United we stand? Coordinating capacity investment and allocation in joint ventures

Among the recent innovative strategies for coping with product variety and market risk some firms have partnered to leverage economies of scale and risk pooling by sharing manufacturing capacity. In this paper we study how to structure such a joint venture to achieve full efficiency at low transaction costs. Specifically, we study whether capacity should be owned jointly or separately. Overall, we find that the two ownership structures have complementary strengths and weaknesses in term of their incentives for coordinating capacity allocation and investment. On the one hand, capacity allocation is simple to coordinate under joint ownership, but may entail high transaction costs under separate ownership when the joint venture consists of many firms with different profit margins. On the other hand, capacity investments remain simple to coordinate under separate ownership, but are efficient under joint ownership only in the presence of large economies of scale or asymmetric demands or asymmetric profit margins, and would otherwise entail high transaction costs. Our analysis thus characterizes the trade-off between economic benefits and transaction costs in the choice of capacity ownership structure.