Competing and Sharing: An Analysis of Optimal Pricing and Capacity Sharing Decisions in a Competitive Market

Abstract

This research investigates the possibility for firms competing in the same market to willingly and profitably share their capacity. We consider two firms selling substitutable products in four different scenarios, according to their competition (non-competing or competing) and capacity sharing (with or without capacity sharing option) situations. In each scenario, each firm’s optimal capacity sharing and retail pricing strategies are characterized. Our results indicate that the two firms are willing to share their capacity only when the capacity selling firm has sufficiently large capacity while the capacity buying firm has sufficiently small capacity. The firms’ relative capacity in turn determine the optimal capacity sharing price, the exchanged capacity sharing quantity, and their retail prices in the market. Going against the common intuition, our results show that it can still be optimal for a firm to sell her capacity to her direct competitor even when she sets a capacity price lower than her retail price (i.e. she makes less per unit of capacity when selling it to the competitor rather than selling it in her own market). Furthermore, capacity sharing can cause the selling firm to willingly lower her retail price despite the smaller capacity she has left after selling some capacity to the competitor. Overall, our research suggests that capacity sharing is a viable and profitable mechanism to help firms selling substitutable products gain more profits and more effectively match their supplies with demand in the market.