Perceived versus actual value of product substitution flexibility: An experimental investigation
| Date | 01 September 2015 |
| Author | Saurabh Bansal,Brent Moritz |
| DOI | http://doi.org/10.1016/j.jom.2015.08.001 |
| Published date | 01 September 2015 |
Journal
of
Operations
Management
38
(2015)
56–70
Contents
lists
available
at
ScienceDirect
Journal
of
Operations
Management
jo
ur
nal
ho
me
pa
ge:
www.elsevier.com/locate/jom
Perceived
versus
actual
value
of
product
substitution
flexibility:
An
experimental
investigation
Saurabh
Bansal∗,
Brent
Moritz
Department
of
Supply
Chain
and
Information
Systems,
405
Business
Building,
Smeal
College
of
Business,
The
Pennsylvania
State
University,
University
Park,
PA
16802,
USA
a
r
t
i
c
l
e
i
n
f
o
Article
history:
Received
21
April
2014
Received
in
revised
form
22
July
2015
Accepted
8
August
2015
Available
online
21
August
2015
Accepted
by
Daniel
R.
Guide
Keywords:
Behavioral
operations
Operational
flexibility
a
b
s
t
r
a
c
t
Prior
literature
suggests
that
in
the
presence
of
operational
uncertainties
such
as
uncertain
demand,
firms
should
deploy
operational
flexibilities.
However,
these
flexibilities
are
costly
to
develop
and
a
correct
valuation
of
these
capabilities
is
necessary
to
ensure
that
they
are
only
deployed
when
the
expected
benefits
exceed
the
cost.
Using
a
set
of
behavioral
decision-making
experiments
for
inven-
tory
of
substitutable
products,
we
investigate
how
decision-makers
perform
when
estimating
the
value
of
operational
flexibility
of
product
substitution.
We
found
that
subjects
consistently
overestimated
the
monetary
value
of
product
substitution.
Furthermore,
the
overestimation
became
more
acute
as
demand
correlation
increased.
This
behavior
is
not
explained
by
risk
aversion
or
random
errors.
Instead,
it
appears
to
be
driven
by
fundamental
and
systematic
behavioral
biases
when
estimating
the
conjunc-
tive
probability
of
substitution.
We
suggest
and
validate
a
decomposition-based
approach
to
mitigate
this
overestimation.
©
2015
Elsevier
B.V.
All
rights
reserved.
1.
Introduction
1.1.
Research
focus
Supply
chains
frequently
operate
in
uncertain
environments,
and
capital
investment
or
inventory
decisions
often
must
be
made
before
the
final
market
potential
is
observed.
To
respond
to
uncer-
tain
demand,
firms
frequently
employ
operational
flexibility
as
either
flexible
capacity
(able
to
produce
more
than
one
prod-
uct
with
shared
infrastructure
or
capital
investment)
or
flexible
product
attributes
such
that
similar
items
in
inventory
can
be
substituted
for
each
other.
In
this
paper,
we
focus
on
a
specific
oper-
ational
flexibility
–
that
of
substitution
where
the
product
could
be
a
physical
product
or
a
service.
In
some
instances,
the
use
of
substitution
is
evident
to
the
cus-
tomer
as
products
or
services
have
a
distinct
ordering
of
attributes
and
where
most
consumers
exhibit
a
clear
preference.
For
example,
most
individuals
prefer
a
first
class
seat
in
an
airplane
rather
than
sit
in
the
economy
cabin,
a
larger
hotel
suite
rather
than
a
standard
room,
and
a
faster
computer
processor
rather
than
a
slower
proces-
sor.
In
such
cases,
the
consumer
can
recognize
and
appreciate
the
substitutions
made
by
a
firm.
However,
in
other
contexts
the
sub-
∗Corresponding
author.
E-mail
addresses:
sub32@psu.edu
(S.
Bansal),
bmoritz@psu.edu
(B.
Moritz).
stitution
may
not
be
evident
to
the
customer:
A
firm
could
invest
in
cross-training
workers
or
multi-functional
equipment
that
would
provide
additional
internal
flexibility
if
necessary.
This
enables
the
firm
to
meet
an
unexpected
demand
beyond
what
is
possible
with
single-skill
workers
or
dedicated
equipment.
Still,
the
end
customer
may
not
be
aware
of
the
substitution
or
investment
made
by
the
firm,
but
both
benefit
from
the
increased
output.
The
focus
of
our
research
is
a
provider
who
must
make
an
inventory
or
capacity
decision
for
substitutable
products
ahead
of
knowing
customer
demand.
Consequently,
there
is
limited
inventory
to
satisfy
each
type
of
demand.
In
this
setting,
there
is
an
intuitive
appeal
to
having
substitutable
products
available,
as
the
inventory
of
other
products
in
the
assortment
can
serve
as
a
“backup”
in
case
the
demand
of
a
product
exceeds
its
available
supply.
However,
this
operational
flexibility
is
costly
to
develop
and
a
correct
valuation
is
necessary
to
ensure
that
it
is
only
acquired
when
the
expected
benefit
exceeds
the
upfront
cost.
Estimating
the
benefit
from
product
substitution
is
important
for
firms
for
several
reasons,
including
policy
making,
process
design,
and
sometimes
even
product
design.
First,
if
the
value
of
product
substitution
is
erroneously
overestimated,
then
a
firm
may
inappropriately
substitute
higher-end
products
or
make
unnec-
essary
free
upgrades.
Such
a
policy
may
be
complex
in
terms
of
transactional
or
production
costs
and
of
little
value
to
the
firm.
Second,
firms
may
need
to
invest
in
specific
process
capabilities
based
on
their
substitution
policy.
For
example,
some
car
rental
http://dx.doi.org/10.1016/j.jom.2015.08.001
0272-6963/©
2015
Elsevier
B.V.
All
rights
reserved.
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