Competitive Capacity Investment under Uncertainty

We consider a long-term capacity investment problem in a competitive market under demand uncertainty. Two firms move sequentially in the competition and a firm’s capacity decision interacts with the other firm’s current and future capacity. Throughout the investment race, a firm can either choose to plan its investments proactively, taking into account possible responses from the other firm, or decide to respond reactively to the competition. In both cases, the optimal decision at each period is determined according to an ISD (Invest, Stayput, Disinvest) policy. We develop two algorithms to efficiently derive proactive ISD policies for the leader and follower firms. Using data from the container shipping market (2000-2015), we show that the optimal capacity determined by our competitive strategy is consistent with the realized investments in practice. By revealing strategical flexibility of proactive strategies, our results demonstrate that firms in the competition can gain more capacity and profit through such a strategy. Using Monte Carlo simulations, we explore the impact of different market conditions and investment irreversibility levels on capacity strategies. In particular, by comparing the results of competitive strategies and strategies that separate firms into different markets, we show that both firms can benefit from the competition and that market downturns likely lead to investment cascades.