Optimal production strategy under demand fluctuations: Technology versus capacity

This paper provides a comparative analysis of five possible production strategies for two kinds of flexibility investment, namely flexible technology and flexible capacity, under demand fluctuations. Each strategy is underpinned by a set of operations decisions on technology level, capacity amount, production quantity, and pricing. By evaluating each strategy, we show how market uncertainty, production cost structure, operations timing, and investment costing environment affect a firm’s strategic decisions. The results show that there is no sequential effect of the two flexibility investments. We also illustrate the different ways in which flexible technology and flexible capacity affect a firm’s profit under demand fluctuations. The results reveal that compared to no flexibility investment, flexible technology investment earns the same or a higher profit for a firm, whereas flexible capacity investment can be beneficial or harmful to a firm’s profit. Moreover, we prove that higher flexibility does not guarantee more profit. Depending on the situation, the optimal strategy can be any one of the five possible strategies. We also provide the optimality conditions for each strategy.