing prospective payoffs to new entrants. This creates a “kill zone” in the space of startups, as described by venture capitalists, where new ventures are not worth funding. Evidence from changes in investment in startups by venture capitalists after major acquisitions by Facebook and Google suggests this is more than a mere theoretical possibility.
Rajan acknowledges support from the Fama-Miller Center and the Stigler Center at the University of Chicago. Zingales also acknowledges financial support from the Stigler Center. We thank Sam Kaplan, Filippo Lancieri, Fiona Scott Morton, and Richard Schmalensee for very useful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. Rajan has given a paid speech for Ripple, which may or may not have interest in the research in this paper. There has been no communication with Ripple about the contents of this paper.