Capacity Expansion

Question 1

What is Capacity Expansion?

Answer 1

The process of increasing an economic unit’s operational scale.

Porter, Competitive Forces — P. 390.

It is one of the most important strategic considerations in many businesses, especially in highly commodified markets.

Question 2

What are the Main Variables when considering whether or how much to Expand Capacity?

Answer 2

• Future demand, to ensure there is a need for the increased capacity.
• Rival capacity expansion, to ensure warfare does not result from overcapacity.

Porter, Competitive Forces — P. 390.

Question 3

How should a Firm evaluate the prospect of Capacity Expansion?

Answer 3

1. Which types of capacity and how much should we add?
2. What is the probability of future demand?
3. What is the total cost?
4. What is the probability of obsolesence?
5. What is the probability and scale of Industry-wide capacity expansion based on all major Rivals’ profiles, and how will they react to news of capacity expansion?
6. How will capacity expansion, and reactions thereto, impact market share and Industry-wide demand, supply, prices, and costs?
7. What are the Firm’s expected cashflows under the new equilibrium?
8. What are the inconsistencies in the Firm’s assumptions, analysis, and predictions?

Porter, Competitive Forces — P. 393.

This process must be performed interactively, with regular cross-referencing of earlier and later questions.

Question 4

What are the Main Causes of Overcapacity?

Answer 4

• High lead times.
• High Exit Barriers.
• High rivalrousness.
• High learning curves.
• High Scale Economies.
• High demand cyclicality.
• High Supplier bargaining power.
• High probability of obsolesence.
• High certainty re future demand.
• High degree of structural change.
• High degree of vertical integration.
• High degree of government subsidisation.
• High pressure from the financial community.
• High divergence in perceptions re future demand and Rival strategies.
• Low Entry Barriers.
• Low differentiation.
• Low trust in market signaling.
• Low certainty re future demand.
• Low precision in capacity addition.
• Low market share concentrations.
• Low credibility with downstream players over capacity.
• Structural rewards for moving first.
• Structural rewards for capacity leadership.
• Managerial aversion toward risk.
• Managerial disposition toward production.

Porter, Competitive Forces — P. 396-402.

Question 5

What is the Preemptive Approach toward Capacity Expansion?

Answer 5

The early securement of major market share through capacity in anticipation of future demand to discourage Rival entry or expansion.

Porter, Competitive Forces — P. 403.

This is very risky because of the high degree of uncertainty with respect to future demand and Rival reactions.

Question 6

Which Conditions are necessary for the Preemptive Approach to be viable?

Answer 6

• High and proprietary learning curves.
• High Firm credibility and the ability to signal it.
• High Scale Economies predicated upon securing major market share.
• High capacity addition relative to expected market size, as informed by each present and prospective Rival’s assumptions of future demand.
• Low tenacity in Rivals.

Porter, Competitive Forces — P. 405-406.