Mike Shor: Research
An experiment on strategic capacity reduction
Revised July 2008
A firm may strategically decrease capacity to gain bargaining power over its suppliers. Equilibrium models of competition imply that this incentive to reduce capacity is small because the buyer captures all available surplus by excluding even a single supplier. However, these models can rest on behaviorally untenable strategies prescribed to suppliers in equilibrium. In this paper, we test this theory using a laboratory experiment in which subjects compete to supply a single firm. We find that as capacity decreases, so do suppliers’ price requests, but according to a pattern quite different from equilibrium predictions. We find that a buyer has incentive to exclude at least 30% of available suppliers. This result calls for greater antitrust oversight and offers a behavioral explanation for observed reductions in capacity.