Explaining Capacity Overshoot and Price War: Misperceptions of Feedback in Competitive Growth Markets

P. A. Langley, M. Paich and J. D. Sterman (1998) Explaining Capacity Overshoot and Price War: Misperceptons of Feedback in Competitive Growth Markets. MIT Sloan School of Management.

Abstract

Companies consistently get into trouble in rapid growth markets. Frequently they grow too fast, overshoot when the market saturates, then get into price wars and suffer huge losses due to low prices and excess capacity. The companies that grow most aggressively sometimes lose the most, contrary to the new conventional wisdom that you have to be the largest player to benefit from increasing returns and positive feedbacks that confer success to the successful. How can the prevalence and persistence of this dynamic be explained? Is it just bad luck or is there a systematic explanation. And how can firms do better? To explore these issues, we designed an experiment involving over 270 subjects (MBA and short course Executives). Subjects played the role of a management team for one firm in a simulated duopoly market, with a rapidly growing demand for the new product. As in the real world, market potential and the course of the product lifecycle were highly uncertain. Subjects made quarterly capacity, pricing and marketing decisions over a simulated ten year period. Performance was measured by cumulative net income. The results showed that subjects systematically made pricing decisions that were not only far from the "optimal" price, but were often in the opposite direction from the optimal change. Subject performance was very poor, compared to a benchmark performance computed using simple behavioral decision rules. Subjects did not substantially modify their policies under different market structures or different competitor strategies. Neither did they modify their policies over trials - little learning took place. The poor performance is explained in terms of flaws in the subjects' mental models - their "misperceptions of feedback". We close with discussion of implications for improved senior management strategies in new product markets.

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