Innovative Applications of O.R.
Technology improvement strategy for green products under competition: The role of government subsidy

https://doi.org/10.1016/j.ejor.2020.07.030Get rights and content

Highlights

  • A game model is applied to explore the firms’ technology improvement strategies.

  • The role of government subsidy is investigated in a competitive environment.

  • An asymmetric equilibrium arises if the cost and market expansion match each other.

  • Firms may trap into a prisoner’s dilemma which can be eased by government subsidy.

  • Government subsidy is not always beneficial from the perspective of firm’s profits.

Abstract

Nowadays, the growing global concerns about sustainable issues have placed high pressure on firms to improve production technology and reduce energy consumption. However, firm’s incentive may be weakened due to high costs. The government has recognized the firms’ predicament and provided financial support to incentivize them to improve technology. This study builds a game model which consists of a government and two competing firms to investigate the equilibrium solutions that the two symmetric firms can reach on their technology improvement strategies, and analyze the role of government subsidy. Results show that both firms apply the existing technology when it is obviously costly to improve technology, and both improve technology when the benefit of market expansion is relatively large, while they reach an asymmetric equilibrium with one improving technology and the other not when the cost and the market expansion associated with improving technology can match each other. Besides, the two firms may trap into a prisoner’s dilemma when they reach the equilibrium of both improving the technology. Encouragingly, government subsidy can serve as an effective way to alleviate the prisoner’s dilemma by easing firms’ financial burden for technology improvement. In addition, government subsidy is conducive to expanding the green product market and improving the social welfare. Finally, government subsidy may improve both firms’ profits except for the firm applying the existing technology in the asymmetric equilibrium when the cost of improving technology is moderate.

Introduction

It is well known that human activities have placed enormous energy burdens on earth. According to the forecast by U.S. Energy Information Administration (EIA), global energy consumption will increase by 50% from 2005 to 2030 at the current growth rate. This rapid surge in energy consumption will not only lead to a serious energy shortage crisis in the future but also harm the environment in the form of greenhouse gas emissions. Therefore, with the dual pressures of energy crisis and environmental protection, many countries around the world have paid great attention to the green products. For instance, for the automotive industry, one effective way to reduce emissions is to use clean energy such as biofuel, which has drawn the worldwide attention. The European Parliament has voted in 2013 in favor of a partial switchover to second-generation biofuel, and the use of waste cooking oil (WCO) as a feedstock for biofuel production has aroused the government’s interest for the reason that the biofuel production cost can be reduced by 60–90% by the usage of WCO (Boutesteijn, Drabik, Venus, 2017, Talebian-Kiakalaieh, Amin, Mazaheri, 2013). In addition, another constructive approach being implemented in the automotive industry is to vigorously promote electric vehicles to gradually reduce the market for existing high-emission gasoline and diesel vehicles. Some major leading electric vehicles, such as Nissan Leaf, have already been introduced to the US market since 2010 (Cohen, Lobel, & Perakis, 2015).

In spite of this general trend, there are still some difficulties holding back the development of the green product market, one of which refers to production technology. Taking the WCO-to-biofuel production in China as an example, as the largest producer of WCO, China has been severely facing the environmental and food safety problems caused by WCO, which highlights the necessity of reasonable recycling and utilization of WCO, especially for the WCO-to-biofuel production. However, China is just in initial stage and the production technology is not mature, many gaps still exist compared with other countries, such as the US, Canada, EU and Brazil. Under the current immature production technology, the purity of biofuel obtained from WCO is low, which affects the combustion performance of biofuel and hinders its market promotion (Stephen & Periyasamy, 2018). Taking the electric vehicles for another example, key technologies are constantly being updated, particularly for the production technology of battery. Compared with vehicles powered by traditional fuels, the relatively limited cruising capacity of electric vehicles is one of the biggest barriers for its further market expansion. Automobile enterprises are always seeking for better technology to produce high-energy and long-lasting battery to meet consumer needs. The production technology is the key issue for green products production and should be highly valued since different production technology can significantly influence the performance of the final product. The unsatisfying performance will weaken the competitiveness of green products compared with conventional ones, which in turn hinders the expansion of the green product market, highlights the necessity for the improvement of production technology. As a result, many countries have spared no effort to promote the development of the technology and encouraged firms to improve their production technology with the purpose of producing higher performance products and expanding the green product market. From the perspective of the firms, their profitability can be enhanced since they can benefit from the market expansion with higher performance products by improving the technology. However, they will also bear serious financial burden due to the high cost of improving technology. Therefore, the firms need to weigh the pros and cons, and decide whether to improve the technology or not.

