A Real Options Model for Workforce Cross-Training

Abstract

In this article, we propose using a real options framework to model and financially value a cross-training policy. The cross-training policy involves a dynamic investment on workforce flexibility. We model it as an approximation of an American call option using binomial lattices. Value stems from the merit of dynamic cross-training compared with the deterministic case using traditional discounted cash flow techniques. This work is discussed in the context of a volatile production system characterized by product dynamics, labor dynamics, task heterogeneity and workforce heterogeneity. Results suggest that cross-training based on the real options approach is dependent on the production capability and the level of workforce heterogeneity. Thus, valuing workforce flexibility using real options has strategic utility beyond that of the net present value approach.

ACKNOWLEDGMENTS

The authors acknowledge the support of the National Science Foundation, for the first author under SES-0217666, and for the second author under grant DMI-0217924. We also recognize the contributions of Ayse Gurses on an earlier working paper related to this research. Finally, we express our thanks to the referees for their helpful suggestions and comments.