Capacity choice under uncertainty in a duopoly with endogenous exit

Applying the real options framework, this article investigates the investment decision of the entrant given that an incumbent is already active. Both firms have an option to exit this market if the demand level falls too low. The combination of three decision components, capacity choice, entry and exit timing, results into multiple trigger strategies for the entrant. In particular, in the presence of a large incumbent, it can either choose to coexist with its rival in a duopoly or (eventually) monopolize the market by installing a sufficiently large capacity. The former scenario is realized when the market is large, while the latter occurs when the market is small. When the market is of intermediate size, a hysteresis region emerges where the entrant does not take any actions and prefers to postpone investment.