The Timing of Capacity Investment by Start-Ups and Established Firms in New Markets

Abstract

We analyze the competitive capacity investment timing decisions of both established …rms and start-ups entering new markets which are characterized by a high degree of demand uncer- tainty. Firms may invest in capacity early (when the market is highly uncertain) or late (when market uncertainty has been resolved), possibly at dierent costs. In our model, established …rms choose investment timing and capacity level to maximize expected pro…ts. Start-ups are prone to bankruptcy if pro…t turns out to be too low, and hence choose investment timing and capacity level to maximize the probability of survival. Surprisingly, we …nd that in monopoly situations, a start-up is more likely to prefer early investment than an established …rm, despite the presence of demand uncertainty. In duopoly situations with one start-up and one estab- lished …rm competing in the same market, we characterize the equilibria of a strategic capacity investment timing game in which …rms choose when to build capacity. We …nd that when demand uncertainty is high and costs do not decline too severely over time, the unique equilib- rium of this game is for the start-up to take a leadership role and invest …rst in capacity while the established …rm follows; by contrast, when two established …rms compete in an otherwise identical game, high demand uncertainty leads to both …rms investing late. Thus, the threat of bankruptcy leads to an increase in sequential investment outcomes in which the start-up leads, a result that we demonstrate persists even if the start-up is concerned with both pro…t and bankruptcy risk or pro…t above the bankruptcy threshold. We conclude that the threat of …rm failure signi…cantly impacts the dynamics of competition involving start-ups.