Essays in Operations Economics

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The first chapter investigates the offshoring decision from a network capacity investment perspective. We analyze a firm that manufactures two products to serve two geographically separated markets using a common component and two localized final assemblies. Two strategic network design questions arise naturally: (1) Should the common part be produced centrally or in two local facilities? (2) If a centralization strategy is adopted, which market should the facility be located in? We present a transportation cost threshold that captures costs, revenues, and demand risks, and below which centralization is optimal The second chapter studies how rework routing together with wage and piece rate compensation can strengthen incentives for quality. Traditionally, rework is assigned back to the agent who generates the defect (self routing) or to another agent dedicated to rework (dedicated routing). In contrast, a novel cross routing scheme allocates rework to a parallel agent performing both new jobs and rework. We compare the incentives of these schemes in a principal-agent model with embedded quality control and routing in a multi-class queueing network. We show that self routing can never induce first-best effort. Dedicated routing and cross routing, however, strengthen incentives for quality by imposing an implicit punishment for quality failure. In addition, cross routing leads to workload allocation externalities and a prisoner's dilemma, thereby creating the highest incentives for quality. In the third chapter, we propose a dynamic model of capacity expansion and withdrawal in a differentiated duopoly where capacity is lumpy and subject to random depreciation. Multiple Markov-perfect equilibria can arise even though we impose symmetry. Strong horizontal differentiation is associated with a coordinated capacity expansion process, and long-run capacity levels that are symmetric or nearly symmetric. By contrast, when horizontal differentiation is weak, the capacity expansion process is not well coordinated. Firms engage in a preemption race that can, for a time, involve significant amounts of excess capacity. High depreciation rate exacerbates the preemption race. The race ends when one firm falls behind and "surrenders," relying on a combination of deliberate capacity withdrawal and capacity depreciation to reduce its capacity.

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