Capacity Expansion as a Strategy

8/2/2019 Capacity Expansion as a Strategy

1/19

CAPACITY

EXPANSION AS

A STRATEGY


2/19

CONTENT

Introduction

Elements of capacity expansion

Causes of excess capacity Preemptive strategy


3/19

INTRODUCTION

Basic assumptions

Expectation about future demand

Competitors behaviour

Capacity expansion

Involves large investments and excess capacity could be

detrimental to the firm.


4/19

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


5/19

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


6/19

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.


7/19

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).


8/19

STRUCTURAL

Significant Exit Barriers

Forcing by Suppliers

Building Credibility.

Integrated Competitors.

Capacity Share Affects Demand

Age and Type of Capacity Affects Demand


9/19

COMPETITIVE

Large Number of Firms

Lack of Credible Market Leader(s)

New entry

First Mover Advantages


10/19

INFORMATION FLOW

Inflation of Future Expectations

Divergent Assumptions or Perceptions

Breakdown of Market Signalling

Structural Change

Financial Community Pressure


11/19

MANAGERIAL

Production Orientation of Management:

Asymmetric Aversion to Risk:


12/19

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.


13/19

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


14/19

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.


15/19

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.


16/19

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.


17/19

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.


18/19

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


19/19

THANK YOU

Capacity Expansion as a Strategy

Documents

Transcript of Capacity Expansion as a Strategy