Game-Theoretic Approaches to Product Introduction Strategies Using Real Options Valuation with Regime Switching

New product demand continuously fluctuates throughout the life of the product.As a result, markets typically experience high volatility.Most companies operate in highly competitive industries where the product volume supplied by the competitors has a significant effect on production plans.These conditions necessitate companies to be flexible and rapidly adapt to such volatility.In this study, we investigate the product introduction strategies under two microeconomic theories: the real options valuation and the game theory.Specifically, we develop a real options valuation framework with a flexible capacity based on the two game theory models, namely, Stackelberg and Cournot, in a duopoly market where competitors have either perfect or imperfect information.Furthermore, we construct a lattice to discretize the demand evolution and adopt a regime-switching approach to characterize the stochastic product lifetime.We conduct an extensive numerical study and compare Net Present Values ($\NetPresentValue$) and optimal initial capacities obtained from the game-theoretic models.Our results show that under perfect information, the Stackelberg competition generates more supply with lower prices and less total $\NetPresentValue$ than the Cournot competition.Moreover, we find that the flexible capacity system increases the $\NetPresentValue$ in the Stackelberg game (by 5.5\%) more than in the Cournot game (by 3.3\%) compared to the fixed capacity system on average.We provide further results on the performance of the companies based on detailed sensitivity analysis for various model parameters.In particular, we observe that fixed and variable production and installation costs majorly impact capacity allocation decisions and the profits.