Capacity sharing: The impacts of agreement and contracting timing

Abstract

We investigate the timing of capacity sharing agreement and contracting between two firms. The firms have the choices of forming an alliance either before or after capacity investment, and signing a specific contract stipulating the price and quantity of capacity sharing either before or after demand observation. We analyze optimal strategies under four alternative cases on the timing of agreement and contracting. We show that, under an ex post agreement, the firms have different preferences for contracting timing, however, the incentives can be aligned when the variances of market intercepts are sufficiently large. Under an ex ante agreement, the firms’ preferences for contracting timing are aligned when the markets are either relatively stable or highly uncertain and the difference in marginal capacity cost is either relatively large or insignificant. Between the two timing of agreement, the ex ante agreement results in more profit gains for both firms. Between the two timing of contracting, we find that the firms do not necessarily benefit from an early contracting scheme. When the markets are highly uncertain or the cost difference between firms is insignificant, spot contracting outperforms forward contracting under both ex ante and ex post agreement.

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