An Evaluation Approach for Flexibility in Manufacturing Enterprises

University Of Wisconsin-Madison, Madison WI

Investigators

Abstract

Flexibility allows firms to compete more effectively in today's world of substantial price and demand uncertainty, product variety, short product life cycles, and rapid product development. In order to benefit from flexibility, managers and manufacturing systems must react to events as they unfold. The real options approach seeks to quantify just how valuable flexibility really is. It incorporates both the uncertainty that is inherent in business and the active intervention required for a strategy to succeed. The purpose of this research is to develop an evaluation approach to quantify flexibility in manufacturing operations in order to improve operational decision making. Specifically, the objectives are to (1) capture and (2) value that flexibility using a real options framework. In order to accomplish these objectives, the first research task will be to develop a model for multi-period options because there is usually a lag between the time when a decision to exercise an alternative option is made and when that alternative option can be implemented. The second research task is to develop a Monte Carlo simulation approach for valuing multi-time period options that allows switches among several choices during a decision horizon. Thus the third research task is to develop an efficient heuristic for fast approximation of option values so that the approach will be practical for industry application. This research is expected to make several contributions. Foremost, it will bring state-of-the-art financial option research to the area of manufacturing enterprises and emphasize realism by collaborating with industry partners. Additionally, as the methodological approach for valuing flexibility in manufacturing enterprises is developed, software tools that can execute the valuation calculations will also be generated. These tools and their research contexts will be incorporated into the engineering curriculum. Finally, this work will promote the careers of underrepresented faculty and students.