Does the Withdrawal of Capacity Help?

As industry prices fall, and companies’ fortunes decline with the resultant squeeze on their margins, some companies, especially the leaders, seek to withdraw capacity from the market.  The leading companies expect the capacity withdrawal to do two things: redress the imbalance between capacity and demand; and raise prices to more attractive levels because of this better balance.  In practice, the withdrawal of capacity often fails to achieve either of these objectives.

Whenever a leader in an industry reduces its capacity to force price increases, it must consider how competitors will respond.  In many, if not most, cases low-cost competitors expand their capacity to make up for the withdrawal of capacity by the industry leaders.  The end result often is even more capacity available in a marketplace and the same or lower prices available for the industry leaders.

After several quarters of improving profits, the airline industry is again slipping into hostile market conditions as rising fuel prices reduce margins and force higher prices.  Higher prices limit demand growth.  In response to the margin squeeze these tougher times bring to the industry, the industry leaders are restricting the growth in their capacity and, in some cases, reducing the capacity they offer in the domestic U.S. market.  The problem is that several of the industry followers are not going along.

United Continental Holdings and AMR Corporation’s American Airlines have both posted losses for the most recent quarter.  Both of these industry leaders plan to reduce their domestic capacity as a result.  They will be reducing seats available flying into and out of selected domestic markets. 

The pattern of leaders reducing capacity and followers adding it seems to be holding in the current airline industry.  Southwest Airlines, JetBlue Airways and Alaska Air Group derive most of their revenues in the domestic U.S. market.  Each of these companies reported profits in the most recent quarter.  This profitability of the three follower airline competitors indicates that their costs are lower than are the costs of the two legacy airlines that have reported losses, United Continental and American Airlines.  Southwest plans to increase its capacity by 5% to 6% in 2011.  JetBlue plans to add 6% to 8% this year, while Alaska Air plans to grow its capacity by 9%. 

The industry followers are able to add capacity in the face of capacity withdrawal by their larger industry-leading competitors because they have these lower costs.  The lower costs enable the follower companies to make a profit while their larger competitors suffer losses.  In the long run, the only way that the industry-leading competitors will be able to stop the expansion of these follower competitors will be to match or beat their lower cost structures

The Long and Arduous Journey of the Airline Industry May be Reaching an End

The government deregulated the airline industry in 1978. Since that time, the basic pricing in the industry, as well as airline fortunes, have been more or less continuously on the downward slope. It has been a very long trip down.

The industry may be heading up again, though. In the third quarter of 2010, the average domestic airfare was 11% higher than a year earlier. Profits returned to the industry in 2010 behind higher prices. In some part, these higher prices were the result of the additional fees that most of the domestic carriers charged passengers for checked baggage, better seating, rerouting and so forth. Still, the industry was able to hold its higher prices.

These prices are holding because the major industry players are less enamored of discounted flying. All of the big airlines are finding ways to extract prices from industry customers. Now that airline capacity utilization is high, the industry is more careful about capacity additions. Higher prices are here to stay.

The consumer still is far ahead. Even at these higher prices, ticket prices are a bargain. In fact, ticket prices, adjusted for inflation, are 20% below the levels of 1995. The industry has continuously stripped benefits from the base product in order to save costs. In 2010, the industry added back a few of those benefits (for example, economy plus seating) for an additional charge. We may see more of that over the next few years.

Constrictions in Components Supply Support Higher Prices

Years ago we were doing some work in the roofing business. In one study, we were working on the asphalt shingle roofing manufacturing business. At the time, this was a terrible business. Returns were low, growth rates were modest, at best, and there was a good deal of overcapacity in the industry. Then the industry caught a break. A shortage in asphalt developed. This shortage of asphalt rolled through the asphalt shingle plants and restricted their output. Immediately, prices jumped, returns became attractive and industry participants breathed a sigh of relief. Unfortunately, this asphalt shortage did not last very long. The industry shortly returned to its previous hostile condition. (See the Perspective, “What Ends Hostility?” on StrategyStreet.com.)

A shortage in any component, or labor, will restrict industry capacity and tend to raise prices. A labor shortage is, in part, responsible for some of the high prices in mining today. Miners work in areas that are often hard to reach. They also are skilled employees. The run-up in commodity prices, especially those related to ores such as silver, gold and copper, has increased the demand for these skilled miners. In addition, the mining industry faces competition for skilled workers from the oil and natural gas industries, which are also growing.

