Capacity Sharing between Competitors

Abstract

Market 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 profitability of capacity sharing between competing firms under both ex
ante and ex post contracting, depending on whether the capacity sharing price is determined before
or after price setting in the buyer market. We show that, with symmetric capacity, committing to
an overly high capacity sharing price may not necessarily improve firm payoffs. Capacity sharing
softens price competition under either contracting scheme, whereas the optimal capacity transfer
price and equilibrium profits may be non-monotonically influenced by buyer loyalty. The equilibrium
outcome under ex ante contracting is more sensitive to variations in market parameters than ex
post contracting. As a result, ex ante contracting is more likely to be preferred when the endowed
capacity is low or buyer loyalty is high. However, when firms' capacity is asymmetric, capacity
sharing may intensify equilibrium competition and hurt firm profitability through reversing the
firms' relative pricing aggressiveness.

Keywords: capacity sharing; contracting timing; co-opetition; subcontracting; transshipment