Working Papers

Mix, Time, and Volume Flexibility: Valuation and Corporate Diversification
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Jiri Chod, Nils Rudi, and Jan A. Van Mieghem
June 2004 (revised January 2006)

Abstract

Flexibility measures the ability to adapt to change and often has multiple dimensions that impact value jointly yet differently. We assess this joint impact in a theoretical model of a two-product firm that makes capacity, output and pricing devisions at three points in time with an underlying continuous-time information evolution. The firm's ability to adapt is characterized by three types of flexibility. The cost of switching capacity between the two products measures the firm's mix flexibility. The fraction of product costs that are postponed until demand information is updated measures the firm's volume flexibility. Finally, the relative timing of the output decision measures the firm's time flexibility. We show that mix and volume flexibilities are substitutes in creating firm value but both are complementary to time flexibility. Furthermore, the marginal values of mix and time flexibility are decreasing in demand correlation whereas the marginal value of volume flexility increases in demand correlation. We discuss the implications of these results to the trade-offs faved by managers when deciding how much to invest in different aspects of flexibility. We also relate these results to corporate strategy and show when different types of flexibility can justify a company to purse market diversification.

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