Capacity Sharing between Competitors

Abstract

Retail competition may lead to mismatch between supply and demand. That is, overpricing may give rise to underselling, and underpricing may yield stockout. Capacity sharing is a common practice to align excessive capacity with excessive demand. Yet the strategic interaction between competition and capacity sharing has not been adequately addressed. In this paper we investigate optimal strategies and firm profitability of capacity sharing between competing firms under both ex ante and ex post bargaining, depending on whether the capacity sharing price is negotiated before or after retail price setting. We show that, with symmetric capacity, committing to overly high capacity sharing price may not necessarily improve firm payoff. Capacity sharing softens price competition under either bargaining scheme, whereas the optimal capacity transfer price and equilibrium profits may be non-monotonically influenced by consumer loyalty. The equilibrium outcome under ex ante bargaining is more sensitive to variations in market parameters than ex post bargaining. As a result, ex ante negotiation is more likely to be preferred when the endowed capacity is low or consumer loyalty is high. However, when firms' capacity is asymmetric, capacity sharing may intensify equilibrium competition and hurt firm profitability through reversing the firms' relative pricing aggressiveness.