Can Uncertainty Increase Investments in the Hospitality Industry? Understanding Overbuilding and Overcapacity

Article - Monday, 12 May 2025

Duro, J.A., Osorio, A., Pérez-Laborda, A. (2025): "Can Uncertainty Increase Investments in the Hospitality Industry? Understanding Overbuilding and Overcapacity", Tourism Economics

Investing in tourism lodging capacity is often a gamble, as decisions must be made long before demand is known. This uncertainty creates a challenging environment where investors must anticipate future market conditions. In our research, we developed a two-stage theoretical model to analyze how firms make capacity investment decisions under uncertainty and how strategic competition shapes these choices. Surprisingly, we found a U-shaped relationship between investment and uncertainty-an insight that reconciles previously conflicting studies on the subject.

When uncertainty is relatively low, an increase in uncertainty tends to reduce capacity investment, as firms become more cautious about potential demand fluctuations. However, when uncertainty is high, the opposite occurs-firms increase their investments. The reason lies in strategic supply restrictions. Once capacity is built, it fixes market supply, which in turn limits competition. In extreme favorable scenarios, demand surges, and firms with larger capacity can capture a disproportionate share of profits. Anticipating this, tourism operators invest aggressively upfront to ensure they are well-positioned when demand spikes.

This finding helps explain why overbuilding is common in tourism and why the hospitality industry frequently experiences overcapacity. It also clarifies conflicting theories on investment under uncertainty, showing that firms aren't just reacting to risk-they're strategically using it to their advantage. Understanding this behavior is crucial for policymakers and investors aiming to balance market efficiency with sustainable tourism development.