Signalling
The incumbent firm has an advantage of being the "first mover" and can therefore act in a way that it knows will influence the entrant's decision. If we assume imperfect knowledge (i.e. the incumbent firm's costs are only known privately) the entrant can only make assumptions about the incumbent's cost structure through its price and output levels. Therefore, the incumbent can use these as a signal to any potential entrant.
One way of using this advantage to deter entry is to charge a price less than the monopoly level. If an entrant is considering entry in a number of similar markets, a low cost incumbent can signal its efficiency to a potential entrant through lowering prices – thereby discouraging what the entrant believes would be unprofitable entry. Signalling needs to be credible to be effective – a low cost firm must be able to show that it can withstand lower profits for an extended period of time, which it would not be able to if it had higher costs.
Read more about this topic: Strategic Entry Deterrence