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CONTENT
Introduction Elements of capacity expansion Causes of excess capacity Preemptive strategy
INTRODUCTION
Basic assumptions Expectation about future demand Competitors behaviour Capacity expansion Involves large investments and excess capacity could be detrimental to the firm.
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Predict capacity additions by each competitor based on the competitors expectations about the industry Determine industry supply and demand balance and resulting industry prices and costs. Determine expected cash flows from capacity addition Test the analysis for consistency
TECHNOLOGY
1. Adding Capacity in Large Lumps. 2. Economies of Scale or a Significant Learning Curve. 3. Long Lead Times in Adding Capacity. 4. Increased Minimum Efficient Scale (MES).
STRUCTURAL
Significant Exit Barriers Forcing by Suppliers Building Credibility. Integrated Competitors. Capacity Share Affects Demand Age and Type of Capacity Affects Demand
COMPETITIVE
Large Number of Firms Lack of Credible Market Leader(s) New entry First Mover Advantages
INFORMATION FLOW
Inflation of Future Expectations Divergent Assumptions or Perceptions Breakdown of Market Signalling Structural Change Financial Community Pressure
MANAGERIAL
Production Orientation of Management: Asymmetric Aversion to Risk:
GOVERNMENTAL
Perverse Tax Incentives: Tax structures and/or investment tax credits can sometimes encourage over investment. Overbuilding is also promoted by tax-free retention of earnings Desire for Indigenous Industry: Many countries will seek to establish a home-based industry, hoping to sell excess supply on world markets. If minimum efficient scale is large relative to the world market, it is likely to lead to overcapacity. Pressures to Increase or Maintain Employment: Governments sometimes exert great pressures on firms to invest (or not disinvest) to increase or maintain employment, a social goal. This factor accentuates problems of overcapacity.
PREEMPTIVE STRATEGIES
In which the firm seeks to lock up a major portion of the market to discourage its competitors from expanding and to deter entry.
PROPERTIES
An approach to capacity expansion in a growing market. Requires not only investments in facilities but also in withstanding marginal or even negative short-term financial results. Capacity is added in anticipation of demand, and prices are often set in anticipation of future cost decline. The preemptive strategy is an inherently risky one -it involves the early commitment of major resources to a market before the market outcome is known. if it is unsuccessful in deterring competition it can lead to disastrous warfare. since major overcapacity results and the other firms attempting preemption have made a major strategic commitment to the market from which it may be hard to back down.
CONDITIONS
Large capacity expansion relative to expected market size. Large economics of scale relative to total market demand. Credibility of preempting firm. Ability to signal preemptive motive before competitors. Willingness of competitors to back down.
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