Investment Timing and Capacity Decisions with Time-to-Build in a Duopoly Market

Abstract

We investigate firms' optimal investment timing and capacity decisions in the presence of time-to-build and competition. Due to the uncertainty in time-to-build, the product of the leader who makes the first investment might enter the market later than that of the follower. We show that a firm dominated by investment lags can become a leader and that the leader's optimal capacity increases in the size of the dominated firm's lags, even when the dominated firm becomes the leader. This result is consistent with the electric vehicles market, in which a relatively new firm lacking experience in mass production makes an aggressive investment, while the biggest car makers capable of mass production with shorter lags are timing their investment. With a welfare-maximizing policy, however, the dominant firm always becomes the leader. Compared to investments according to the welfare-maximizing policy, the leader and follower's investment choices in the market are inefficiently late and early, respectively. The welfare-maximizing capacities of both the leader and the follower are much higher than those determined in the market, but the difference is more pronounced in the leader's capacity. There is a significant loss of social welfare resulting from the dominated firm becoming the leader, and the loss increases as the dominated firm's time-to-build increases.

Keywords: Time-to-Build, Investment Lags, Investment Capacity, Duopoly Market, Real Options

JEL Classification: D25, G32, L13