Premium
Perceived versus actual value of product substitution flexibility: An experimental investigation
Author(s) -
Bansal Saurabh,
Moritz Brent
Publication year - 2015
Publication title -
journal of operations management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 3.649
H-Index - 191
eISSN - 1873-1317
pISSN - 0272-6963
DOI - 10.1016/j.jom.2015.08.001
Subject(s) - substitution (logic) , flexibility (engineering) , valuation (finance) , econometrics , product (mathematics) , substitution effect , computer science , microeconomics , value (mathematics) , production (economics) , risk aversion (psychology) , economics , expected utility hypothesis , mathematics , mathematical economics , geometry , management , finance , machine learning , programming language
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 inventory 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 conjunctive probability of substitution. We suggest and validate a decomposition‐based approach to mitigate this overestimation.