Abstract: Certain extensions of the competitive newsvendor model are presented in this paper in an attempt to investigate the value of using reactive capacities under demand substitution. Two demand structures are considered here: the former denotes total demand as a piece-wise linear function of inventory levels for the two firms, and the latter holds that the mean of the total demand is an arbitrary function of stocking quantities for the two firms. In accordance with demand structures, two inventory-based competition models are formulated and corresponding equilibrium inventory policies are developed. Then, based on the relevant equilibrium results, values of reactive capacity are derived. It is identified that the firm can simultaneously lower its inventory level and increase the customer service level by applying reactive capacity. Besides, under different demand structures, the value of applying reactive capacity increases along with the reactive capacity level and the unit shortage penalty cost, but decreases with the unit cost of reactive capacity.

Key words: reactive capacity, demand substitution, inventory competition, value