Strategic Capacity Investment Under Uncertainty with Volume Flexibility

Abstract

This article considers investment decisions in an uncertain and competitive framework, with a first investor, the leader, always producing up to full capacity and a second investor, the follower, capable of adjusting output levels within the constraint of installed capacity. Both firms need to decide on the investment timing and the investment capacity levels. The main findings are as follows. Compared to a situation where the follower always produces up to full capacity, the leader has a larger incentive to accommodate a flexible follower. This is because the leader also benefits from the follower's volume flexibility. Due to the first mover advantage, the leader's value is higher than the follower's value, despite the follower's technological advantage in flexibility.