Multi-Resource Investment Strategies: Operational Hedging Under Demand Uncertainty

European Journal of Operational Research 113(1)17-29, February 16, 1999

13 Pages Posted: 12 Jun 2015

Date Written: May 1, 1997

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.

Keywords: Strategic planning, Capacity investment, Prices, Operational hedging, Multi-dimensional newsvendor model

Suggested Citation

Harrison, J. Michael and Van Mieghem, Jan Albert, Multi-Resource Investment Strategies: Operational Hedging Under Demand Uncertainty (May 1, 1997). European Journal of Operational Research 113(1)17-29, February 16, 1999, Available at SSRN: https://ssrn.com/abstract=2616991

J. Michael Harrison

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-4727 (Phone)
650-725-6152 (Fax)

Jan Albert Van Mieghem (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

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