Demand has turned up bringing a tight market and more capacity

Symptom: The recent upturn in demand and subsequent tight capacity have prompted some competition to add capacity.

Implications for the market:

• These capacity additions are inevitable. They offer very high returns on investment, even without the more-or-less temporary higher price levels. This is because overhead costs, which are downstream of the production capacity added, are more fixed than are production costs and do not need to be increased proportionally as the business grows. Capacity additions are therefore marginally attractive–and competitors all seem to follow the same rule of thumb: "If I can sell it, I will make it."

• They are also problematic. Normally, an industry increases its effective capacity by 1-3% every year, for little or no cost, due to the effects of learning curve. But, when new capacity comes on in large increments in a relatively fragmented a relapse into overcapacity is a likely result.

• But the end of hostile times has relatively little to do with capacity. Rather, hostility ends when competitors stop competing on price.

  • Virtually all industries have excess capacity to one degree or another. Yet some industries can have high returns despite this "overcapacity." This happens because the key competitors in the market: (1) control over 75% of the market; (2) will not discount to gain share; and (3) are reasonably satisfied with their current market shares.

  • Hostility ends, finally, when customers cannot get a better price on equivalent performance from an alternate supplier because no one is willing to discount to gain share.