Co-Opetition - Adam M. Brandenburger [61]
The textbook analysis of capacity expansion assumes that the profit from a sale is the same, regardless of whether there’s a shortage or a surplus. That’s a bad assumption. There’s a big asymmetry between the two cases. Underbuild a little, and each customer has little added value. Overbuild a little, and every customer is as powerful as you are. Your margins will be much healthier when there’s a shortage rather than a surplus. It’s the Card Game once again. Just a small change, up or down, in the number of black cards made a big difference in how Barry fared relative to the students.
Thinking in terms of added value tips the balance in favor of building less rather than more. You’d rather err by having too little capacity. Excess capacity carries a big cost—in terms of lost bargaining power—that is often overlooked.
The surprising asymmetry between shortages and surpluses helps explain the recurring cycles seen in industries ranging from pulp and paper to chemicals to hotels to memory chips to property and casualty insurance. Someone expands capacity and suddenly everyone’s profits fall precipitously. Even a very little excess capacity can cause profits to fall a very long way. The sharp fall in profits leads to a moratorium on capacity expansion.15 Meanwhile, demand continues to grow, and before too long, there’s insufficient capacity. Power shifts back to the producers, and now they’re back in the black. Someone gets enthusiastic and overexpands, even just a little, and the cycle repeats itself.
So far, the message is: beware oversupply. But don’t go overboard. There are some hidden costs of undersupply that you need to factor into the equation. Undersupplying products shrinks the pie: it leaves unsatisfied demand today. And a lost sale today can mean a lost relationship—lost future sales, too. The shortage is also likely to create ill will. Customers who don’t get the product will certainly be unhappy, and even those who do get supplied may resent the high price you charge. There’s an offsetting factor if the shortage creates a cachet effect—as with Nintendos and diamonds—but that shouldn’t be taken for granted.
In short, undersupply creates a hole in the market and disenchants customers. It’s an invitation for others to enter. Even the customers you’re selling to might welcome the chance to switch and teach you a lesson. That’s why you might do better in the long run by playing Adam’s version of the Card Game rather than Barry’s. You’d sacrifice some profits today, but you’d keep the game going.
Limiting Supply
PROS
1. Gets you a bigger slice of the pie.
2. May give you cachet.
3. May provide free publicity.
4. May lead customers to buy your slower-moving products while waiting for the shortage to end.
CONS
1. Shrinks the pie—costs you sales today.
2. May cost you a relationship and thereby future sales.
3. Creates ill will.
4. Leaves a hole in the market, inviting entry.
So far we’ve been assuming that you have some added value. The focus was on whether and how to limit the added values of the other players in the game. Of course, you can’t take your added value for granted. The next section takes a look at ways to engineer added value.
2. Added Value in a Competitive World
In a competitive world, you have to work hard to have any added value. This hard work is what a lot of basic business is about. You find ways to make a better product, and you look to use resources more efficiently. You listen to your customers to learn how to make your products more attractive to them. You work with your suppliers to discover ways to run your business more efficiently for you and more effectively for them. You step into the shoes of your customers and suppliers and understand their perspectives.
But life isn’t that simple. There’s a catch: improving the product increases the cost. Likewise, if you cut costs, you compromise your product. There’s a quality-cost trade-off. You can have higher