Du Pont’s Titanium Business Take Aways

Leader’s Capacity Affects Industry Profitability Two firms with capacities q 1 and q 2 Firm 1 is industry leader Market demand is Q < q 1 + q 2 There is excess capacity in the industry Willingness to pay in the market is v Firm 1 earns v * (Q – q 2 ) Firm 2 earns v * (Q – q 2 ) * (q 2 /Q)

Increasing Concentration Increases Industry Profits Now suppose that industry becomes more concentrated: Firm 1 obtains 1 more unit of capacity and firm 2 one less unit of capacity relative to Q Firm 1 earns v profits on this additional unit Firm 2 loses v * (q 2 /Q) from the reduction in its relative capacity Hence, industry profits increase

Incentives to Acquire Capacity – Ignoring Game Theory Naïve model: Firm 1 already has idle capacity So the marginal value of acquiring more capacity is zero Firm 2 is using all its capacity, so its marginal valuation is v * (q 2 /Q) Hence the naïve model predicts that firm 2 will have greater incentive to acquire additional capacity

Incentives to Acquire Capacity – Game Theory Incentives Sophisticated model: As demand grows, market will become more concentrated if firm 1 acquires additional capacity Marginal value of this capacity to firm 1 is v Marginal value of this capacity to firm 2 is v * (q 2 /Q) Thus, a strategic firm 1 will seek to pre-empt capacity expansions by firm 2

How does industry concentration affect prices? Key assumption in DuPont’s analysis: Growth strategy will raise industry prices Thought experiment: Shift one unit of capacity from firm 2 to firm 1 Suppose v = 26c/lb Pre-shift price: v (Q – q 2 + (q 2 /Q) * q 2 ) Post-shift price: v (Q – q (q 2 /Q) * (q 2 -1) Price increase: v * ( 1 - (q 2 /Q) )

Matching Price Increases Without sufficient excess capacity, not matching a price increase does nothing to the profits of rivals With sufficient excess capacity, not matching a price increase leads to market share gains at the expense of rivals

Take Aways – Strength of DuPont’s Strategy Pre-emptive capacity expansion depends on current structure of the industry: Pros for DuPont Cost asymmetry Positive feedback (experience curve effects) Favorable policy environment Announcements (signals) were a key part of DuPont’s strategy Leveraging corporate reputation in the future

Take Aways – Weaknesses of DuPont’s Strategy Projections had problems: No accounting for cycles Overconfidence about sales and policy outcome Little regard for variation in rival responses Pricing strategy had problems Holding the line on prices in an industry with high capacity utilization was simply ineffective Not clear that the upside was worth the gamble