Using capacity as a competition strategy in a manufacturing duopoly

Abstract

Capacity is a strategic factor of competition in asset-heavy industries. However, when demand is volatile, capacity expansion is hazardous to profits. In this paper, a game theory method is developed for analyzing whether capacity can be used as a competition strategy and for determining its sufficient conditions. We consider a manufacturing service duopoly of differentiated service prices and volatile demand. Sufficient conditions for Nash equilibrium of capacity expansion are derived for lognormal demand. Those conditions specify a choice space for the leader Arm to increase its own profit at the expense of the follower's profit by aggressively expanding its capacity.