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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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Managing operational flexibility under demand uncertainty l.jpg

Managing Operational Flexibility Under Demand Uncertainty of shape”

Dissertation Defense:

Manu Goyal


Slide3 l.jpg

Chapter 2: of shape” 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 l.jpg

Chapter 2 of shape”

Strategic Technology Choice and Capacity Investment under Demand Uncertainty.


Slide5 l.jpg

Town & Country of shape”

Chrysler

PT Cruiser

Odyssey

CR-V

Ford Freestar

Ford Escape

Honda

Ford


Research questions l.jpg
Research Questions … of shape”

  • 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 l.jpg
The Model of shape”

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 l.jpg

Choose capacity of shape”

: 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 l.jpg
The Technology Game of shape”

Firm j

D

F

D

Firm i

F


The technology game profits l.jpg
The Technology Game of shape”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 l.jpg
The of shape”Stochastic EffectProfits (symmetric costs and distribution)

Stochastic

Deterministic


The best response functions when competitor invests in dedicated technology l.jpg

Dedicated of shape”

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 l.jpg

Dedicated of shape”

Dedicated

Monopolist

Flexible

Flexible

Infeasible Region

The Best Response Functions - When Competitor invests in flexible technology



Slide15 l.jpg

The Nash Equilibrium of shape”

(D,D)

(D,F) and (F,D)

(F,F)

Infeasible Region

Pure Flexible Market

Mixed Market


Other effects l.jpg
Other Effects of shape”

  • 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 l.jpg
Equilibrium with market size effect of shape”

(D,F) and (F,D)

(D,D)

(F,F)

(D,D) and (F,F)


Other effects18 l.jpg
Other Effects of shape”

  • 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 l.jpg
The cost effect of shape”

cost

(F,D)

(D,F) and (F,D)

I

V

III

(D,D)

(F,D)

VII

VI

(F,D)

IV

(F,F)


Slide20 l.jpg

cost of shape”


Summary and conclusions l.jpg
Summary and Conclusions of shape”

  • 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 l.jpg

Chapter 3 of shape”

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


The hypotheses l.jpg
The Hypotheses of shape”

  • 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 l.jpg
Hypotheses (cont).. of shape”

  • 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 l.jpg
The Data of shape”

  • 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 l.jpg
Measures of shape”

  • 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 l.jpg
Measures (cont).. of shape”

  • 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 l.jpg
Control Variables of shape”

  • Plant Capacity

  • Plant Utilization.

  • Manufacturer dummies.


The analysis descriptive statistics l.jpg
The Analysis: of shape”Descriptive Statistics


Correlations l.jpg
Correlations of shape”


Univariate test l.jpg
Univariate Test of shape”

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



Logit regression l.jpg
Logit Regression of shape”

  • 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 l.jpg
Productivity Analysis of shape”

  • Study the implications of deploying flexibility, measured against extant theories.

  • Hours per Vehicle (HPV) as a measure of productivity.


Hpv over the years l.jpg
HPV over the years of shape”


Mismatches l.jpg
Mismatches.. of shape”

  • 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 l.jpg
Regression of shape”

  • Regress HPV against these six mismatches (OLS).

  • Control Variables:

    • Flexibility

    • Utilization

    • Plant Capacity

    • Companies

    • Years

    • Number of Chassis Configurations.


Results l.jpg
Results of shape”

  • 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 l.jpg
The six benchmarks of shape”

  • 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 l.jpg
The Control Variables of shape”

  • 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 l.jpg
Summary of shape”

  • 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 l.jpg

Chapter 4 of shape”

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


Product flexible technology with volume flexibility v p l.jpg

K- of shape”ε

K+ε

Product Flexible Technologywith volume flexibility(VP)

Demand for product1

product1

Demand for product2

product2

K


Product flexible p technology l.jpg
Product Flexible of shape”(P) Technology

Demand for product1

product1

Demand for product2

product2


Product flexibility l.jpg
Product Flexibility of shape”

Capacity Allocated to Product 1

Capacity Allocated to Product 2

Total Capacity fixed


Volume flexible technology v l.jpg

+ of shape”ε

Demand for product1

product1

Demand for product2

product2

Volume Flexible Technology (V)


The dedicated d technology l.jpg
The Dedicated of shape”(D) Technology

Demand for product1

product1

product2

Demand for product2


Volume and product flexibility l.jpg
Volume and Product Flexibility of shape”

  • 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 l.jpg
The Model of shape”

Uncertain Demand Curve

Uncertain Demand Curve

Two markets

Choice of Technology

D,V,P or VP


Decision timeline l.jpg

Adjust and/or allocate capacity of shape”

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 l.jpg

Frictional cost of capacity adjustment of shape”

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 l.jpg
Expected Profits of shape”

D

P

V

VP

Deterministic

Leverage

Stochastic


The cost thresholds l.jpg
The cost thresholds of shape”

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 l.jpg
Comparing D,V and P - Large Correlation of shape”

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 l.jpg

Comparing D,V and P - Medium Correlation of shape”

Cost of flexibility

Volume

Flexibility

Volume Flexibility

V>D>P

Dedicated

D>(V,P)

V>P>D

Product Flexibility

P>V>D

Variance


Slide58 l.jpg

Comparing D,V and P - Low Correlation of shape”

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 l.jpg
Technology upgrade (addition) of shape”

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 l.jpg
Key Findings of shape”

  • 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.


Appendix l.jpg
Appendix of shape”


Vol product flexibility l.jpg
Vol-Product Flexibility of shape”

Capacity Allocated to Product 1

Capacity Allocated to Product 2

Total Capacity not fixed


Flexibilities as building blocks and technologies l.jpg
Flexibilities as “Building Blocks” and of shape”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 l.jpg
The Problem Formulation of shape”

Firm i invests in D technology

Firm i invests in P technology


Model of volume flexibility l.jpg
Model of Volume Flexibility of shape”

Cost of flexibility

Kyv

Adjusted Capacity,

K+ε=K~

K-ε=K~

K


Frictional cost of volume flexibility source the second century holweg and pil l.jpg
Frictional Cost of Volume Flexibility of shape”(Source: The Second Century, Holweg and Pil)


Financials l.jpg
Financials of shape”

  • 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 l.jpg

K- of shape”ε

K+ε

Product Flexible Technologywith volume flexibility(VP)

Demand for product1

product1

Demand for product2

product2

K


Product flexible p technology69 l.jpg
Product Flexible of shape”(P) Technology

Demand for product1

product1

Demand for product2

product2


Product flexibility70 l.jpg
Product Flexibility of shape”

Capacity Allocated to Product 1

Capacity Allocated to Product 2

Total Capacity fixed


Volume flexible technology v71 l.jpg

+ of shape”ε

Demand for product1

product1

Demand for product2

product2

Volume Flexible Technology (V)


The dedicated d technology72 l.jpg
The Dedicated of shape”(D) Technology

Demand for product1

product1

product2

Demand for product2


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