This thesis analyzes investment incentives of strategic firms in industries where either demand is uncertain, or the good produced is economically non-storable and demand fluctuates. In those industries, investment is a long run decision, whereas production has to be adjusted short-run. Prominent examples are recently liberalized utilities such as the electricity sector. Regulated monopolies have been replaced by a small number of competing firms, which often are considered to behave strategically in order to exercise market power. Whereas the regulatory regimes prior to liberalization induced generous (over-)investment choices, we observe increasing unease of experts and policy makers regarding investment incentives in liberalized electricity markets. The first three chapters of this thesis (part one) analyze total capacity choice of strategic firms prior to producing for the spot market. We first determine the equilibrium of the market game. In the remainder of the first part we analyze the interdependency of enhanced spot market competition and firms overall capacity choice. We first analyze the impact of complete elimination of market power at the spot market giving rise to marginal cost pricing. We then consider the impact of price caps at the spot market. And finally we study the impact of reduced market power at the spot markets due to forward contracting. In the second part of the thesis firms can invest into several technologies. This allows them to determine not only their total capacity but also it's precise composition. In the absence of strategic interaction, for a single regulated firm, this has already been thoroughly analyzed in the so called peak load pricing literature, which has been widely applied for electricity markets prior to liberalization. In order to accommodate for the completely changed situation after liberalization, however, we extend this framework to the case of strategically interacting firms. Based on data of the German electricity market, we then illustrate and empirically quantify our theoretical results. We determine firms’ investment choices for different market structures and quantify the impact of spot market interventions on investment decisions and welfare. This allows us to quantify the potential for the exercise of market power, in the long run, when firms’ investment decisions are taken into account.

Increasing competition and regulation are raising the pressure on manufacturing organisations to innovate their products. Innovation is fraught by significant uncertainty of whole product life cycle costs and this can lead to hesitance in investing which may result in a loss of competitive advantage. Innovative products exist when the minimum information for creating accurate cost models through contemporary forecasting methods does not exist. The scientific research challenge is that there are no forecasting methods available where cost data from only one time period suffices for their application. The aim of this research study was to develop a framework for forecasting cost uncertainty using cost data from only one time period. The developed framework consists of components that prepare minimum information for conversion into a future uncertainty range, forecast a future uncertainty range, and propagate the uncertainty range over time. The uncertainty range is represented as a vector space representing the state space of actual cost variance for 3 to n reasons, the dimensionality of that space is reduced through vector addition and a series of basic operators is applied to the aggregated vector in order to create a future state space of probable cost variance. The framework was validated through three case studies drawn from the United States Department of Defense. The novelty of the framework is found in the use of geometry to increase the amount of insights drawn from the cost data from only one time period and the propagation of cost uncertainty based on the geometric shape of uncertainty ranges. In order to demonstrate its benefits to industry, the framework was implemented at an aerospace manufacturing company for identifying potentially inaccurate cost estimates in early stages of the whole product life cycle.

Firms developing new products often face the challenge of making investment decisions under uncertain input-cost conditions due to the price volatilities of the materials they use. These decisions need to be made long before the final products are launched on the market. Therefore, firms who invest in the opportunity to switch materials in a timely manner will have the flexibility to react to material price changes and realize competitive advantages. However, volatile material prices may also cause a firm to delay investment. Using real-options reasoning, this article studies the influence of input-cost fluctuations on the timing decision to start new product development (NPD) and thus create the follow-on opportunity to later replace an existing product. A model that combines waiting and switching options to derive influencing factors of the flexibility value which triggers the investment is developed and tested on a sample of material substitution projects from manufacturing firms. The results show how price uncertainty of the new and the old material, their joint price development, the expected project duration, and competitive preemption are related to the propensity to delay the start of NPD. The findings provide new insights on how timing in adopting materials can be used to hedge exposure to volatile material prices. The insights are relevant for adopters and producers of new materials, as well as for policy makers who strive for supporting the diffusion of new materials. (authors' abstract)

The thesis consists of four papers. The first two essays deal with entry externalities, the third studies the Law of One Price (LOP), while the last essay examines average profits for a monopolist under uncertainty. In the first essay, entry externalities in the form of information and positive payoff externalities are studied. When a firm enters a market, it often imposes externalities on existing firms and/or future potential entrants. If products are substitutes, these externalities are typically negative; if products are complements, the externalities are typically positive. Externalities related to substitution or complementarities between products are called payoff externalities, since entry by one firm has a direct effect on the other firms' payoff. Another type of externality arises when firms have private information about the profitability of entry. In this case, the entry decision of one firm potentially reveals that firm's private information. The focus of the paper is on the scope for intervention for an uninformed social planner, when firms privately know the profitability of entry and moreover, the firms have an option to delay their entry. The main result is that there is insufficient entry, since firms delay too much in equilibrium and further, the social planner can increase welfare by subsidizing early entry. Continuing on this theme, the second essay has the same focus, but instead takes the time of entry as fixed, while generalizing the analysis of payoff externalities also to the case of negative payoff externalities. The main contribution is the characterization of equilibria under both positive and negative payoff externalities and the implications for public policy. Here, the scope for intervention will, in contrast to the results in the first essay, be low, when entry is profitable for uninformed firms. In the third essay (joint with Richard Friberg), deviations from the LOP are studied in the presence of transport costs, under the assumption that firms can endogenously choose to segment markets in order to prevent arbitrage by consumers. It is shown that the deviation from LOP can increase as transport costs fall between countries. The last essay (joint with Richard Friberg), studies the problem facing a monopolist when the cost of inputs is uncertain. The main result is that the monopolist can gain from this uncertainty, in the sense that average profits are increasing in the variability of costs. / Diss. Stockholm : Handelshögsk., 2001