Capacity investment under cost sharing contracts

Capacity planning is widely applied in various industries, such as electric utilities, shipping industries and automobile industries. However, because of market uncertainty and inaccurate industry wide demand forecasts, manufacturers may take a high risk in capacity investment. This paper investigates the role of a retailer in a manufacturer's capacity investment strategies. Two capacity sharing contracts are introduced, i.e., the full capacity cost sharing contract (FCCSC) and the partial capacity cost sharing contract (PCCSC). In both contracts, a retailer shares the capacity cost with a manufacturer. Differently, in the FCCSC, a retailer shares a fraction of the capacity cost with the manufacturer. However, in the PCCSC, a retailer shares capacity cost only when the manufacturer's capacity level exceeds a certain threshold. We find that the retailer would share more cost but less capacity quantity in the PCCSC than that in the FCCSC. We also find that in the PCCSC, when the threshold of capacity level is sufficiently high, the retailer would choose the PCCSC while the manufacturer would choose the FCCSC. Conversely, when the threshold of the capacity level is small, the retailer would choose the FCCSC, while the manufacturer would choose the PCCSC. There exists a certain interval in which both players would choose the PCCSC.