To actively promote and encourage the firm’s technology improvement, the government, as a lever to regulate the market and optimize its allocation, has concentrated a lot on employing generous financial support to the firm in the hope that the firm will widely replace the existing backward technology. In terms of policies, for instance, the Chinese government has launched the Tenth Five year Programme for National Key Technology Research and Development in 2004. Specially, for the biofuel, according to Middle and Long Term Programme of Renewable Energy Development issued in 2007, the government should attach importance to biofuel technology, which has a favorable development prospect (Zhang, Wang, & Mortimer, 2012). One of the most important financial support measures is that the government has provided subsidy to the firm who decides to improve the technology to lighten the firm’s financial burden for technology improvement. Nevertheless, whether the government subsidy can indeed promote the firm’s technology improvement effectively and what are the impacts of government subsidy are ambiguous, which deserve further exploration.

One key factor affecting the firm’s decision is competition, that is, there is usually more than one firm on the market. In the field of lithium-ion battery, many companies are taking actions in this industry in the hope of applying battery to electric vehicles, thereby reducing greenhouse gas emissions. E-One Moli Energy and Chinese Wanxiang Group are some of the major companies trying to improve the production technologies to enhance the performance of the battery and compete for the battery market (Feng & Magee, 2020). Competition can influence the value of technology improvement, which in turn affects the firm’s incentive to improve the technology. On one hand, the firms may be more motivated to improve their technology in highly competitive environments for the reason that the more advanced technology usually improves their competitiveness and product performance. On another hand, the improvement of technology which incurs high costs will further aggravate the competition, leading the firms to be less willing to improve their technology. The joint effects of the two opposite predictions on the firms’ technology improvement decisions are not clear. Hence, it is especially necessary to investigate the firms’ strategies in a competitive environment.

Based on the above-mentioned issues, this paper is motivated to investigate the firm’s technology improvement strategy under competition. Besides, to explore the role of the government, we first examine the firms’ technology improvement strategies without government subsidy, which serves as a benchmark. Then we further explore their technology improvement strategies under government subsidy. Accordingly, the above discussions raise the following research questions: (i) What are the equilibrium outcomes both firms will reach with respect to their willingness for technology improvement without government subsidy? Are the equilibrium outcomes in the best interests of the two firms? (ii) What is the government’s optimal subsidy strategy if he decides to intervene? And how the equilibrium outcomes will change compared with those without government subsidy? (iii) What are the effects of the government subsidy on both firms’ profits, the environment as well as the social welfare?

