Capacity Investment Under Postponement Strategies, Market Competition, and Demand Uncertainty
AbstractWe 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.
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Bibliographic InfoArticle provided by INFORMS in its journal Management Science.
Volume (Year): 54 (2008)
Issue (Month): 11 (November)
postponement; flexibility; duopoly; Cournot competition; Bertrand competition;
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- Yang, L. & Ng, C.T. & Cheng, T.C.E., 2011. "Optimal production strategy under demand fluctuations: Technology versus capacity," European Journal of Operational Research, Elsevier, vol. 214(2), pages 393-402, October.
- Reimann, Marc, 2012. "Accurate response by postponement," European Journal of Operational Research, Elsevier, vol. 220(3), pages 619-628.
- He, Yuanjie, 2013. "Sequential price and quantity decisions under supply and demand risks," International Journal of Production Economics, Elsevier, vol. 141(2), pages 541-551.
- Tang, Christopher S., 2010. "A review of marketing-operations interface models: From co-existence to coordination and collaboration," International Journal of Production Economics, Elsevier, vol. 125(1), pages 22-40, May.
- Fu, Qi & Lee, Chung-Yee & Teo, Chung-Piaw, 2012. "Modified critical fractile approach for a class of partial postponement problems," International Journal of Production Economics, Elsevier, vol. 136(1), pages 185-193.
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