Dedicated vs product flexible production technology: Strategic capacity investment choice

• DOI: 10.1016/j.ejor.2015.01.007
• Publication Date: 2015-01-19T23:18:18Z
• Authors: H.J. Boonman; V. Hagspiel; P.M. Kort
• Keywords: Commit; Investment; Stochastic game

This paper studies the optimal investment strategies of an incumbent and a potential entrant that can both choose between a product flexible and dedicated technology, in a two-product market characterized by uncertain demand. The product flexible production technology has certain advantages, especially when the economic environment is uncertain. On the other hand, the dedicated production technology allows a firm to commit to production quantities. This gives strategic advantages, which can outweigh the ‘value of flexibility’. It turns out that both firms prefer, for some scenarios, the dedicated production technology. However, we find that in a game with sequential technology choices, both firms investing dedicated, will not be an equilibrium. Especially when the economic environment is more uncertain, the incumbent overinvests in product flexible capacity to force the entrant to choose the dedicated technology. Then, the incumbent is the only firm with the product flexible production technology, which results in a high payoff.