Capacity Investment Under Postponement Strategies, Market Competition, and Demand Uncertainty

Abstract

We consider duopoly models where firms make decisions on capacity, production, and price under demand uncertainty. Capacity and price decisions are made, respectively, ex ante and ex post demand realizations. The interplay between the timings of demand realization and production decision endows firms with different capabilities. Flexible firms can postpone production decisions until the actual demand curve is observed, but inflexible firms cannot. Under general demand structures and cost functions, we characterize the equilibrium for a symmetric duopoly and establish the strategic equivalence of price and quantity competitions when firms are flexible. We investigate the stochastic order properties of capacity and profit and show that they both increase for a flexible firm when the market is more volatile. We find that flexibility allows a firm to increase investment in capacity and earn a higher profit while benefiting customers by keeping the price in a narrower range; strategic equivalence implies that these properties are robust to market conjectures. We also show that flexibility plays an important role in mitigating the destructive effect of competition when the demand shock is additive; the destructive effect is nonexistent for firms facing multiplicative demand shock. When flexibility decision is endogenous, a firm's strategic flexibility choice depends on the cost of technology as well as the nature of demand shock. In particular, faced with a multiplicative demand shock, firms always choose to be inflexible, whereas all the possible equilibria are observed under additive demand shocks.postponement, flexibility, duopoly, Cournot competition, Bertrand competition

On the Value of Input Efficiency, Capacity Efficiency, and the Flexibility to Rebalance Them

“…In many settings, flexibility is a tool to cope with variability in the external environment, and so investing in flexibility is sensible provided that the variability in the external environment is sufficiently high (Tombak and DeMeyer 1988, Mills 1984, Anupindi and Jiang 2008, Chod and Rudi 2005, Goyal and Netessine 2011. Proposition 3 identifies circumstances under which precisely the opposite is true regarding flexibility in input efficiency versus capacity efficiency.…”

Competition through capacity investment under asymmetric existing capacities and costs

“…Within a capacity constrained environment even allowing Bertrand type price competition can lead to a Cournot competition at the point of capacity investment (Kreps and Scheinkman, 1983). In the same way Anupindi and Jiang (2008) have suggested that price competition can also be modeled in this way if firms have some flexibility to exercise control on quantity through production or delivery. Due to its analytical simplicity, the choice of linear demand is conventional and this is often a good approximation to more general demand functions (see Shapiro, 1986).…”

“…In this case the degree to which holdback is employed is a function of changing market conditions which are unknown at the outset. However, in this paper we concentrate on the simplest case in which a production quantity is set only once (following the operations literature including Anupindi and Jiang (2008)) and uncertainty in market conditions is sufficiently small that it can be ignored (following the economics literature including Dixit (1980)). …”

The Effect of Salvage Market on Strategic Technology Choice and Capacity Investment Decision of Firm Under Demand Uncertainty

“…Choosing unified production process enables a firm to manufacture the final product with lower costs and also can be interpreted as a strategic commitment device whereby a firm commits to bring a certain quantity to market (Anupindi, Jiang 2008). On the other hand, choosing modular production process implies that a firm invests on a more expensive technology which empowers it to manufacture the final product with higher costs by producing a general component -which can be used in other productsassembled sequentially with a specific component which is specialized for certain product based on the demand information of the market.…”