Sequential entry with capacity, price, and leadtime competition. Working paper

In this paper we develop an analytic model to provide insight into strategic capac-ity planning in competitive environments. We consider two firms, an incumbent and a (potential) entrant, operating in make-to-order fashion and competing with identical products. Customers react to full price (the sum of nominal price and expected cost of delivery leadtime). The market is imperfect in the sense that firms can influence equilibrium full prices. We model firms as queuing systems, characterized by produc-tion variability—a proxy for operational efficiency—and capacity cost. Firms choose capacities (i.e., queuing service rates) according to a sequential game. The firms then engage in a simultaneous price game, with endogenously determined delivery leadtimes. In contrast to existing sequential entry models, this one includes a price (instead of quantity) post-entry subgame with a pure Nash equilibrium, incorporates “time to build, ” and as a direct consequence of its assumptions, predicts the incumbent will never hold idle capacity to deter entry, this model predicts either a complete or a very strong first mover advantage. Depending on market conditions, this advantage can be overcome by an entrant whose operational or cost capabilities are vastly superior to those of the incumbent. The model also suggests that an entrant may gain from concealing information on his capabilities since that information can be very valuable in achieving market entry. However, depending on market conditions, the incumbent may be able to use capacity as a hedge against incomplete information. 1