Mining companies are now going to great lengths to attract and retain these skilled workers. Some of these miners are now earning 25% more in compensation than they were a year ago. Some companies are flying workers to and from remote mines. For example, BHP Billiton plans to fly 500 workers from Brisbane, about 500 miles away, to a coal mine site that they are opening and then fly them back home after a couple of weeks.

If this commodity boom continues, the industry’s total capacity will be determined more by labor availability than by its more traditional measures of capacity. (See “Audio Tip #117: Capacity Constraints and Pricing” on StrategyStreet.com.)

More Steel Capacity. Why?

China’s Anshan Iron and Steel Group has announced plans to invest in up to five new steel mills along with a U.S. domestic partner. The last time I looked, the U.S. was swimming in excess steel capacity. So why would this company enter the U.S. to add to an already over-supplied market? This is a political decision, not an economic one. Though, politics will obviously translate into dollars and cents eventually.

Anshan is partnering with Steel Development Company, a U.S. corporation, to invest $175 million in an initial “micro-mill” in Mississippi. Despite its cost, this is really a small investment. (See “Audio Tip #196: Why Economies of Scale Exist” on StrategyStreet.com.) The capacity of the mill is 300,000 metric tons. This mill will make reinforced metal bar. It adds relatively little to total capacity. The U.S. rebar market has 8 to 10 million short tons of capacity in the U.S. Nor does the new capacity add much to Anshan’s total capacity. Its total capacity in China totals 25 million metric tons.

This is a political investment. The U.S. government is under pressure from U.S. steelworkers. They charge that China competes unfairly in the steel industry. This investment is a partial response to that political problem.

We’ve seen this before. In the 1970s, I worked on a study to determine where a major Japanese electronics manufacturer should establish its first U.S. manufacturing facility. That new U.S. facility was not going to be a lower cost facility than those the company already had in Japan. But it would short-circuit arguments that the Japanese company was dumping its electronic products on the U.S. market. The Japanese automobile manufacturers, notably Honda and Toyota, did the same thing at roughly the same time. Over time, the Japanese auto plants were able to supply the domestic market economically. The domestic plants of the Japanese automakers, of course, have been operating under the cost umbrella held up by the United Autoworkers’ union wage rates and work rules. The U.S. steel industry has a lower union cost umbrella, so we are unlikely to see big foreign investments bringing a lot of new capacity to the U.S. steel industry. That is, we won’t see much more than is needed for political expediency. (See the Perspective, “Must the Cycle Start Again?” on StrategyStreet.com.)

Pricing Flexibility

Monsanto is the dominant leader in the seed business. It has led in the development of genetically modified seeds for corn, soy beans and cotton. This spring, the company introduced new second generation versions of its herbicide tolerant soy bean line and its herbicide and pest resistant corn seed. The company expected to sell enough of the soy bean line to plant 8 to 10 million acres and enough of the corn line to plant 4 million acres. Instead, the farmers bought 6 million acres worth of the soy bean line and 3 million acres worth of the corn line. The overall demand for seeds was down somewhat due to the depressed economy, but DuPont’s Pioneer Hi-Bred seed line also gained share against Monsanto.

The problem Monsanto encountered went beyond the economy. It simply priced the new lines too high for the market. The new soy bean line cost 42% more than its predecessor. The new corn line 17% more than its predecessor. The company simply did not leave enough incentive for enough farmers to make the switch to hit the company’s volume targets. (See “Audio Tip #68: Producing a Net Value Improvement for Customers” on StrategyStreet.com.)

The company responded quickly. After watching the market make a shambles of its volume forecasts, it announced that it would reduce its pricing by enough to increase its market share again.

This speedy response by a company in the marketplace stands in stark contrast to our governmental response to high pricing. If governments set a price too high, both consumers and the suppliers suffer. Current examples are the government interventions in the market to fix minimum wages and to increase taxes on employment.

In simple terms, the government sets a minimum wage price that is generally above the price that some employers are willing to pay. This new price, whether a minimum wage or an additional tax on employment, depresses demand for employees at the same time as it raises the potential supply. In a market where there is already more supply than demand, this is a prescription for a great deal of pain for both employees and employers. Some employers will shift jobs to less expensive areas of the world or simply not do them. Some employees will simply not find work. In particular, the employees least likely to find work are those with the lowest levels of skills, primarily the young and uneducated.

