We consider a supply chain consisting of a supplier and two retailers. The supplier sells a
single product to the retailers, who, in turn, retail the product to customers. The supplier has
limited production capacity, and the retailers compete for the supplier's capacity and are
duopolists engaged in Cournot competition for their customers. When the sum of the
retailers' orders exceeds the supplier's capacity, the supplier allocates his capacity
according to a preannounced allocation rule. We propose a new capacity allocation rule …

In practice, a supplier with limited capacity often puts capacity on allocation, ie, rationing
capacity through quantity competition of retailers rather than through a pricing mechanism.
Capacity allocation is a common occurrence in industries in which capacity expansion is
costly and time consuming and price is given exogenously (eg, steel and paper). A supplier
can use his prior beliefs on his own and the retailers' needs to construct a capacity allocation
mechanism for allocation of his capacity among retailers.