Mix, Time, and Volume Flexibility: Valuation and Corporate Diversification

Abstract

This article examines the joint impact of three types of operational flexibility in a theoretical model of a two-product firm that makes capacity, production and pricing decisions at three points in time with an underlying continuous-time information evolution. Mix flexibility is measured by the cost of switching production between the two products. Volume flexibility is measured by the fraction of production cost that is variable at the time when the production decision is made. Finally, time flexibility is measured by the relative timing of the production decision. We show that mix and volume flexibilities are substitutes in creating firm value but both are complementary to time flexibility. We discuss the implications of these results for the optimal investment in different aspects of flexibility. We also relate these results to corporate strategy and show how different types of flexibility impact the benefits of corporate diversification.

Keywords: Flexibility, Real Options, Forecast Updating, Diversification

JEL Classification: C61, C44