Throughout the post-war period, Europe created a cradle-to-grave system of social protections. They financed these social protections with high tax rates, charges on employment, and restrictions on the ability of an employer to reduce its workforce. At the end of 2009, Europe faced high employment rates for its young people. Belgium, France, Italy, the U.K., Sweden and Finland had rates of unemployment for people under 25 around 20% to 30%. The U.S. is now approaching the same level. Its unemployment rate for workers under 25 is about 20%, while overall unemployment rate is around 10%. The unemployment rate among black teenage males is 50%.

Not all of this high unemployment will go away with the reduction in the cost of employment. Some of our unemployed youth simply must have training they do not have today. But we show no signs today of recognizing what our high cost employment system has done to the demand for our youngest potential employees. It is too bad that our politicians don’t measure success in market share terms. Monsanto does and reverses course. Our response, if it ever comes, will be very late. (See "Video #41: Pricing Considerations in Hostile Markets” on StrategyStreet.com.)

New Capacity in a Shrinking Market

Big companies are pulling out of the petroleum refining industry. In the last year, Shell, Chevron, Valero and Sunoco have put refineries up for sale or shut them down. There is simply too much capacity in the industry. But there seems to be one guy coming in through the exit doors in the refining industry. Marathon Oil just opened a new $4 billion addition to its Louisiana refinery. Further, the company announced that it made a profit in all six of its other refineries in the U.S. in 2009. 2009 was a terrible year for the U.S. refinery business. 2010 isn’t much better.

Why would anyone add capacity in a hostile market with clear overcapacity? These capacity additions turn out to be commonplace. (See “Audio Tip #103: Capacity Creep Expansion of Industry Capacity” on StrategyStreet.com.) In Marathon’s case, the company started its capacity expansion in 2007, while the refining industry was roaring along. It simply took until 2010 to bring the refinery addition online. So this addition, while large, is really the result of expansion in the good times. The new capacity shows up when times have turned bad.

But, virtually every hostile industry sees small amounts, at least 1% to 2% per annum, increases in industry capacity every year. This capacity addition is the result of companies learning how to run their existing capacity with greater efficiency and effectiveness. It is almost a free addition to industry capacity. We call this annual capacity addition, despite overcapacity, the learning curve capacity addition. We named it after the well-known Boston Consulting Group strategic concept from the early 70s. The rate of this free capacity addition depends, in part, on the rate of growth in the industry itself. The faster the industry grows, the more free capacity will come online each year due to this learning curve effect. This effect can be pernicious. In the newsprint industry, the learning curve effect added more capacity every year than demand in the newsprint industry grew. During most of the 90s, the capacity industry’s addition due to the learning curve effect outstripped the growth of industry demand. Every year, hostility got just a little worse because of it. Real prices remained under pressure the whole time. (See “Audio Tip #133: What Tells Us Prices Will be Under Pressure?” on StrategyStreet.com.)

Recycling of Capacity in a Tough Market

Sweden is a small country with a proud tradition of producing tough, high-end, automobiles. We call these high-end products Performance Leaders. In a hostile market, a Performance Leader usually suffers from scale disadvantages compared to the much larger industry leaders, whom we call Standard Leaders. Often, these Performance Leaders become acquisitions for the industry’s Standard Leaders. (See the Symptom & Implication, “The industry is consolidating through mergers and acquisitions” on StrategyStreet.com.) That was the case when GM bought Saab and Ford bought Volvo.

Both of these automobile industry Standard Leaders operated their Swedish acquisitions as separate companies. However, as GM and Ford themselves faltered in the market, they both decided to jettison their foreign high-end products. Spyker Cars NV, a Dutch company, has purchased Saab from General Motors. China’s Geely Automobile Holdings Ltd. has purchased Volvo from Ford. Both the Saab and the Volvo brands, then, will continue into the future.

These purchases illustrate the sometimes difficult workings of a hostile marketplace. (See “Video #10: Industry Consolidation and Recycling of Capacity” on StrategyStreet.com.) Both Volvo and Saab were failing as stand-alone Performance Leader competitors. But they did not go out of business. Instead, larger industry Standard Leaders bought them and kept their capacity in operation. This is a first example of the recycling of brands, but more particularly, productive capacity in an industry that already had too much of it. Neither GM nor Ford was able to make a go of it with these Performance Leader brands. Rather than shut the brands and their productive capacity down, however, both the Standard Leaders found willing buyers for the brands and their industry capacity. This is the second example of recycling of the same capacity. In each case, the buyer got the company and its capacity for a cost below the book value of the original seller.

