Capacity investment decisions of two competing ports under uncertainty: A strategic real options approach

Ports worldwide operate in an uncertain environment and compete with nearby ports to attract cargo. The extent of competition is influenced by the geographical location and differentiated services offered at ports. In this paper, we study the flexible investment decision of two ports with an option to delay investment in a capacity level that is not ex-ante determined. Ports compete on quantity (Cournot competition) under demand uncertainty and congestion. In a leader-follower timing game, we consider both the entry deterrence and accommodation strategies for the leader port. If one of the ports only has a limited cost advantage, the leader role will be endogenous and will be the result of preemption. Uncertainty is included in the model by a geometric Brownian motion, allowing us to analyse the impact of growth and uncertainty (variability) independently. We find that higher growth, uncertainty and port customers’ aversion to waiting lead to a larger project installed at a later moment. If competition intensifies however, the option value of waiting is reduced, leading to earlier investment, but surprisingly also in less capacity. Finally, if more shares of the ports are publicly owned, the investment will be larger and will take place earlier.