Retreat, Defend, or Attack? Optimal Investment Decisions in Green Technology

Abstract

Firms that already invest in more sustainable technologies as a proactive measure against changing market dynamics, for example by converting their internal combustion vehicles to alternative fuel vehicles, are likely to gain a competitive advantage. Nevertheless, this strategy could also fail if it does not translate into sufficient market share increase to justify early investment at much higher prices. We analyze a focal firm's optimal green investment strategy when there is uncertainty in green market potential. We also account for the uncertainty in the competitors' actions, which consists of myriads of companies with varying sizes in the transportation sector. We develop a stylized model and characterize the optimal policy when the green market size is known. This policy composes of `Retreat’, `Defend’, and `Attack’ strategies, one of which is optimal based on the problem parameters. We then analyze the general model with uncertain green market size and characterize the optimal policy. We conduct theoretical and numerical analyses to understand the characteristics of the optimal solution and the regret associated with making sub-optimal decisions, and we generate managerial insights, some of which are: 1) Investing in the new technology right away can be the optimal solution, even if the new technology brings negative profit margins. 2) Companies with smaller market share should invest in green technology relatively more aggressively than larger companies. 3) Over-estimating green demand results in less regret than under-estimating it. 4) An increase in the variability of the green demand calls for more aggressive attacking.

Keywords: Sustainability, Transportation, Investment Decisions, Electric Vehicles