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Investment Strategies for Flexible Resources

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  • Jan A. Van Miegham

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. Key Words: Flexibility, technology, strategy, capacity investment, prices, operational hedging, multi-dimensional newsvendor model.

Suggested Citation

  • Jan A. Van Miegham, 1997. "Investment Strategies for Flexible Resources," Discussion Papers 1201, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    • Handle: RePEc:nwu:cmsems:1201
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    References listed on IDEAS

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    1. Xavier de Groote, 1994. "The Flexibility of Production Processes: A General Framework," Management Science, INFORMS, vol. 40(7), pages 933-945, July.
    2. 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.
    3. George Stigler, 1939. "Production and Distribution in the Short Run," Journal of Political Economy, University of Chicago Press, vol. 47(3), pages 305-305.
    4. He, Hua & Pindyck, Robert S., 1992. "Investments in flexible production capacity," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 575-599.
    5. Eaton, B Curtis & Schmitt, Nicolas, 1994. "Flexible Manufacturing and Market Structure," American Economic Review, American Economic Association, vol. 84(4), pages 875-888, September.
    6. 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.
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