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“Blessed are the flexible, for they will never be bent out of shape” Managing Operational Flexibility Under Demand Uncertainty Dissertation Defense: Manu Goyal Chapter 2: Strategic Technology Choice and Capacity Investment under Demand Uncertainty.

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slide3

Chapter 2: Strategic Technology Choice and Capacity Investment under Demand Uncertainty.

Analytically studies the impact of competition on the adoption of product flexibility in an environment characterized by uncertain demand.

Chapter 3:Deployment of Manufacturing Flexibility: an Empirical Analysis of the Automotive Industry.

Empirically tests the findings of the second chapter. Evidence suggests that product and volume flexibility may be linked.

Chapter 4:Capacity Investment and the Interplay between Volume Flexibility and Product Flexibility.

Analytically explores the intertwined nature of volume flexibility and product flexibility.

chapter 2

Chapter 2

Strategic Technology Choice and Capacity Investment under Demand Uncertainty.

slide5

Town & Country

Chrysler

PT Cruiser

Odyssey

CR-V

Ford Freestar

Ford Escape

Honda

Ford

research questions
Research Questions …
  • Does the technology investment decision (flexible vs dedicated) depend on what competition is doing?
  • Is the impact of problem parameters different with and without competition?
  • Will every firm adopt flexible technology in the equilibrium?

..and answers

  • It does
  • It is
  • No
the model
The Model

Uncertain Demand Curve

Two markets

One flexible

or

two dedicatedplants

One flexible

or

two dedicated plants

Uncertain Demand Curve

decision timeline for each of two firms competing in two markets

Choose capacity

: Cost of flexible capacity per unit

: Cost of dedicated capacity per unit

Decide production qty

for both markets

q1i, q2i

Decide choice of technology, Dedicated (D)or Flexible (F)

Prices determined as per Cournot competition. Profits gleaned

Flexible Firm: one decision

Ded. Firm: two decisions

Decision timeline for each of two firmscompeting in two markets

Demand Curve realized

Capacity Game

Technology Game

Production Game

time

the technology game
The Technology Game

Firm j

D

F

D

Firm i

F

the technology game profits
The Technology Game Profits

Firm profit in (D,D) market

Dedicated Firm profit in (D,F) market

Flexible Firm profit in (F,D) market

Firm profit in (F,F) market

the stochastic effect profits symmetric costs and distribution
The Stochastic EffectProfits (symmetric costs and distribution)

Stochastic

Deterministic

the best response functions when competitor invests in dedicated technology

Dedicated

Dedicated

Monopolist

Flexible

Flexible

Infeasible Region

The Best Response Functions - When Competitor invests in dedicated technology
the best response functions when competitor invests in flexible technology

Dedicated

Dedicated

Monopolist

Flexible

Flexible

Infeasible Region

The Best Response Functions - When Competitor invests in flexible technology
slide15

The Nash Equilibrium

(D,D)

(D,F) and (F,D)

(F,F)

Infeasible Region

Pure Flexible Market

Mixed Market

other effects
Other Effects
  • Market size effect
    • Pulls threshold curves down.
    • Additional (F,F) and (D,D) equilibrium is simultaneously possible.
  • Product Substitutability Effect.
    • Amplifies both the stochastic and market size effects
  • The Cost Effect.
    • Induced by asymmetries in the costs of firms.
equilibrium with market size effect
Equilibrium with market size effect

(D,F) and (F,D)

(D,D)

(F,F)

(D,D) and (F,F)

other effects18
Other Effects
  • Market size effect
    • Pulls threshold curves down.
    • Additional (F,F) and (D,D) equilibrium is simultaneously possible.
  • Product Substitutability Effect.
    • Amplifies both the stochastic and market size effects
  • The Cost Effect.
    • Induced by asymmetries in the costs of firms.
the cost effect
The cost effect

cost

(F,D)

(D,F) and (F,D)

I

V

III

(D,D)

(F,D)

VII

VI

(F,D)

IV

(F,F)

summary and conclusions
Summary and Conclusions
  • The paper covers three levels of firm decisions: strategic (technology investment), tactical (capacity investment) and operational (production decisions).
  • Distilled the impact of competition on the technology choice of firms
    • Flexibility is more valuable if competitor uses dedicated technology, less valuable if competitor uses flexible technology
    • Technology choice decision cannot be made in isolation.
    • Flexible and dedicated technologies can co-exist in equilibrium.
  • The differential Impact (under competition) of:
    • Product substitution
    • Market Size
    • Costs
chapter 3

Chapter 3

Deployment of Manufacturing Flexibility: an Empirical Analysis of the Automotive Industry.

