TechnologyExcess capacity may be dictated by the technology. If the only efficient way to increase capacity is in plants of relatively large size, a firm will have to maintain some excess capacity or risk being caught short by an unexpected increase in demand.

Excess capacity may also be dictated by marketing considerations. Where distributors’ services are essential to commercial success and manufactures do not integrate forward into distribution, a manufacturer will have to convince distributors to support his product.  Excess capacity will demonstrate a commitment to distributors that the firm that has invested in the capacity is in the market to stay.

But by the same token, an investment in excess capacity will demonstrate this same intent to potential entrants. It will signal to such firms and to existing fringe firms a willingness to defend a dominant market position.

For such a signal to be convincing, the capacity must be sunk. If an investment could be liquidated with relatively small capital losses, it does not demonstrate a commitment to the industry. If excess capacity is sunk, then it, like vertical integration, can help a dominant firm maintain its position without suffering the reduction in profit or of market share predicted by limit price models.