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Investment Strategies for Flexible Resources

Author

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  • Jan A. Van Mieghem

    (J. L. Kellogg Graduate School of Management, Northwestern University, Evanston, Illinois 60208-2009)

Abstract

This article studies optimal investment in flexible manufacturing capacity as a function of product prices (margins), investment costs and multivariate demand uncertainty. We consider a two-product firm that has the option to invest in product-dedicated resources and/or in a flexible resource that can produce either product, but has to make its investment decision before demands are observed. The flexible resource provides the firm with a hedge against demand uncertainty, but at a higher investment cost than the dedicated resources. Our analysis highlights the important role of price (margin) and cost mix differentials, which, in addition to the correlation between product demands, significantly affect the investment decision and the value of flexibility. Contrary to the intuition also prevalent in the academic literature, we show that it can be advantageous to invest in flexible resources even with perfectly positively correlated product demands.

Suggested Citation

  • Jan A. Van Mieghem, 1998. "Investment Strategies for Flexible Resources," Management Science, INFORMS, vol. 44(8), pages 1071-1078, August.
    • Handle: RePEc:inm:ormnsc:v:44:y:1998:i:8:p:1071-1078
    DOI: 10.1287/mnsc.44.8.1071
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    References listed on IDEAS

    as
    1. Robert A. Jones & Joseph M. Ostroy, 1984. "Flexibility and Uncertainty," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 51(1), pages 13-32.
    2. Charles H. Fine & Robert M. Freund, 1990. "Optimal Investment in Product-Flexible Manufacturing Capacity," Management Science, INFORMS, vol. 36(4), pages 449-466, April.
    3. Eberly, Janice C. & Van Mieghem, Jan A., 1997. "Multi-factor Dynamic Investment under Uncertainty," Journal of Economic Theory, Elsevier, vol. 75(2), pages 345-387, August.
    4. Shanling Li & Devanath Tirupati, 1994. "Dynamic Capacity Expansion Problem with Multiple Products: Technology Selection and Timing of Capacity Additions," Operations Research, INFORMS, vol. 42(5), pages 958-976, October.
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