Market Preferences and Process Selection (Mapps): The Value of Perfect Flexibility

In this paper we investigate the value of perfect flexibility. Perfect flexibility is defined as the increase in profit that can be obtained by responding instantly to changes in market preferences, compared to a “robust” policy of offering only a single product mix over time. We assume that the market evolves over time throughm states or scenarios, defined by the preferences of the market. In response to this evolving marketplace, a producer can respond by switching its facilities to one of t technological states, defined by plant capabilities. We model the evolution of market preferences and policies for process selection as a Markov Decision Process. With an objective of profit maximization, we show that when the cost of switching production processes is very high, the optimal policy is to select a single “robust” process and to never switch from it. In contrast, when process switching costs are zero, we show that the optimal policy is “perfect flexibility” where production processes are immediately matched to market preferences. An optimal production policy will exist between these two extreme policies. We define the value of perfect flexibility as the difference in expected profits between 1Address: College of Business and University of Colorado, Boulder, CO 80309-0419, phone: (303) 492-4351 2Corresponding author. Address: Department of Business Administration, University of Illinois at Urbana-Champaign, 1206 South Sixth Street, Champaign, IL 61820, phone: (217) 333-8270 3Address: Babcock Graduate School of Business, Wake Forest University, Wake Forest, NC 27109-7659, phone: (910) 759-4423