Competition through capacity investment under asymmetric existing capacities and costs

• Formulate a game where each firm has an existing capacity and faces fixed costs.
• A holdback strategy will undermine the commitment value of existing capacity.
• Sinking operational costs enables a firm to keep some preemptive advantage.
• Existence of fixed costs can result in either no equilibrium or multiple equilibria.
• Innovative integration of capacity strategy and the well-known (s, S) inventory policy.

This paper discusses the way that different operational characteristics including existing capacity, scale economies, and production policy have an important influence on the capacity outcomes when firms compete in the market place. We formulate a game-theoretical model where each firm has an existing capacity and faces both fixed and variable costs in purchasing additional capacity. Specifically, the firms simultaneously (or sequentially) make their expansion decisions, and then simultaneously decide their production decisions with these outputs being capacity constrained. We also compare our results with cases where production has to match capacity. By characterizing the firms’ capacity and production choices in equilibrium, our analysis shows that the operational factors play a crucial role in determining what happens. The modeling and analysis in the paper gives insight into the way that the ability to use less production capacity than has been built will undermine the commitment value of existing capacity. If a commitment to full production is not possible, sinking operational costs can enable a firm to keep some preemptive advantage. We also show that the existence of fixed costs can introduce cases where there are either no pure strategy equilibrium or multiple equilibria. The managerial implications of our analysis are noted in the discussion. Our central contribution in this paper is the innovative integration of the strategic analysis of capacity expansion and well-known (s,S)(s,S) policy in operations and supply chain theory.