How to escape a declining market: Capacity investment or exit

摘要

In the advent of digital photography, industrial giant Kodak started losing its revenue steadily since conventional photographic materials were fading from the market. The company tried to get as much from their existing technology for few more years and tried to be in the business with digital camera the market for which is too small for a company of Kodak's size. Eventually that also failed because of the boom in camera phones. The company has to face its natural end because of evolving new technology. Firms in such situations have to decide either to exit or invest in new technologies. Kodak's example is one where investment is a futile option. However, there are organizations that faced similar problems but escaped because of innovative ideas and investments. This study examines the problem of a price setting firm with declining sales so that it has to either exit or invest in new technology. The firm is a monopolist with uncertain demand and the inverse demand function depends on a geometric Brownian motion process. Upon investment the new product will have a higher demand than the established product but may have negative drift. The objective of this study is to find whether it is optimal to enter into the new product line and if the decision is for it the capacity of the new product to be produced in the facility for which investment has to be made. The firm can also decide to exist the manufacturing of the existing product and deter from new investment. It is shown that when the uncertainty goes up the firm invests later but on higher capacity when the market is uncertain. If the market trend is encouraging, then the firm invests without waiting but on lesser capacity. This is because with lower optimal capacity the firm wants to enter the market as fast as possible. Another factor of importance is the effect of the price on the demand. If the effect is high then the firm invests in lower capacity. Also if the quantity affects the price, the profitability of the product is low and the firm would like to make the investment later. (32 refs.)