| When making irreversible investments in resources such as capacity or inventory, firms are typically uncertain about future market conditions, such as demand, prices and exchange rates. The ensuing risk exposure can often be mitigated by various operational hedging strategies where initial commitment is made only to an aggregate quantity, whereas the allocation between different products, markets or firms is delayed until a more accurate market forecast becomes available. Examples of operational hedging include postponement of product differentiation, employment of flexible capacity, or capacity subcontracting and inventory transshipment among multiple firms. This dissertation contributes to the understanding of the value of operational hedging by (1) endogenizing product pricing, (2) capturing the natural information dynamics and (3) considering the strategic interactions within the firm's supply chain.; The first chapter introduces the problem of a single-product price-setting firm which has to make an irreversible resource investment, assuming two alternative stochastic demand curves: iso-elastic with multiplicative uncertainty and linear with additive uncertainty. The second chapter examines the problem of investing in a flexible resource which can be used to satisfy two distinct demand classes. While the resource investment decision must be based on uncertain demand curves, the resource allocation and pricing decisions respond to the realized demand curves. The investment cost is endogenized by considering the pricing decision of the resource supplier. We characterize the effects of two key drivers of flexibility: demand variability and correlation, on the optimal investment level, expected profit, value of flexibility, and consumer surplus, under each of the two alternative demand curves.; The third chapter extends this model by considering two independent firms which invest in resources based on imperfect market forecasts. As new information becomes available, the firms update their forecasts and have the option to trade their resources. Assuming that the firms face iso-elastic demand curves and set prices after all uncertainty is resolved, we analyze the effects of trading, cooperative versus non-cooperative behavior, quality of forecast revisions, demand variability and correlation, and foreign exchange volatility on equilibrium investments, expected prices, profits and consumer surplus. The last chapter further discusses some managerial implications of the models. |
