Flexible Capacity Investments and Product Mix: Optimal Decisions and Value of Postponement Options

Abstract

I n this article, we study a firm's interdependent decisions in investing in flexible capacity, capacity allocation to individual products, and eventual production quantities and pricing in meeting uncertain demand. We propose a three-stage sequential decision model to analyze the firm's decisions, with the firm being a value maximizer owned by risk-averse investors. At the beginning of the time horizon, the firm sets the flexible capacity level using an aggregate demand forecast on the envelope of products its flexible resources can accommodate. The aggregate demand forecast evolves as a Geometric Brownian Motion process. The potential market share of each product is determined by the Multinomial Logit model. At a later time and before the end of the time horizon, the firm makes a capacity commitment decision on the allocation of the flexible capacity to each product. Finally, at the end of the time horizon, the firm observes the demand and makes the production quantity and pricing decisions for end products. We obtain the optimal solutions at each decision stage and investigate their optimal properties. Our numerical study investigates the value of the postponed capacity commitment option in supplying uncertain operation environments.

Surface vs. Air Shipment of Humanitarian Goods under Demand Uncertainty

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Strategic Investment Decisions: An Empirical Study of Power Sector in India

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Complexity and workload considerations in product mix decisions under the theory of constraints

“…Other scholars have developed improved algorithms , but drawbacks still exist in their methods. Primarily, most of these algorithms are validated based on simple examples and may not effectively scale up to large‐scale or real‐world operations in a job‐shop system with complex operations scheduling.…”

“…The TOC is an operations philosophy that focuses on constraints in a system to improve its overall throughput, and it has drawn the attention of scholars addressing the product mix problem , 35, 36].…”