Process flexibility and inventory flexibility via product substitution

This paper studies the optimal control of and interaction between two types of flexibility under Markov models of demand and production: process flexibility and inventory flexibility. In our model, process flexibility is generated by a multi-functional production facility that can produce two types of products, and inventory flexibility is manifested in firm-driven one-way product substitution. Both process flexibility and inventory flexibility are important drivers of supply chain performance and are strategic design considerations. To analyze the interaction between these two types of flexibility, we model a dynamically controlled two-product, make-to-stock system with stochastic processing times and stochastic demand. We characterize the complex joint optimal production and post-production policy for a special case and numerically show that a simply structured multi-threshold policy is a near-optimal heuristic policy for the general case. We gain further insight into the impact of system parameters on the value of process flexibility and inventory flexibility via a comprehensive numerical study. We find that for a wide range of capacity and cost parameters, process flexibility and inventory flexibility complement each other, so pursuing both forms of flexibility is effective.