One approach to capacity expansion in a growing market is the preemptive strategy, in which the firm seeks to lock up a major por-tion of the market to discourage its competitors from expanding and to deter entry. If future demand is known with certainty, for exam-ple, and a firm can build enough capacity to supply all the demand, other firms may be discouraged from building capacity. Usually a preemptive strategy 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 declines.
The preemptive strategy is an inherently risky one because it in-volves the early commitment of major resources to a market before the market outcome is known. In addition, if it is unsuccessful in de-terring 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.
As a result of the cost and risk of a preemptive strategy, it is im-portant to set forth the conditions that must be present for success. The preemptive strategy is risky partly because all these conditions must be satisfied.
Large Capacity Expansion Relative to Expected Market Size. If a move is not large in relation to the expected size of the market, it cannot be preemptive. Thus there are straightforward conditions for the size of the capacity expansion that must be made to preempt a market whose future demand conditions are known. However, a crucial issue is the expectations each competitor and potential com-petitor holds about future demand. If any competitor or potential competitor believes that future demand will be large enough to ab-sorb the preemptive capacity move and then some, it may choose to invest as well. Thus a firm attempting preemption either must be confident it knows the expectations of its competitors or must try to influence those expectations in such a way as to insure that its move will be viewed as preemptive.7 If competitors’ view of potential de-mand is unrealistically high, the preempting firm must communicate a credible commitment to quickly add further capacity if future de-mand proves higher than initially anticipated.
Large Economies of Scale Relative to Total Market Demand, or Significant Experience Curve. If economies of scale are large rela-tive to total market demand, an early preemptive capacity move may deny competitors enough residual demand to be efficient (see Figure 15-2). In this case, competitors who invest must invest heavily and risk a bloody battle to fill capacity, or they will have inherently higher costs if they invest on a small scale. Either they will be de-terred from investing at all, or if they invest on a small scale they will have a permanent cost disadvantage.
If there is a significant experience curve operating whose bene-fits can be made proprietary, the early, large-scale investor in capa-city will have a lasting cost advantage as well.
FIGURE 15-2. Preemptive Capacity Given Economies of Scale
Credibility of the Preempting Firm. The preemptive firm must carry credibility in its announcements and moves that it is committed to and able to execute the preemptive strategy. Credibility involves the presence of resources, needed technological capacity, historical delivery on planned investments, and so on.8 Without credibility, competitors either will not perceive the move as preemptive or will be willing to take on the preemptor anyway.
Ability to Signal Preemptive Motive Before Competitors Act. A firm must be able to signal that it is preempting the market in ad-vance of competitors’ commitments to invest. Thus it must put a preemptive amount of capacity in place before competitors even consider capacity decisions, or more likely, it must be able to an-nounce or otherwise credibly communicate its intentions. A firm must have credibility in executing the preemptive strategy as dis-cussed, and it must also have a credible way of indicating that pre-emption is its motive.
Willingness of Competitors to Back Down. The preemptive strategy assumes that competitors will weigh the potential returns of fighting the preempting firm and conclude that they do not justify the risks. A number of conditions may interfere with such a decision, a common thread being perceived high stakes in establishing or maintaining a significant position in the particular business being contested. Preemption will be risky against the following types of competitors:
- Competitors with goals other than purely economic: If competitors highly value participation in the industry be-cause of a long history or other emotional commitments, they may try to maintain their position against the preemp- tor despite the presence of other favorable conditions for preemption as described above.
- Competitors for whom this business is a major strategic thrust or is related to others in their portfolio: In this situa-tion, even though it might be rational not to fight the pre- emptor firm were a competitor to view the contested busi-ness in isolation, it perceives its presence in the business as broadly signifi Thus it may be nearly impossible to suc–cessfully preempt.
- Competitors who have equal or better staying power, a longer time horizon, or a greater willingness to trade profits for market position: There may be competitors who will take a very long view of success in the business and be willing to battle it out for a long period of tim A preemptive strategy becomes questionable in such a situation.
Source: Porter Michael E. (1998), Competitive Strategy_ Techniques for Analyzing Industries and Competitors, Free Press; Illustrated edition.