The International Journal of Flexible Manufacturing Systems, 13: 241–265, 2001 c  2001 Kluwer Academic Publishers. Manufactured in The Netherlands. Direct and Indirect Effects of Product Mix Characteristics on Capacity Management Decisions and Operating Performance SHANNON W. ANDERSON University of Michigan Business School, Ann Arbor, MI 48109-1234 swanders@umich.edu Abstract. Studies of the performance effects of product mix complexity typically treat plant capacity utilization and machine scheduling (for example, setup frequency) as exogenous factors associated with technology choices, economies of scale, and the level of market demand. However, capacity utilization and machine scheduling also reflect tactical operating decisions taken by local managers to maximize short-run performance. If managers rationally anticipate a negative relation between performance and product mix complexity, we expect tactical operating decisions to be used to mitigate performance degradation. Previous empirical studies that ignore this simultaneity provide an incomplete assessment of the performance effects of product mix complexity. This paper uses path analysis to examine the combined impact of product mix on capacity management decisions and operating performance in three textile manufacturing plants. The results support the hypothesis that product mix acts through capacity management decisions to reduce performance from the level implied by direct effects alone. The evidence also supports the behavioral proposition that managers use capacity management decisions strategically—creating production slack when product mix is anticipated to most affect performance. However, although managers use discretionary capacity management intensively when the product mix is composed of complex, heterogeneous products, they are unable or unwilling to use these decisions to fully offset the performance impact of product mix. Key Words: capacity utilization, complexity, economies of scope, machine setups 1. Introduction In surveys, U.S. and Japanese manufacturing managers assert that product mix flexibility is the most critical manufacturing capability (Stewart, 1992; DeMeyer, Nakane, Miller, and Ferdows, 1989; Slack, 1987). Product mix flexibility is the ability to produce a wide range of products, to accommodate modifications to existing products, and to assimilate new products, all with minimal degradation of performance (Slack, 1984). Research suggests that flexibility is difficult to achieve—that it is more common for performance to decline with a changing mix of heterogeneous products. The root cause of performance degradation is heterogeneity in production activities that disrupts learning, creates complex material and information flows, and precipitates complex scheduling and capacity management problems (see Skinner, 1974; Panzar and Willig, 1977, 1981; Hayes and Wheelwright, 1984; Hill, 1985; Miller and Vollmann, 1985; Johnson and Kaplan, 1987; Cooper and Kaplan, 1987; Karmarkar and Kekre, 1987; Kekre, 1987; Banker, Datar, and Kekre, 1988; Cooper, 1990; Suarez, Cusumano, and Fine, 1996). This paper focuses on the scheduling and capacity management problems that arise when a complex, changing mix of products is produced.