the hypotheses
The Hypotheses
  • H1: The use of flexibility is associated with higher uncertainty in demand for individual products.
  • H2: The use of flexibility is associated with lower demand correlation for individual products.
  • H3a: The use of flexibility is associated with a larger number of flexible competitors.
  • H3b: Under moderate demand uncertainty, the use of flexibility is associated with fewer flexible competitors.
hypotheses cont
Hypotheses (cont)..
  • H4: The use of flexibility is associated with lower mean demand for products.
  • H5: Flexibility is associated with lower difference in mean demand (demand differential) for products.
  • H6a: Under high demand uncertainty, the use of flexibility is associated with higher product substitutability in the marketplace
  • H6b: Under a low demand differential, the use of flexibility is associated with lower product substitutability in the market place.
the data
The Data
  • Primary Sources
    • Harbour Reports
    • Ward’s Automotive.
  • The “Big Three” US Manufacturers.
  • Years 1996-2003.
  • Over 70 manufacturing facilities in North America.
  • Unit of analysis is a given plant in a given year (plant-year combinations, 483 in numbers).
measures
Measures
  • Flexibility: “Demonstrated” vs. “Potential”

Assembly Line Flexibility (ALF): 1 if the number of platforms manufactured in a plant is greater than the number of assembly lines, and 0 otherwise.

  • Other Ways?
measures cont
Measures (cont)..
  • Demand Uncertainty: Coefficient of Variation of de-seasoned monthly sales.
  • Correlation.
  • Mean demand.
  • Demand Differential.
  • Competition: number of flexible competitors.
  • Substitutability. Price difference.
control variables
Control Variables
  • Plant Capacity
  • Plant Utilization.
  • Manufacturer dummies.
univariate test
Univariate Test

Univariate Test of Differences in Means (dependent variable: ALF)

logit regression
Logit Regression
  • Evidence suggests that plants that are observed to be flexible have:
    • Higher demand uncertainty (H1).
    • Lower correlation (H2).
    • Higher (flexible) competition (H3a).
  • Control Variables:
    • Flexible plants have lower utilization.
    • No significant differences between the “big three”.
productivity analysis
Productivity Analysis
  • Study the implications of deploying flexibility, measured against extant theories.
  • Hours per Vehicle (HPV) as a measure of productivity.
mismatches
Mismatches..
  • Measure mismatch benchmarked against six environmental variables:
    • Demand Uncertainty (H1)
    • Demand Correlation (H2)
    • Flexible Competition (H3a)
    • Competition with moderate uncertainty (H3b).
    • Mean Demand (H4).
    • Demand differential (H5).
regression
Regression
  • Regress HPV against these six mismatches (OLS).
  • Control Variables:
    • Flexibility
    • Utilization
    • Plant Capacity
    • Companies
    • Years
    • Number of Chassis Configurations.
results
Results
  • In the absence of the environmental variables, flexible plants have significantly higher HPV than inflexible plants.
  • Adjusting for deviations from the benchmarks determined by the six environmental variables, flexibility is no longer significant.
  • Flexibility by itself does not cause lower productivity
the six benchmarks
The six benchmarks
  • Uncertainty: not matching flexibility deployment to environmental uncertainty decreases productivity.
  • Competition: Responding to flexible competition with flexibility decreases productivity.
  • Demand Differential: Contrary to theory.
the control variables
The Control Variables
  • Plants with higher capacity and utilization have higher productivity.
  • Productivity has been increasing over the past years.
  • GM and Ford have higher productivity than DCX.
summary
Summary
  • One of the first studies to formalize the deployment of manufacturing flexibility.
    • Demand uncertainty
    • Correlation.
  • Though flexibility is used as a competitive weapon (flexible plants have higher flexible competition), evidence also suggests that this could be a cause of lower productivity.
  • Flexible plants have lower utilization, a possible reason is the presence of volume flexibility in conjunction with product flexibility.
chapter 4

Chapter 4

Capacity Investment and the Interplay between Volume Flexibility and Product Flexibility.

product flexible technology with volume flexibility v p

K-ε

K+ε

Product Flexible Technologywith volume flexibility(VP)

Demand for product1

product1

Demand for product2

product2

K

product flexible p technology
Product Flexible (P) Technology

Demand for product1

product1

Demand for product2

product2

product flexibility
Product Flexibility

Capacity Allocated to Product 1

Capacity Allocated to Product 2

Total Capacity fixed

volume flexible technology v

Demand for product1

product1

Demand for product2

product2

Volume Flexible Technology (V)
the dedicated d technology
The Dedicated (D) Technology

