Development of a strategic capital-expenditure decision model incorporating the product abandonment option

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Virginia Tech


The worldwide technological explosion has dramatically changed the basis of international competition. The accelerated rate of change in product engineering and process technology has led to decreasing product life cycles and made equipment obsolescence a primary concern to U.S. manufacturers. Researchers in academia, industry, and the government have unanimously agreed on the primary role that the investment in advanced manufacturing technologies (AMT, eg., Flexible Manufacturing Systems) can play in meeting the challenges of the new global business environment. However, U.S. manufacturing technology is still lagging far behind U.S. innovation , and many U.S. firms are practically unable to justify the needed modernization.

Many authors have written about the necessity to account for strategic, long-term benefits associated with acquiring new AMT’s in order for U.S. manufacturers to justify more easily, and more realistically, their investment decisions. However, most of these authors have overlooked the fact that the decision to acquire a new AMT is most likely to displace existing resources, and that unless manufacturers are offered a tool to evaluate the impact of abandoning obsolete or less-than-profitable products and/or processes and justify such a decision, the needed modernization process will continue to be hindered.

The objective of this research is bifold. First, the product/process abandonment problem is reformulated from a new perspective which is congruent with the requirements of the new global business environment. And second, a global decision model (GDM) incorporating the product abandonment option into the company’s overall strategic planning and control system is developed which seeks to help U.S. manufacturers make world-class capital expenditure decisions. To this end, an extensive taxonomic analysis was first conducted to investigate the product abandonment analysis topic as treated in the literature of engineering economy, financial management, management accounting, marketing, strategic management, and corporate organizational and behavioral sciences. The product abandonment problem is then reformulated in view of both the strengths and shortcomings of traditional models and the requirements of the new business environment. Finally, the developed solution methodology is described, implemented as a computer program, and illustrated through an actual case-study.

The GDM is governed by an abandonment algorithm and a multi-attribute decision module (MADM) which are interfaced in a highly interactive mode. The proposed abandonment algorithm uses a recursive dynamic programming search method to determine at each decision point in the project life cycle whether it is more profitable to abandon a product or to continue its operations for one more time period. The MADM translates various strategic objectives of the company, financial and non-financial, into quantifiable performance measures and ranks alternative improvement portfolios. Production simulation techniques and activity-based costing (ABC) are suggested to collect the needed input data for the model. Preference ordering theory is used to account for management’s attitude toward risk and make trade-offs between project profitability and riskiness. Once a course of action is selected, its performance must be continuously monitored and controlled in view of pre-specified strategic performance targets.

The results obtained from the analysis of the case study confirmed the economic validity of the philosophy underlying the developed solution methodology as well as the ease of application of such a methodology to a wide range of real-life problems. They also demonstrated the benefits that a company can forgo by ignoring the abandonment option throughout the product life cycle.

In conclusion, the developed model is believed to be a sophisticated, yet practical, tool which can help engineering managers reach more informed, and therefore more competitive, decisions about their firms’ portfolio of products. Furthermore, pertinent recommendations were made to direct future research regarding this subject matter.