We have found this recycling of capacity to occur in virtually every industry that goes through over-capacity and hostile times. Capacity will not go away until it cannot produce cash for any owner. The recent closing of the San Francisco Bay Area Nummi plant, once co-owned by GM and Toyota, is a clear indication that the plant can no longer produce cash as an automobile plant. It may finally stop producing automobiles forever. It is worth noting, however, that this was a GM automobile plant before it became Nummi. It had already been recycled once in the mid-1980s.

An Update on Cutting Capacity to Raise Prices

Several months ago, we wrote a blog (See Blog Here) that noted the capacity reductions in the airline industry. In particular, the large legacy airlines were reducing their capacity in order to raise industry pricing. At the time, this effort was showing relatively little help with industry pricing.

As part of this original blog, we noted that there was a problem with the withdrawal of capacity in order to force prices up. The problem is expansion of capacity by low cost competitors. We explained that we had seen many cases in other industries where industry leaders reduced capacity to force industry prices up, only to be stymied by the addition of capacity by low-cost competitors.

Well, some new numbers have shown that the same thing is happening in the airline industry. AirFinancials.com has measured the change in domestic capacity of the airline industry between 2003 and 2009. The four largest legacy carriers, Delta, American, United and U.S. Airways, reduced their available seat miles, the best measure of domestic capacity, by 85 billion miles, a 21% average reduction. However, during the same period of time, low-cost competitors, including Southwest, JetBlue, AirTran and four other smaller carriers, added 84 billion available seat miles to their capacity. (See the Symptom & Implication, “Foreign competitors are expanding with low prices” on StrateyStreet.com.) So the legacies reduced capacity by 85 billion and the smaller, low-cost carriers, added 84 billion. The industry’s total capacity dropped by 1 billion available seat miles, far less than demand has fallen over the last year. Price competition and low industry returns continue.

The legacy carriers are shrinking away their network and scale advantages to the low-cost carriers. The low-cost carriers are more than happy to replace the capacity that the legacy carriers drop. (See the Symptom & Implication, “Some competitors are using growth to reduce their costs” on StrategyStreet.com.) Bad news for the legacy carriers.

Price Increases in a Recession

Our recession continues, but not every industry suffers in this recession. One industry that is not suffering today is the auto rental market. The average rental rate, at an airport, for a compact car in 2009 was up over 50% from that of 2008. This, while demand in 2009 fell 20%. What accounts for this surprising result of a price rise despite a fall-off in demand? Capacity reduction. (See “Audio Tip #116: The Withdrawal of Capacity to Raise Prices” on StrategyStreet.com.)

The industry reduced its fleet size by an average of 25% in 2009. And capacity is down by 50% compared to a few years ago. This capacity reduction has given the industry power to raise its prices because the industry is running at a high rate of its fleet utilization. (See Audio Tip #101: When is Price Likely to go up in a Market?” on StrategyStreet.com.)

The industry learned to reduce its capacity in order to get pricing power in 2001. The 9/11 attack led to a steep decline in business and leisure travel. In response to that, most major auto rental companies reduced their fleet numbers. Fleet sizes dropped 20% to 25% in the industry. This gave the industry pricing power despite the fall-off in demand. For example, Hertz raised its daily rates an average of 10% and weekly rates an average of 26% during this period.

Of course, the risk is always that low-cost/low-priced competitors do not go along with the industry-wide reduction in capacity.

Not all of the industry reduced its capacity in 2009. For example, off-airport auto rental locations, many of which are the home of low-cost/low-priced auto rental competitors, saw weekly rates rise by 12% in 2009 compared to 2008. Obviously, the capacity reduction was not as great in that market. Something similar happened in 2001 when Enterprise Rent-A-Car, a low-cost competitor, announced that it would not follow the industry leader’s plans to reduce capacity.

If the industry leaders reduce capacity but low-cost competitors do not follow, the low-cost competitors will gain share (see “Audio Tip #136: Should we put our Product on Allocation” on StrategyStreet.com). Enterprise Rent-A-Car is now the largest auto rental firm in the U.S. Southwest Airlines continues to gain share against legacy airlines, who have reduced their capacity by more than has Southwest.

Fewer Customers? Cut Capacity

For a year now the economy has weighed down passenger airline traffic. The industry expects a 4% reduction in passenger volume for 2009’s Thanksgiving season compared to the previous year. And, as demand has fallen, so have prices. Ticket prices this year are down 13% compared to 2008, so the industry is getting hit twice: by a fall-off in passenger seat miles flown, and by falling prices per seat mile. (See the Symptom & Implication “Demand in the industry is falling” on StrategyStreet.com.)

