Strategic capacity investment under uncertainty

Abstract

This article considers investment decisions within an uncertain dynamic and duopolistic framework. Each investment decision involves to determine the timing and the capacity level. The simultaneous analysis of timing and capacity decisions extends work on entry deterrence/accommodation to consider a timing/delay element. We find that, when applying an entry deterrence policy, the first investor, or incumbent, overinvests in capacity for two reasons. First, it delays the investment of the second investor, or entrant. Second, the entrant will invest in less capacity. We also find that greater uncertainty makes entry deterrence more likely.

Entry deterrence and hidden competition

“…The main difference between the model presented by Huisman and Kort (2013) and the current modification is that the results of the latter are to a great extent influenced by two additional parameters associated with hidden competition. The key assumption of the presented model is that the positioned firms face a non zero probability of hidden entry, λdt.…”

“…The result is presented in Figure 2b. Huisman and Kort (2013) came to the conclusion that the deterrence interval expands with uncertainty. However, in the presented setting another type of uncertainty is involved, namely the uncertainty about the market participants.…”

“…to stay longer in the market than the larger competitor. Huisman and Kort (2013) analyze accommodation and deterrence strategies of the market leader in a duopoly setting.…”

“…Following Huisman and Kort (2013), we present a model, where in order to enter the market, firms invest in a plant with a certain capacity, i.e. the firms choose the investment scale.…”

Strategic Technology Switching Under Risk Aversion and Uncertainty

“…Real options models often address the problem of optimal investment timing without considering strategic interactions Siegel, 1985 and1986), while the ones that do, either ignore the sequential nature of investment opportunities (Pawlina & Kort, 2006;Siddiqui & Takashima, 2012) or attitudes towards risk (Huisman & Kort, 2015). In the area of competition, Spatt & Sterbenz (1985) analyse how the degree of rivalry impacts the learning process and the decision to invest, and find that increasing the number of players hastens investment and that the investment decision resembles the standard NPV rule.…”