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.

[1]  Drewry Shipping Consultants.  Ship Operating Costs Annual Review and Forecast 2012/13 , 2012 .

[2]  Benoît Chevalier-Roignant,et al.  Strategic Investment Under Uncertainty: A Synthesis , 2010, Eur. J. Oper. Res..

[3]  Serguei Netessine,et al.  Capacity Investment Timing by Start-ups and Established Firms in New Markets , 2011, Manag. Sci..

[4]  Ranjay Gulati,et al.  Roaring Out of Recession , 2010 .

[5]  Drewry Shipping Consultants.  Ship operating costs : annual review and forecast , 2010 .

[6]  Felipe L. Aguerrevere.  Real Options, Product Market Competition, and Asset Returns , 2009 .

[7]  Lenos Trigeorgis,et al.  Option Games The Key to Competing in Capital-Intensive Industries , 2009 .

[8]  K. Back,et al.  Open Loop Equilibria and Perfect Competition in Option Exercise Games , 2009 .

[9]  Shailesh S. Kulkarni,et al.  Risk Pooling Advantages of Manufacturing Network Configuration , 2004 .

[10]  Pankaj Ghemawat,et al.  The Risk of Not Investing in a Recession , 2009 .

[11]  Elsevier Sdol,et al.  International Journal of Industrial Organization , 2005 .

[12]  Jan A. Van Mieghem,et al.  Risk Mitigation in Newsvendor Networks: Resource Diversification, Flexibility, Sharing, and Hedging , 2007, Manag. Sci..

[13]  Manu Goyal,et al.  Strategic Technology Choice and Capacity Investment Under Demand Uncertainty , 2007, Manag. Sci..

[14]  Peter M. Kort,et al.  Investment in Oligopoly Under Uncertainty: Accordion Effect , 2006 .

[15]  W. T. Huh,et al.  A general strategic capacity planning model under demand uncertainty , 2006 .

[16]  Martin B. Haugh,et al.  Optimal Control and Hedging of Operations in the Presence of Financial Markets , 2006, Math. Oper. Res..

[17]  Erica L. Plambeck,et al.  The Impact of Duplicate Orders on Demand Estimation and Capacity Investment , 2003, Manag. Sci..

[18]  Robin O. Roundy,et al.  A continuous‐time strategic capacity planning model , 2005 .

[19]  Erica L. Plambeck,et al.  Sell the Plant? The Impact of Contract Manufacturing on Innovation, Capacity, and Profitability , 2005, Manag. Sci..

[20]  Ebru K. Bish,et al.  Optimal Investment Strategies for Flexible Resources, Considering Pricing and Correlated Demands , 2004, Oper. Res..

[21]  Pauli Murto,et al.  Timing of investments in oligopoly under uncertainty: A framework for numerical analysis , 2004, Eur. J. Oper. Res..

[22]  Lenos Trigeorgis,et al.  Strategic Investment: Real Options and Games , 2004 .

[23]  Sarah M. Ryan,et al.  Capacity Expansion for Random Exponential Demand Growth with Lead Times , 2004, Manag. Sci..

[24]  Pauli Murto,et al.  Exit in duopoly under uncertainty , 2004 .

[25]  P. Kort,et al.  The effects of information on strategic investment and welfare , 2006 .

[26]  Jan A. Van Mieghem,et al.  Commissioned Paper: Capacity Management, Investment, and Hedging: Review and Recent Developments , 2003, Manuf. Serv. Oper. Manag..

[27]  Felipe L. Aguerrevere.  Equilibrium Investment Strategies and Output Price Behavior: A Real-Options Approach , 2003 .

[28]  Jan A. Van Mieghem.  Capacity Management, Investment, and Hedging: Review and Recent Developments , 2003 .

[29]  Grzegorz Pawlina,et al.  Real Options in an Asymmetric Duopoly: Who Benefits from Your Competitive Disadvantage? , 2002 .

[30]  Robert Novy-Marx,et al.  An Equilibrium Model of Investment Under Uncertainty , 2002 .

[31]  Nils Rudi,et al.  Newsvendor Networks: Inventory Management and Capacity Investment with Discretionary Activities , 2002, Manuf. Serv. Oper. Manag..

[32]  Patrick T. Harker,et al.  Competition and Outsourcing with Scale Economies , 2002, Manag. Sci..

[33]  Steven R. Grenadier.  Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms , 2002 .

[34]  Evan L. Porteus,et al.  Simultaneous Capacity and Production Management of Short-Life-Cycle, Produce-to-Stock Goods Under Stochastic Demand , 2002, Manag. Sci..

[35]  Serguei Netessine,et al.  Flexible Service Capacity: Optimal Investment and the Impact of Demand Correlation , 2002, Oper. Res..

[36]  J. Birge,et al.  Optimal Portfolio of Reconfigurable and Dedicated Capacity under Uncertainty , 2002 .

[37]  Lilach Nachum.  United Nations Conference on Trade and Development (UNCTAD): World Investment Report 2000: Cross-Border Mergers and Acquisitions and Development United Nations, New York and Geneva 2000. (Biblio Service) , 2001 .

[38]  Apostolos Burnetas,et al.  Future Capacity Procurements Under Unknown Demand and Increasing Costs , 2001, Manag. Sci..

[39]  Jan Olhager,et al.  Long-term capacity management: Linking the perspectives from manufacturing strategy and sales and operations planning , 2001 .

[40]  Kevin Cullinane,et al.  ECONOMIES OF SCALE IN LARGE CONTAINERSHIPS: OPTIMAL SIZE AND GEOGRAPHICAL IMPLICATIONS. , 2000 .

[41]  Heidrun C. Hoppe.  Second-mover advantages in the strategic adoption of new technology under uncertainty , 2000 .

[42]  L. Trigeorgis,et al.  Project flexibility, agency, and competition : new developments in the theory and application of real options , 2000 .

[43]  Jan A. Van Mieghem,et al.  Price Versus Production Postponement: Capacity and Competition , 1999 .

[44]  Gérard P. Cachon,et al.  Capacity Choice and Allocation: Strategic Behavior and Supply Chain Performance , 1999 .

[45]  Pankaj Ghemawat,et al.  Strategic Valuation of Investment Under Competition , 1999, Interfaces.

[46]  J. V. Mieghem.  Investment Strategies for Flexible Resources , 1998 .

[47]  Phillip J. Lederer,et al.  Pricing, Production, Scheduling, and Delivery-Time Competition , 1997, Oper. Res..

[48]  Janice C. Eberly,et al.  Multi-Factor Dynamic Investment Under Uncertainty , 1996 .

[49]  Eduardo S. Schwartz,et al.  Investment Under Uncertainty. , 1994 .

[50]  Ming-Jer Chen,et al.  Nonresponse and Delayed Response to Competitive Moves: The Roles of Competitor Dependence and Action Irreversibility , 1992 .

[51]  H. Groenevelt.  Two algorithms for maximizing a separable concave function over a polymatroid feasible region , 1991 .

[52]  Mark E. Ferguson,et al.  PRODUCTION AND OPERATIONS MANAGEMENT , 2008 .