Quality and capacity choices in a vertical differentiation model with congestion

We consider a vertically differentiated market in which consumers utility is assumed to depend on the price, congestion level and the stand-alone quality of the good or service. Two firms compete on this market, choosing capacities, stand-alone qualities and prices. We characterize completely the subgame perfect equilibrium for the homogenous market case (where only one firm is active without congestion). We prove that both firms are active, choosing minimal differentiation along the capacity and quality dimensions. Therefore, the presence of congestion rules out market preemption as a possible outcome in equilibrium and weakens the incentive to differentiate.