The Manufacturing Flexibility to Switch Products: Valuation and Optimal Strategy

This paper applies a dynamic programming methodology to the valuation problem for the flexibility to switch. In our model, flexibility provides an investor with the right, or option, to perform a switch between a less profitable and a more profitable project at no cost. In contrast to previous analyses, the option to switch can be exercised in the future at any time during the decision horizon. We present the solution methodology that allows to determine the value of the flexibility and to identify the optimal timing of the switching decision. Comparative statics demonstrate how changes in the input parameters affect the values of the problem"s solution. The results partially explain why investing in flexible manufacturing systems is reported to have both low profitability and rate of diffusion.