The airline industry thought it had an answer to this developing problem: cutting capacity. The industry has reduced capacity by 6.9% this year in the expectation that the industry could improve its efficiency and raise prices. (See “Audio Tip #116: The Withdrawal of Capacity to Raise Prices” on StrategyStreet.com.)

So, why haven’t prices risen? There are two possible answers. The first is that the industry has panicked and is offering lower prices to keep demand from falling any further than it already has. This answer is certainly in keeping with the industry’s previous practices. But there is a more subtle and more problematic answer as well, and that is that the smaller industry carriers are adding capacity faster than the industry leaders are reducing it.

Over the years we have witnessed many cases where industry leaders would reduce their capacity in order to constrain supply and force industry prices to rise. Time and again industry followers have stymied these initiatives. These followers insist on adding capacity, even as the industry leaders withdraw it. The result is the same, or more capacity, and continued low or falling prices.

To some extent, this addition of capacity by follower competitors is predictable (see “Audio Tip #106: How do we Predict Competitor Responses to our Price Moves?” on StrategyStreet.com). These smaller competitors already added capacity in the face of low industry pricing. They have even more incentive to add capacity as industry prices rise.

Layoffs, Expectations and the Economy

We are flirting with the highest levels of unemployment in a generation. Things feel bad and are bad. They could get a lot worse.

Consider some of the recent lay-offs. Macy’s laid off 4% of its workforce. U.S. Steel laid off 16%. Sun Microsystems announced plans to lay-off 15 to 18% of its workforce, Texas Instruments 12%, Sprint 14%. In most of these cases, the lay-offs seemed large, and they are.

But they are not as large as they may seem. In fact, an unscientific analysis suggests there may be a pattern here that contains a warning for the future. Most of the companies reporting in the last few weeks are laying off between 10 and 20% of their workforce. However, behind those lay-offs are reductions in current quarterly revenues of 20 to 30%. These companies are laying off at a slower rate than their revenues are falling. (See the Perspective, “Costs: The Last Consideration” on StrategyStreet.com.)

So, what does this tell us? Two things. First, the companies believe there will be a turn-around within a year or so. They are willing to see margins fall in order to hold experienced employees in anticipation of a rebound in demand. Second, the economy could be much worse than it is. If the average employer has laid off about 75% of the workers it would need to lay off to match the workforce with the current revenues, unemployment would be even higher than it already is. If the anticipated turn-around does not appear as expected, there would be a catch-up period as companies “right size” their organizations for the new, lower, revenue base.

Now there’s a scary thought for the politicians.

"Illogical" Pricing

How can pricing hit zero? This has just happened with container freight rates or shipments from South Asia to Europe. Other rates are not much better. Container shipment fees from North Asia to Europe have fallen to $200, taking them below the shippers’ operating costs. $200 per container is bad, but how to you get to zero?

Our previous blog (“Why Overcapacity Often Gets Worse” below) discusses pricing in overcapacity. The price in a commodity industry is equivalent to the cash cost of the next person to enter the industry or the last person to exit. So, what do these prices tell us about costs? Are they “illogical”?

First of all, the prices are not what they seem. In addition to the “price” there are other charges for fuel, called bunker costs, and other fees. So, even at a zero price for the container shipment, the shipping company still makes some cash contribution. Second, the cash costs of operating ships are largely fixed. One observer noted that idle ships are now stretched in rows outside Singapore’s harbor. These are ships whose cash cost of operation are higher than those ships that are now sailing, even though shipping rates are “zero”.

Third, the industry is in severe overcapacity. This overcapacity is the result of a significant fall-off in export demand. Exported container movements have fallen between 25 and 40% in Japan, Korea and Taiwan. Even China is now seeing a contraction in shipments. Activity in the U.S. ports is also falling. Shipments from Long Beach and Los Angeles, which are America’s two top ports, have fallen nearly 20% from a year ago.

Container fees from North Asia, at $200, represent a demand level relative to capacity somewhat better than that from South Asia. Still, few, if any, shipping companies are making an operating profit at $200 a container.

