Overcapacity or excess capacity, what is good?

There is debate all around whether over capacity or excess capacity is good for the firm, buyers and the market in general. Let me explain the difference between these two and there after zeroing in answering which is good in for business in general and for geoeconomics in particular.

Overcapacity implies in common parlance too much of a product coming out from a firm chasing too few willing buyers. This is not a new thing and has come into prominence with the industrial revolution of the west. Over capacity has excellent features built in though. It leads to lowering of the average cost of production as high quantum absorbs the fixed cost fully and even making adjustments for in the variable cost also due to economy of buying and efficiency in using resources that ultimately spur competitiveness in terms of price and quality in the market.

It has dark side too. Overcapacity arises primarily due to investments made into the plant more than what was required at a particular time. This over investment has opportunity cost as well. That is if used elsewhere the economic scale efficiency would have helped areas that are essential for the daily life of people. Additional drawback is over capacity is spread as long-term issue and would be subjected to external influence and/or intervention. For example China investing heavily in Electric vehicles could enrage the West and push them to undertake counter measures.

Now let me turn to excess capacity. This arises when demand for a product is less than the quantum of that product in a market. Here the firm is producing items in high quantity to take advantage of lowering cost of production but unable to dispose the excess load. This creates a glut in the market and the price plummets, profit margin nosedives to the level where only the fixed cost could be recouped. The chances of recovering variable cost ranges to partial to none, normally speaking.

Excess capacity is generally a short term affair and is subjected to cyclical movements of price, quantum and the demand associated with it. One main plus point in excess capacity is that the management has full control to set it right at any given moment. Excess products could be recalled and sent to different markets domestically and/or mark these for exports to countries to which economies of scale can be transferred. Put it other way, the recipients get the products at cheaper price.

In terms of geoeconomics both can be used. Over capacity simply suggests that goods are affordable and the global demand for it could be at sustainable level. In the case of China for example over capacity is part of her geoeconomics power spectrum where she can play both east and west to increase demand dynamics. Excess capacity on the other hand gives limited sway for China as she can use it to recover sunk cost rather than making sizable profits. But the moot point is her competitors mainly from the west are put at unease and may react threateningly albeit temporarily.

 

Cheers!

 

Muthu Ashraff Rajulu

Business Strategist

Mobile: + 94 777 265677

E-mail: cosmicgems@gmail.com

Blog:   Business Strategist