BUS4098 Week 2

Capital Spending Decisions

© 2016 South University

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Business Simulation

©2016 South University

2 [Document Title]

[Parent Lecture Name]

Capital Spending Decisions

Capital spending commitments are some of the strongest signals a firm can send to the marketplace about its competitive intentions. Even before a new factory or store comes online, a firm can impact the actions of rivals just by announcing its intentions. For this reason, announcements of major expansions and the like are such big news in the business world. Just knowing that a major commitment has been made allows firms to predict future competitive patterns more accurately.

All managers know that large capital expenditures are two-sided. On one side, they represent the acquisition or development of a major strategic asset that a firm can use in future competition. This may be something that makes rivals "get out of the way" because the rivals know that they cannot compete when the asset comes online. On the other side, however, the firm has committed itself to a strategy which uses that asset and only a limited number of strategic options may employ the resource or capability. Firms with other strategic goals may then be able to act more confidently, knowing that it would be difficult for the announcing firm to compete against them in the near future.

There are three main reasons why this commitment can be assumed:

 A firm has to commit a significant amount of its capital resources to such investments. Given that the firm has limited capital available, by choosing to invest in one asset or a set of assets, the firm is forgoing any investment in other assets due to the exhaustion of inexpensive capital for that investment.

 Large capital investments often tend to take a significant amount of time to develop. Barring any dramatic change in the environment, such as the advent of a radical new technology that clearly makes the investment obsolete, it will take years for the firm to determine whether the investment is a good one or a poor one. In the intervening time, the firm will most likely stay with its strategic commitment and not change direction.

 When managers commit to a major strategic thrust, they know that announcing a future change, even after disappointing results come in, is tantamount to announcing a major blunder on their part. Doing so may cost top managers their jobs in publicly held corporations. Therefore, management teams will stick with a strategy that is based on significant capital expenditures long after the strategy is shown wanting for that firm.