Capacity Precommitment as a Barrier to Entry: A Bertrand-Edgeworth Approach by

With few exceptions, the literature on the role of capacity as a strategic entry deterrent has assumed Cournot competition in the post-entry game. In contrast, our model is in the spirit of Kreps and Scheinkman (1983): the incumbent and entrant sequentially precommit to capacity levels before competing in price. Interesting deterrence effects arise because firms need time to build, i.e. cannot adjust capacity instantaneously in the post-entry game. Depending on the sizes of the fixed set-up cost, the cost of capacity and the relative costs of production, our model produces a wide spectrum of equilibrium behaviors. Using a "reverse-judo" tactic a cost disadvantaged incumbent may limit his capacity to induce the entrant to respond less aggressively. When the incumbent is equally or more efficient, a stochastic version of Gelman and Salop's (1983) judo equilibrium may arise. Entry accommodation can also result in the Stackelberg outcome, or the equilibria from Dixit's (1980) quantity-setting game. In contrast to much previous work, we find that when entry is deterred the incumbent may hold idle capacity. Our model thus provides a unified framework in which several equilibrium phenomena previously suggested in the literature appear as special cases, while at the same time suggesting some new ones. Furthermore, it generates clear predictions about the circumstances under which these different outcomes are likely to occur.