An Experiment on Strategic Capacity Reduction

Abstract:     
A firm may strategically decrease capacity to gain bargaining power over its suppliers. While traditional models of bargaining imply that the incentive to do so is minimal, I report results from a laboratory experiment that suggest the existence of incentives to decrease capacity quite substantially below efficient levels, excluding at least 30% of available suppliers. The experiment is a market game in which subjects - both MBA students and executives of two large corporations - make simultaneous requests for their share of the profit if they are included among a firm's suppliers. The lowest offers are selected with remaining subjects earning zero. Treatments vary the capacity constraint representing the number of suppliers that can be accommodated. As capacity decreases, so does the average request, but according to a pattern quite divorced from equilibrium predictions. Quantal response equilibria also perform poorly as a benchmark. An explanation for subjects' bids incorporating both fairness and strategic concerns is offered. Results from surveys suggest that the benchmark is a reasonable predictor of behavior.

Keywords: experiment, capacity, discriminatory auction, shelf space

JEL Classifications: C78, C90, L13

Working Paper Series