intematkmat journal of zyxwvu p ro d uc tio n e c o no m ic s zyxwvuts ELSEVIER Int. J. Production Economics 38 (1995) 281-291 An options view of investments in expansion-flexible manufacturing systems Ram L. &mar* Department of MIS and Operations Management, The Belk College of Business Administration, The University of North Carolina at Charlotte, Charlotte, NC 28223, USA Received January 1994; revised August 1994 Abstract Traditional financial investment evaluation methods are often unsuitable for evaluating investments in flexible manufacturing systems. We present a novel method of valuing expansion flexibility, based on options theory, and illustrate its use through a detailed example. This method captures additional characteristics of the problem that are not addressed by traditional methods, and can be used for comparing investment alternatives as well as justifying them. The managerial implications of this method are analyzed. 1. Introduction Manufacturing organizations in the US have found that competition, often on a global scale, has significantly impacted manufacturing practices. There is increasing emphasis on flexibility in order to meet changing customer needs. Flexibility could be of different types. Examples of flexibility include the ability to vary production volume and/or prod- uct mix, faster response times, etc. Flexibility can be short-term or long-term [l]. A detailed discussion of different types of flexibility from economic, or- ganizational, and manufacturing perspectives can be found in [2]. These include machine, material handling, operation, process, product, routing, vol- ume, expansion, program, production, and market llexibilities. A major factor in achieving flexibility is * E-mail: rlkumar@unccvm.uncc.edu. the use of advanced manufacturing technology that could range from relatively simple numerically controlled machines to more complicated com- puter integrated manufacturing systems [3]. Investment justification is a serious problem that often impedes the introduction and use of flexible manufacturing systems (FMS) [4, 51. The problem arises because of the nature of benefits resulting from FMS. These benefits are often rela- tively intangible and difficult to quantify in the form of cost savings or revenue generation oppor- tunities. A variety of techniques have been suggested for justification of investments in flexible manufac- turing systems [S-14]. These techniques can be classified into economic techniques, analytical techniques, and strategic techniques [3]. Strategic justification is often qualitative. However, there is a need to support qualitative arguments with quantitative financial information in order to en- 0925.5273/95/$09.50 0 1995 Elsevier Science B.V. All rights reserved SSDI 0925-5273(95)00024-O