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Chapter 18: Problem 1

Why would anyone want to add capacity before demand has materialized? Why would anyone want to lag behind demand?

Short Answer

Expert verified
Answer: Adding capacity before demand materializes has pros like being prepared for future demand, gaining a competitive advantage, securing resources, and taking advantage of economies of scale. However, it comes with cons like increased risk, opportunity cost, and negative cash flow. On the other hand, lagging behind demand offers benefits like lower risk, financial stability, and flexibility, but it also has downsides like delays in meeting demand, competitive disadvantage, and potentially higher costs. The appropriate strategy depends on market conditions, competitive landscape, and financial situation of the company.

Step by step solution

01

Understand adding capacity before demand materializes

Adding capacity before demand materializes refers to a proactive approach, where a business invests resources to increase its production or service capacity in anticipation of future demand. This strategy can be beneficial in certain situations, such as when there are high growth expectations, competitive advantages to be gained, or when there is a need to secure resources in advance.
02

Pros of adding capacity before demand materializes

The benefits of adding capacity before demand has materialized are: 1. Being prepared to meet the future demand, avoiding delays or shortages. 2. Gaining a competitive advantage by being the first to provide new products or services in the market. 3. Securing important resources, such as labor, materials or equipment, that may become scarce or more expensive in the future. 4. Taking advantage of economies of scale, lowering production costs and increasing profit margins.
03

Cons of adding capacity before demand materializes

The downsides of adding capacity before demand has materialized include: 1. Increased risk: There's no certainty that the anticipated demand will materialize, potentially leading to unutilized capacity and wasted resources. 2. Opportunity cost: The company may miss out on other investment opportunities while focusing on expanding capacity. 3. Negative cash flow: Expanding capacity typically requires significant upfront investment, which can strain the company's finances.
04

Understand lagging behind demand

Lagging behind demand refers to a reactive approach, where a company waits for the demand to materialize before expanding its capacity. This strategy can be beneficial in certain situations, such as when the market is uncertain or volatile, and resources need to be optimized.
05

Pros of lagging behind demand

The benefits of lagging behind demand include: 1. Lower risk: Companies can validate demand before investing in capacity expansion, reducing the risk of underutilized resources. 2. Financial stability: Delaying expansion allows the company to maintain positive cash flow and invest in capacity only when there's a proven need. 3. Flexibility: Companies can adapt quickly to market changes without being burdened by excess capacity.
06

Cons of lagging behind demand

The downsides of lagging behind demand include: 1. Delays in meeting demand: Unable to quickly respond to an increase in demand may lead to customer dissatisfaction and lost sales. 2. Competitive disadvantage: Other companies may capitalize on the demand, resulting in a loss of market share. 3. Higher costs: Delaying capacity expansion may result in higher costs due to scarcity of resources or inefficiencies in scaling production when demand finally materializes.
07

Conclusion

In conclusion, both strategies - adding capacity before demand materializes and lagging behind demand - have their advantages and disadvantages. The appropriate strategy depends on various factors, such as the market conditions, competitive landscape, and financial situation of the company. Ultimately, businesses should carefully analyze these factors and choose the strategy that best aligns with their goals and risk tolerance.

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