Product and Process Flexibility: Implications for Organizational Design

In this paper, we study the interaction between a firm’s internal organizational design, which we treat as an irreversible technology choice, and its external environment. We focus on two internal organizational design variables: product design flexibility and process flexibility. Along a given dimension, flexibility lowers the future cost of adjusting production decisions in response to changes in the external environment. Product design adjustments affect the demand for the firm’s products, while process adjustments lower the firm’s production costs. Our analysis reveals that these two types of adjustments are complementary in terms of increasing the firm’s net revenue in a given period. However, we argue that in terms of the initial organizational design costs, there are tradeoffs between product design flexibility and process flexibility. The complementarities between product design and process adjustment compete with the tradeoffs between product design and process flexibility. We find that, due to these competing effects, an increase in the expected future returns to adjustment in a given dimension does not always lead to an increase in the optimal choice of flexibility in that dimension. Thus, our paper draws substantively different conclusions than those which would be reached from a model with only one dimension of flexibility, or from a model that neglected the interactions which arise in terms of either (i) the costs of internal organizational design decisions, or (ii) the benefits to adjusting production decisions.