Flexible capacity strategy in an asymmetric oligopoly market with competition and demand uncertainty

Abstract

This article studies flexible capacity strategy (FCS) under oligopoly competition with uncertain demand. Each firm utilizes either the FCS or inflexible capacity strategy (IFCS). Flexible firms can postpone their productions until observing the actual demand, whereas inflexible firms cannot. We formulate a new asymmetrical oligopoly model for the problem, and obtain capacity and production decisions of the firms at Nash equilibrium. It is interesting to verify that cross-group competition determines the capacity allocation between the two groups of firms, while intergroup competition determines the market share within each group. Moreover, we show that the two strategies coexist among firms only when cost differentiation is medium. Counterintuitively, flexible firms benefit from increasing production cost when the inflexible competition intensity is sufficiently high. This is because of retreat of inflexible firms, flexibility effect, and the corresponding high price. We identify conditions under which FCS is superior than IFCS. We also demonstrate that flexible firms benefit from increasing demand uncertainty. However, when demand variance is not very large, flexible firms may be disadvantaged. We further investigate the effects of cross-group and intergroup competition on individual performance of the firms. We show that as flexible competition intensity increases, inflexible firms are mainly affected by the cross-group competition first and then by the intergroup competition, whereas flexible firms are mainly affected by the intergroup competition. Finally, we examine endogenous flexibility and identify its three drivers: cost parameters, cross-group competition, and intergroup competition.