You are on page 1of 19

CAPACITY EXPANSION AS A STRATEGY

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.

ELEMENTS OF THE CAPACITY EXPANSION DECISION


Determine the firms options for the size and type of capacity addition Assess probable future demand and cost of inputs Assess probable technological changes and probability of obsolescence

CONTIuuu..
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

CAUSES OF OVERBUILDING CAPACITY


COMMODITY BUSINESSES Demand is generally cyclical Cyclical demand not only guarantees overcapacity in downturns but also seems to lead to optimistic expectations in upturns. Products are not differentiated This factor makes costs crucial to competition, since the buyers' choice is heavily based on price. Also, the absence of brand loyalty means that firms' sales are closely tied to the amount of capacity they have. Thus, firms are under great pressure to have large, modern plants to be competitive and adequate capacity to achieve their target market share.

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.

LIMITS TO CAPACITY EXPANSION


There are some checks against the tendency for overbuilding, Some of the most common are the following: Financing constraints Company diversification, which raises the opportunity cost of capital and/or widens the horizons of management who may have been production-oriented or prone to overbuild to protect their position in their traditional industry Infusion of top management with finance background to replace management with marketing or production backgrounds Pollution control costs and other increased costs of new capacity Great uncertainty about the future that is widely shared Severe problems because of previous periods of overcapacity

DISCOURAGING CAPACITY ADDITIONS BY COMPETITORS:


A firm can sometimes influence the capacity expansion process in number of ways, by using its own behaviour to signal to competitors about its expectations or plans or by otherwise trying to influence competitors' expectations. a large announced capacity addition by the firm announcements, other signals, or information that carries a discouraging message about future demand. announcements, other signals, or information that elevates the perceived likelihood of technological obsolescence of the current generation of capacity.

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.

PREEMPTION WILL BE RISKY AGAINST THE FOLLOWING TYPES OF COMPETITORS:


Competitors with goals other than purely economic Competitors for whom this business is a major strategic thrust or is related to others in their portfolio Competitors who have equal or better staying power, a longer time horizon, or a greater willingness to trade profits for market position

THANK YOU

You might also like