Demand for product1

product1

product2

Demand for product2

volume and product flexibility
Volume and Product Flexibility
  • Both types of flexibility help cope with demand uncertainty.
    • Ample literature on capacity investment into product flexibility.
    • Virtually non-existent literature on volume flexibility.
    • When would a firm prefer one flexibility to another?
  • A plant may possess (to some extent) both flexibility types.
    • No analytical models combining two flexibility types.
    • When would a firm add one flexibility over another?
the model51
The Model

Uncertain Demand Curve

Uncertain Demand Curve

Two markets

Choice of Technology

D,V,P or VP

decision timeline

Adjust and/or allocate capacity

Decision timeline

Demand Curves realized

Capacity Investment

Choice of Technology

Production

time

Choose capacity

: Cost of capacity per unit

x={D,V,P,VP}

Decide choice of technology, Dedicated (D), Product-Flexible (P), Volume-Flexible (V), Vol & Prod-Flexible (VP),

the problem formulation

Frictional cost of capacity adjustment

As c→,

Vol-Product Flexible → Product Flexible

As c→,

Volume Flexible →Dedicated

The Problem Formulation

Firm i invests in V technology

Firm i invests in VP technology

expected profits
Expected Profits

D

P

V

VP

Deterministic

Leverage

Stochastic

the cost thresholds
The cost thresholds

Dedicated Vs Volume Flexible

How do these thresholds behave?

Cost

Dedicated Vs Product Flexible

Dedicated

Dedicated

Product Flexible

Volume Flexible

Variance

comparing d v and p large correlation
Comparing D,V and P - Large Correlation

With large aggregate uncertainty in demand Volume Flexibility is more useful

Cost of flexibility

Volume

Flexibility

Dedicated

D>(V,P)

V>D>P

Volume

Flexibility

V>P>D

Variance

slide57

Comparing D,V and P - Medium Correlation

Cost of flexibility

Volume

Flexibility

Volume Flexibility

V>D>P

Dedicated

D>(V,P)

V>P>D

Product Flexibility

P>V>D

Variance

slide58

Comparing D,V and P - Low Correlation

With small aggregate uncertainty in demand Product Flexibility is more useful

Cost of flexibility

Volume Flexibility

V>P>D

Dedicated

Product

Flexibility

D>(V,P)

Product

Flexibility

P>D>V

P>V>D

Variance

technology upgrade addition
Technology upgrade (addition)

Incremental value of Volume Flexibility:

Additional volume flexibility helps when aggregate demand uncertainty is large but individual demand uncertainty does not matter.

Incremental value of Product Flexibility:

Additional product flexibility helps when aggregate demand uncertainty is small and individual demand uncertainty is large.

key findings
Key Findings
  • Match flexibility to the environment (preference):
    • Product flexibility - individual demand uncertainty.
    • Volume flexibility - aggregate demand uncertainty.
    • Product flexibility - substitutable products (VCR and DVD Player)
    • Volume flexibility - complementary products (VCR and TV)
  • Incremental Product flexibility may be harmful even if it is costless (V>VP).
  • Linking: Quick Response(volume flexibility) and Variety Postponement(product flexibility).
  • Empirical study on the adoption of flexibility in the automotive industry is in progress.
vol product flexibility
Vol-Product Flexibility

Capacity Allocated to Product 1

Capacity Allocated to Product 2

Total Capacity not fixed

flexibilities as building blocks and technologies
Flexibilities as “Building Blocks” and Technologies

Volume Flexible

Product Flexible

X

X

D

Dedicated

X

V

Volume Flexible

X

P

Product Flexible

Volume and Product Flexible

VP

the problem formulation64
The Problem Formulation

Firm i invests in D technology

Firm i invests in P technology

model of volume flexibility
Model of Volume Flexibility

Cost of flexibility

Kyv

Adjusted Capacity,

K+ε=K~

K-ε=K~

K

financials
Financials
  • The typical scale of operation is about 200-250,000 vehicles per year.
  • In year 2002, the average incentive for the US automotive industry was $1873 per vehicle (The Second Century, Holweg and Pil).
    • The average incentives for the Big Three was $2300 per vehicle.
  • The pretax profit per vehicle ranged from $226 (DCX) to $2069 (Nissan) per vehicle in 2002 (The Harbour Report, 2004).
product flexible technology with volume flexibility v p68

K-ε

K+ε

Product Flexible Technologywith volume flexibility(VP)

Demand for product1

product1

Demand for product2

product2

K

product flexible p technology69
Product Flexible (P) Technology

Demand for product1

product1

Demand for product2

product2

product flexibility70
Product Flexibility

Capacity Allocated to Product 1

Capacity Allocated to Product 2

Total Capacity fixed

volume flexible technology v71

Demand for product1

product1

Demand for product2

product2

Volume Flexible Technology (V)
the dedicated d technology72
The Dedicated (D) Technology

Demand for product1

product1

product2

Demand for product2

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