Schweser Equity, pg 96 #14 Here is my quarrel with this question: A. The answer says that due to overproduction among the producers the consumers will be forced to cut prices, hence the increase of bargaining power of buyers. I think that a niche or differentiated product, i.e. lightweight furniture creates brand loyalty and/or forces the customer to buy the only product available in the market - how would this increase buyer power? Also, what is the basis around the assumption of overproduction (even if we assume that competitive firms manage to enter the industry - the vignette does not say anything about this at all). B. The answer says the increase in CapEx is least likely to increase barriers to entry b/c new firms entering the industry may not opt to spend the money to redesign their products. However - Bergleaf is increasing CapEx in what seems to be an already capital intensive industry - isn’t this suppose to create a high barrier to entry? C. Since Bergleaf is moving towards a differentiated niche market (of manufacturing lightweight furniture) - how does this create a rivalry among the existing competitors? It seems this was brought up before but not fully explained: http://www.analystforum.com/phorums/read.php?12,916364,916517#msg-916517 Thanks.
I know this is a bit of a long-ended read but these are the questions we should opt to get 100% correct. Anyone care to take a stab at it?
I think you are getting confused with the GENERAL result from CAPEX increase and this specific case. In general, an increase in CAPEX is generally what firms are supposed to do to INCREASE barriers to entry by achieving economies of scale, which can’t be copied easily. However, in this specific case, an increase in CAPEX is not necessarily going to result in economies of scale, because they are nowhere near their full capacity. When you increase your capacity to produce more, when you don’t need to produce more in the first place, what do you do? You have to lower your price to cover your fixed costs. Thus, it will result in rivalry among existing firms in the industry and buyers will have more negotiating power, because all your competitors will offer similar pricing and they can just buy from whoever that’s the cheapest (given that all products are nearly the same and there is low switching costs).
Let’s take this one issue at a time: 1. Barriers to entry: agreed that CapEx investment which embodies economies of scale should ward off competitors in general - in the case of Bergleaf are we saying that competitors will in fact try and penetrate into the industry to capture sales of other common products (since this is isolated from Bergleaf’s niche product line)? 2. Rivalry among firms: you mention the following: "When you increase your capacity to produce more, when you don’t need to produce more in the first place, … " This is not stated in the vignette though. For this assumption to be valid, demand has to be at a decrease and maybe I am missing something but I don’t see the clues in the vignette. In general though I don’t disagree that overproduction will cause prices to plummet due to the overcrowding of production by new competitors entering the industry. My take on Bergleaf is that if we assume competitors are able to enter the industry and compete ONLY on the common products and cause excess supply then there will be overproduction - but what about the niche product that Bergleaf’s 40% of revenue will be based on? Surely, the product differentiation from the rest shouldn’t be a cause of the rivalry? 3. Buyer power: this is related to #2. There will be buyer power if the prices plummet and common products exist - however the niche product should command a premium in the market place and consumers who are unwilling to forgo the benefits of lighter weight may not want to switch - thus decrease in buyer power in this case. Another reason for Schweser’s views could be that new competitors entering the industry will also start offering the new lightweight furniture in which case they are directly competing with Bergleaf - in THIS case Schweser’s answers do make sense - but the vignette does not state that competitors likley to enter the industry have found other means of competing with this new technology. Is this your understanding as well?