The Timing of Capacity Investment with Lead Times: When Do Firms Act in Unison?

Abstract

We study competitive capacity investment for the emergence of a new market. Firms may invest either in capacity leading demand or in capacity lagging demand at different costs. We show how the lead time and other operational factors including volume flexibility, existing capacity, and demand uncertainty impact equilibrium outcomes. Our results indicate that a type of bandwagon behavior is the most likely equilibrium outcome: if both firms are going to invest, then they are most likely to act in unison. Contrary to much received wisdom, we show that leader–follower behavior is very uncommon in equilibrium where firms do not have volume flexibility, and will not occur at all if lead times are sufficiently short. On the other hand, if there is volume flexibility in production, then the likelihood of this sequential investment behavior increases. Our findings underscore the importance of operational characteristics in determining the competitive dynamics of capacity investment timing.