Strategic Capacity Investment Under uncertainty

Abstract: This paper considers investment decisions within an uncertain dynamic and competitive framework. Each investment decision involves to determine the timing and the capacity level. In this way we extend the main bulk of the real options theory where the capacity level is given. We consider a monopoly setting as well as a duopoly setting. Our main results are the following. In the duopoly setting we provide a fully dynamic analysis of entry deterrence/accommodation strategies. We find that the first investor overinvests in capacity in order to delay entry of the second investor. In very uncertain economic environments the first investor always ends up being the largest firm in the market. If uncertainty is moderately present, a reduced value of waiting implies that the preemption mechanism forces the first investor to invest so soon that a large capacity cannot be afforded. Then it will eventually end up with a capacity level being lower than the second investor.