A real options model of phased migration to cellular manufacturing

Abstract

The literature is replete with models that examine various aspects of cellular manufacturing (CM), such as optimisation of cell layouts. However, many firms may realise zero to marginal returns from CM. Given this uncertainty, the manager should first determine the value of CM to the firm before deploying it. Although traditional valuation models employing discounted cash flow analysis allow for uncertainty, they treat future investments as fixed when computing the investment’s present value. The real options (RO) logic of valuation allows the manager to exercise the option to invest in or abandon a project based on expected outcomes. Future investments are thus options. This paper presents an RO model for CM migration that addresses whether a firm should migrate to CM; and it prescribes the sequence of cell deployment, which has not been addressed in the literature. Our model is also much more transparent and accessible to practitioners, with an accompanying software tool for prospective users. Finally, we use simulation extensively to discover the drivers of the optimal cell deployment sequence. Our results show that there is a complex interplay between net present value, speed of cellularisation, inter-cell learning and volatility in terms of their influence on the cell sequence.

Keywords:

• real options
• cellular manufacturing
• decision-making model
• learning model

Disclosure statement

No potential conflict of interest was reported by the authors.