Can uncertainty increase investments in the hospitality industry? Understanding Overbuilding and Overcapacity

Abstract

The investment in tourism lodging capacity is often done in contexts of great uncertainty because decisions are made well before the demand is known. In this paper, we consider a two-stages theoretical model of capacity investment and strategic competition to study investment under uncertainty. We found a puzzling u-shaped relation between investment and uncertainty. While for low levels of uncertainty capacity investments may decrease with uncertainty, the opposite happens for high levels of uncertainty. In the latter, the ex ante capacity investments fix the ex-post supply which restricts competition. This restriction increases prices and profits in extreme favourable scenarios proportionally more than in unfavourable scenarios. Anticipating this possibility, touristic operators increase their ex ante investments to obtain a larger share of this excess demand and consequent profits. Our findings conciliate existing contradictory results, explain the tourism overbuilding phenomena and the hospitality industry tendency for overcapacity.