To answer these questions, this paper resorts to the commonly used game-theoretic approach in a management system which consists of the government and two competing firms. The two firms will conduct the Cournot competition and each of them needs to decide the production quantity of green products. Besides, under the condition of government subsidy, a Stackelberg game model is conducted where the government will act as the leader and the two firms act as the followers. By solving the model, the comparisons of the equilibrium outcomes without government subsidy and those with government subsidy are also carried out to explore the effects of government intervention. Main results are summarized as follows. First, for both cases without the government subsidy and with government subsidy, the two firms apply the existing one when it is obviously costly to improve technology; they will both improve technology when the benefit of market expansion is large; otherwise, they may reach an asymmetric equilibrium with one improving technology and the other not when the cost and the market expansion associated with improving technology can match each other. We also find that without the government subsidy, a prisoner’s dilemma may occur when the cost of improving technology is moderate and both firms improve the technology. The parameter regions of the prisoner’s dilemma always enlarge as the basic market demand expands, while may shrink as competition intensifies when the market expansion level is relatively large. Second, the government subsidy can effectively ease the firms’ financial burden and promote them to improve the technology, more likely resulting in the equilibrium that both firms improve the technology (denoted as SII). Moreover, under government subsidy, the prisoner’s dilemma can be well alleviated, though cannot be completely eliminated. Third, the effects of government subsidy can be revealed by comparing the total quantity of green products, both firms’ profits as well as the social welfare. We find that the total production quantity under government subsidy is always no less than that without government subsidy. This translates that the government can improve environmental governance to some extent by providing financial support. Moreover, the government subsidy is not always beneficial considering both firms’ profits. When the cost of improving technology is moderate, the government subsidy may change the equilibrium from that both firms do not improve technology (denoted as NN) to that only one firm improves technology (denoted as SIN/SNI), and the profit of the firm who applies the existing technology will be severely damaged. Otherwise, when the technology improvement cost is relatively small/large, both firms’ profits will be no less than that without government subsidy. As for the social welfare, it has also been significantly improved, indicating the effectiveness of government subsidy.

The remainder of this paper is organized as follows. Section 2 provides literature review. Section 3 presents the basic model setting. Section 4 explores both firms’ technology improvement strategies without government subsidy. Section 5 carries out both firms’ technology improvement strategies with government subsidy. Section 6 makes comparisons of the previous two sections and explores the impacts of government subsidy, which gives managerial implications. Section 7 extends the model by altering the assumptions of the same social effects of the products produced by different technologies and an exogenous product performance improvement in the base model. This study ends up by some concluding remarks in Section 8.

Section snippets

Literature review

Our research lies at the intersections of the literature on the green products and production technologies, the government subsidy as well as competition. Next we will describe the relationship between our work and the literature in these areas in detail and highlight our contributions.

Model

We consider a management system which consists of the government (he) as well as two firms (she) producing green products. Each firm can choose to improve her technology or use the existing one. The government, as a lever to regulate the market, will provide subsidy to the one who chooses to improve the technology for promoting the development of green product industry. The two firms will conduct the Cournot competition and each of them needs to decide the production quantity of the green

Without government’s subsidy

In this section, we investigate the equilibrium solutions for the cases that without government’s subsidy: neither firm improves (case NN), one of the firms improves (case IN) and both firms improve (case II). In this benchmark setting, only two firms are involved in the game and they conduct the Cournot competition. Accordingly, the sequence of events is described as follows. First, each firm decides whether to improve the technology or not. If the decision for technology improvement has been

With government’s subsidy

In this section, we explore the equilibrium results in the presence of government subsidy. For better description, another capital letter “S” is applied to stand for the condition with government subsidy, and the three cases correspond to the benchmark are represented by SNN, SIN and SII, respectively. As we described before, then the firm’s profit can be formulated as follows:maxqiπiS=(pi+s×I1)qiK×I1,where I1 is also an indicator function which equals to 1 if the firm chooses to improve the

Impacts of government subsidy

In this section, we will further examine whether the government subsidy can improve the environmental impact, the firms’ profits, as well as the social welfare. Due to the analytical challenge, we have to resort to numerical studies. The benchmark parameter settings are applied as follows: a=1,β=1,θ=0.4, which can ensure that both players’ decisions, firms’ profits and social welfare are positive. Note that it can be numerically verified that the main outcomes would not be influenced

Extensions

This section verifies the robustness of our proceeding results by extending the model from the aspects of considering different social effects and endogenous product performance improvement, which are respectively explored in the following sections.

Conclusions

With the increasingly serious energy crisis and environmental problems, the green products have been drawing the worldwide attention. The high cost for improving the technology and competition in the market have been barriers in the firms’ decisions of whether to improve the technology. The government has been conscious of firm’s predicament and is committed to providing financial support to the firm who improves technology. By conducting game model in a management system which consists of the

Disclosure statement

No potential conflict of interest was reported by the authors.

Acknowledgments

This work was supported by National Natural Foundation of China No. 71971152 and No. 71771164.

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