Capacity Investment and the Interplay between Volume Flexibility and Product Flexibility

It has been widely recognized that different flexibility types (e.g. product or mix flexibility, volume flexibility, platform-based flexibility, etc.) are interrelated and that exploiting the linkages between flexibility types can aid decision-making. In particular, both product flexibility and volume flexibility are tools for coping with uncertain demand. In this paper, we explore the intertwined nature of volume and product flexibility by studying four technologies in a monopolistic setting: volume-flexible, product-flexible, both volume and product-flexible and neither volume nor productflexible. Specifically, we model a firm manufacturing two products and facing uncertain demand curves in both markets. The firm installs capacity and then, depending on the selected technology, adjusts and/or allocates this capacity after observing the demand curve realizations. We isolate conditions (in the form of demand/market parameters and technology costs) under which the firm selects each of the four technologies. Similarities and differences among these technologies are highlighted. In particular, we systematically show that product flexibility mitigates uncertainty in demand for individual products better than volume flexibility, which in turn is better at managing uncertainty in the aggregate demand. Moreover, product-flexible technology handles substitutable (complementary) products better (worse) than volume-flexible technology. Surprisingly, there are limited advantages to adding product flexibility to volume flexibility because of possible diseconomies of scope. The analysis is undertaken with both endogenous and exogenous (retro-fitting) capacity choices.