Multi-resource investment strategies: Operational hedging under demand uncertainty

J. Michael Harrison, Jan A. Van Mieghem*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

109 Scopus citations

Abstract

Consider a firm that markets multiple products, each manufactured using several resources representing various types of capital and labor, and a linear production technology. The firm faces uncertain product demand and has the option to dynamically readjust its resource investment levels, thereby changing the capacities of its linear manufacturing process. The cost to adjust a resource level either up or down is assumed to be linear. The model developed here explicitly incorporates both capacity investment decisions and production decisions, and is general enough to include reversible and irreversible investment. The product demand vectors for successive periods are assumed to be independent and identically distributed. The optimal investment strategy is determined with a multi-dimensional newsvendor model using demand distributions, a technology matrix, prices (product contribution margins), and marginal investment costs. Our analysis highlights an important conceptual distinction between deterministic and stochastic environments: the optimal investment strategy in our stochastic model typically involves some degree of capacity imbalance which can never be optimal when demand is known.

Original languageEnglish (US)
Pages (from-to)17-29
Number of pages13
JournalEuropean Journal of Operational Research
Volume113
Issue number1
DOIs
StatePublished - Feb 16 1999

Keywords

  • Capacity investment
  • Multi-dimensional newsvendor model
  • Operational hedging
  • Prices
  • Strategic planning

ASJC Scopus subject areas

  • Computer Science(all)
  • Modeling and Simulation
  • Management Science and Operations Research
  • Information Systems and Management

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