Technical Note: Options-Based Costing and the Volatility Portfolio

Journal of Operations Management, Forthcoming

Kelley School of Business Research Paper No. 17-1

16 Pages Posted: 16 Dec 2016 Last revised: 25 Jan 2017

See all articles by Suzanne de Treville

Suzanne de Treville

University of Lausanne - Faculty of Business and Economics; Swiss Finance Institute

Kyle Cattani

Indiana University Kelley School of Business

Lauri Saarinen

University of Lausanne - Faculty of Business and Economics

Date Written: December 7, 2016

Abstract

It has been clearly established that a cost premium for responsiveness may be justified for profitable time-sensitive products, and that this cost premium may suffice to render production in a high-cost environment competitive. Time-insensitive products considered in isolation seldom justify a cost premium, leading many decision makers to conclude that their production does not belong in a high-cost environment. This leads to a manufacturing-location decision in which profitable and time-sensitive products are produced in a high-cost environment and time-insensitive products are transferred to a low-cost environment. Responsiveness, however, requires a capacity buffer that provides the option to meet a demand peak for a profitable, time-sensitive product. Leftover capacity can then be ideally deployed to manufacture time-insensitive products to stock. We propose that the cost of the capacity buffer be considered as an option cost and assigned to the time-sensitive product: “option-based costing”. We then demonstrate use of demand volatility to create a portfolio of products that are time sensitive and insensitive to generate profit and increase competitiveness. Option-based costing combined with a volatility portfolio reveals opportunities to produce competitively in a high-cost environment that have typically been considered unfeasible.

Keywords: Responsive Manufacturing, Product Costing, Capacity Planning, Time-Based Competition

JEL Classification: D24

Suggested Citation

de Treville, Suzanne and Cattani, Kyle and Saarinen, Lauri, Technical Note: Options-Based Costing and the Volatility Portfolio (December 7, 2016). Journal of Operations Management, Forthcoming, Kelley School of Business Research Paper No. 17-1, Available at SSRN: https://ssrn.com/abstract=2885370

Suzanne De Treville (Contact Author)

University of Lausanne - Faculty of Business and Economics ( email )

Anthropôle 3073
Lausanne, 1015
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Kyle Cattani

Indiana University Kelley School of Business ( email )

1309 East Tenth Street
Bloomington, IN 47405-1701
United States

Lauri Saarinen

University of Lausanne - Faculty of Business and Economics ( email )

Unil Dorigny, Batiment Internef
Lausanne, 1015
Switzerland

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