New Product Introduction and Capacity Investment by Incumbents : Effects of Size on Strategy

The paper addresses the question how production capacities on an established market affect the innovativeness of firms. We analyze the strategic interactions in an oligopoly setting where firms offer an established product and have the option to offer an additional new product. We show that the firm with a smaller capacity on the established market has a higher incentive to innovate and reaches a larger market share on the market for the new product. Furthermore, changing capacities on the established market has qualitatively different impacts on the smaller and the larger firm. The larger firm can use capacity expansion as an instrument to prevent its competitor from innovating, whereas the smaller firm cannot prevent innovation of its competitor in this way. Overall, total payoffs depend non-monotonously on the capacities on the established market and the firm with smaller capacity on the established market might outperform the larger firm with respect to total payoffs