Chapter 15 (Capacity Expansion) Capacity expansion is one of the most significant strategic decisions faced by firms, measured both

in terms of the amount of capital involved and the complexity of the designmaking problem. It is probably the central aspect of strategy in commodity-type business. Because capacity additions can involve lead times measured in years and capacity often long lasting, capacity decisions require the firm to commit resources based on expectations about conditions far into the future. In this chapter Potter try to explain the capacity expansion decision in a strategic context. First, will explain about the element of decision outliner, and next is the causes of overbuilding and some approach to preventing it. Elements of the Capacity Expansion Decision The mechanics of making a capacity expansion decision in the traditional capital budgeting sense are quite straightforward, for an instance like a future cash flow and the positive cash flow. In view of the complexity of the discounted cash flow calculation that properly includes these elements, it is useful model to capacity decision with as high as possible. And the steps are : Determine the firms options for the size and type of capacity additions, Assess probable future demand and costs of inputs, Asses probable technological changes and probability of obsolescence, Predict capacity additions by each competitor based o the competitors expectations about the industry, Add these to determine industry supply and demand balances, and resulting industry prices and costs, Determine expected cash flows from capacity addition, and Test the analysis for consistency. Causes of Overbuilding Capacity There seems to be a strong tendency toward overbuilding of capacity, particularly in commodity business. The risk of overbuilding is most severe commodity businesses, for two reasons: Demand is generally cyclical and Products are not differentiated. And the condition leads to overbuilding are: technological Aspect (Adding Capacity in Large Lumps, Economies of Scale a Significant Learning Curve, Long Lead Times in Adding Capacity, Increased Minimum Efficient Scale, Changes in Production Technology), structural aspect (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 Leaders, New entry, First Mover Advantages), Information Flow (Inflation of Future Expectations, Divergent Assumption or Perceptions, Breakdown of Market Signaling, Structural Change, Financial Community Pressure), Managerial ( Production Orientation of Management, Asymmetric Aversion to Risk), Governmental (Perverse Tax Incentives, Desire for Indigenous Industry, Pressures to Increase or Maintain Employment). And there are factors that can limit the capacity expansion, which are: Financing constraint, Company diversification, Infusion of top management, Pollution control cost and uncertainty. Preemptive Strategies The approach to capacity expansion in a growing market is the preemptive strategy. Usually a preemptive strategy requires not only investment in facilities but also in withstanding marginal or even negative short-term financial result. The preemptive strategy is an inherently risky one because it involves the early commitment of major resources to a market before the market outcome is known. To conducting preemptive strategy, there are some factors and conditions that needed to fulfill, there are conditions: Large Capacity Expansion Relative to Expected Market Size, Large Economies of Scale Relative to Total Market Demand or Significant Experience Curve, Credibility of the Preempting Firm, Ability to Signal Preemptive Motive before Competitors Act, Willingness of Competitors to Back Down.