Strategic capacity expansion under a potential entry threat

•The study derives an investment strategy on expansion thresholds and capacity scales.•The strategic value of capacity expansion is evaluated.•An incumbent firm expands its capacity to deter a potential market entry.•The study examines the impact of expansion on an incumbent's initial capacity choice.

This paper examines strategic investment decisions on capacity expansion in the presence of a potential entry threat. The model derives an equilibrium investment strategy on expansion thresholds and scales and evaluates the strategic value of the capacity expansion. It demonstrates that an incumbent firm expands its production capacity by strategic incentive to deter a potential competitor's market entry and prolong its period of monopoly. The results suggest that the strategic value of the expansion is high enough to induce the incumbent firm to undertake the capacity expansion that generates negative cash flows in the future as a stand-alone project.