This situation is likely to continue until demand begins to grow again. (See the Symptom and Implication, “Prices are rising as the industry runs out of capacity” on StrategyStreet.com.) Overcapacity ends in one of two situations. In the first situation, price competition stops despite there being more capacity than the industry needs. This occurs when a maximum of four competitors gain control of 85% or more of industry capacity. Furthermore, these four competitors must refuse to discount against one another in search of additional sales volume. In the second situation, industry demand grows by enough to sop up excess capacity and prices begin to rise in order to attract new capacity into the market. By far, the most common way that industries exit overcapacity is through demand growth. (See the Perspective, “What Ends Hostility” on StrategyStreet.com.)

Why Overcapacity Often Gets Worse

The global semiconductor industry is in severe overcapacity today. There are two causes for this current overcapacity: competitor expansion and a fall-off in demand. Competitors expanded rapidly over the last few years when demand was relatively high. New semiconductor capacity comes on stream in big chunks, produced in factories costing more than a billion dollars. Now, many of those factories are running at half their rated capacity as demand has fallen off in the last year. The situation is bad enough that, today, no company can make a profit on standard semiconductor memory chips.

So, why don’t semiconductor manufacturers reduce industry overcapacity by closing plants? The answer lies in the cost structure of these factories. Seventy percent of these factory costs are fixed. They neither rise nor fall with short term changes in demand. As a result, these factories continue operating as long as their operators can make a cash contribution to fixed costs.

These high fixed costs explain why semiconductor prices fall so low in overcapacity. Prices have to fall low enough to discourage someone from producing. That discouragement has to include pricing through the level of any fixed cost. In a commodity-like market, such as semiconductor memory chips, the industry price is equivalent to the cash costs of the next person into the market. As a market expands, the cash cost of the next addition to capacity sets the price. In a market that is shrinking, the cash cost of the last person to leave the market is a pretty good estimate for industry prices. The last person to leave the market is usually the high cost producer. So, a declining demand industry sees industry prices fall below the cash costs of the high cost producer until enough high cost production is taken off-line to balance demand.

Even once a plant reaches the stage where it can not make a cash contribution on sales in its present structure, there are still instances where that capacity does not close permanently. Instead, the capacity recycles in the industry as another competitor, often with a lower cost structure, acquires the productive facility and keeps it operating at a lower cash cost. (See the Symptom and Implication, “Industry profits are low but downsized capacity remains” on StrategyStreet.com.)

Once productive capacity exists, it goes away with difficulty, even in an industry downturn. High cost capacity may not go away permanently until it is unable to compete with the cost structure of newer, more technologically advanced plants, even in a rising price environment. (See the Symptom and Implication, “The industry is adding new more efficient capacity in the effort to reduce cost” on StrategyStreet.com.)

Industry Capacity Expansion Despite Overcapacity

The global automobile industry is in world-wide overcapacity. In 2006, the industry had the capacity to build 80 million vehicles. It produced just under 65 million vehicles that year. The industry breaks even on factory output at about an 80% utilization rate, roughly where the industry was in 2006. And with demand falling globally by 3% or so in 2008, you would think that the industry would not be adding capacity, but it is. Capacity is increasing rapidly. By 2011, the global auto industry is likely to be able to produce 100 million vehicles in a year.

Why would this be happening? There are three reasons that capacity might expand in an industry despite overcapacity. The first reason is that some geographic segments are growing faster than average. India and China, in particular, are growing faster than the average world-wide demand and will add capacity to meet local needs. (See the Symptom & Implication, “Both new entrants as well as existing competitors have added capacity” on StrategyStreet.com.) Second, some industry competitors can afford to add capacity under the pricing umbrella of other competitors. This is going on today in North America. Honda is just opening a new assembly plant in Indiana. Honda is operating under the pricing umbrella set by the UAW and its big three auto plants. Third, virtually all industries see capacity expansion through what we call the “learning curve” effect. A plant in operation can become more productive each year simply by learning to do things more efficiently. This increase in productivity causes the plant capacity and, therefore, the industry capacity to increase.

We have studied over fifty industries in overcapacity. In each of those industries where we had the opportunity to measure plant productivity, capacity increased every year due to the “learning curve” effect. This effect works even in slow-growing industries, such as newsprint. Its effect on capacity grows as the rate of growth in the industry increases. A high tech plant would have a greater growth in productivity and capacity from the “learning curve” effect than would a newsprint facility.

Industries that appear to be in severe overcapacity may still be adding capacity. This growth in capacity adds to the pressure on industry prices and margins. It prolongs the industry’s pain from overcapacity. (See the Symptom & Implication, “The company believes the industry will be more diplomatic about adding capacity” on StrategyStreet.com.)