capacity expansion as a strategy
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CAPACITY
EXPANSION AS
A STRATEGY
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CONTENT
Introduction
Elements of capacity expansion
Causes of excess capacity Preemptive strategy
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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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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
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CONTIuuu..
Predict capacity additions by each competitor based on the
competitors expectations about the industry
Determine industry supply and demand balance and resultingindustry prices and costs.
Determine expected cash flows from capacity addition
Test the analysis for consistency
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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.
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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).
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STRUCTURAL
Significant Exit Barriers
Forcing by Suppliers
Building Credibility.
Integrated Competitors.
Capacity Share Affects Demand
Age and Type of Capacity Affects Demand
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COMPETITIVE
Large Number of Firms
Lack of Credible Market Leader(s)
New entry
First Mover Advantages
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INFORMATION FLOW
Inflation of Future Expectations
Divergent Assumptions or Perceptions
Breakdown of Market Signalling
Structural Change
Financial Community Pressure
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MANAGERIAL
Production Orientation of Management:
Asymmetric Aversion to Risk:
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GOVERNMENTAL
Perverse Tax Incentives:
Tax structures and/or investment tax credits can sometimes encourageover investment. Overbuilding is also promoted by tax-free retention ofearnings
Desire for Indigenous Industry:
Many countries will seek to establish a home-based industry, hoping tosell excess supply on world markets. If minimum efficient scale is largerelative 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 notdisinvest) to increase or maintain employment, a social goal. This factoraccentuates problems of overcapacity.
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LIMITS TO CAPACITY EXPANSION
There are some checks against the tendency for overbuilding, Someof 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 havebeen production-oriented or prone to overbuild to protect theirposition in their traditional industry
Infusion of top management with finance background to replacemanagement 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
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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 theperceived likelihood of technological obsolescence of the current
generation of capacity.
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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.
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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.
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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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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
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THANK YOU
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