Entry deterrence and hidden competition

This paper studies strategic investment behavior of firms facing an uncertain demand in a duopoly setting. Firms choose both investment timing and the capacity level while facing additional uncertainty about market participants, which is introduced via the concept of hidden competition. We focus on the analysis of possible strategies of the market leader in terms of its capacity choice and on the influence of hidden competition on these strategies.

We show that due to hidden competition the follower is more eager to invest. As a result, an entry deterrence strategy of the leader becomes more costly, and it can only be implemented for smaller market size, leaving additional room for entry accommodation. The leader has incentives to prevent entry of the hidden competitor stimulating simultaneous investment if the hidden firm has a large capacity, and has more incentives to apply entry deterrence in the complementary case of a small capacity of the hidden player. In the first case overinvestment aimed to deter the follower's entry does not occur for a wide range of parameters values.