Collaboration in tool development and capacity investments in high technology manufacturing networks

The procurement of capital intensive tools for hi-tech industries is one of the most complex tasks. Astronomical amounts of capital are invested in the processing equipment. Further, there is a large effort from the original equipment manufacturer (OEM) in customizing the high capital intensive equipment to suit their production process. This problem has received little attention from the quantitative decision making literature. For the first time we analyze the problem of OEM deciding on collaborating with the tool supplier via a special type of contract which we refer as "collaboration options". We show that there are benefits to both the OEM and the tool suppliers from the collaboration. We develop a two-stage strategic model for collaborative tool development and optimal capacity investment. In the first stage, we solve an optimal collaboration problem faced by the OEM. We formulate this problem as a discrete time stochastic stopping problem for a finite horizon. We use a policy iteration algorithm for deciding on optimal collaboration policy. In the second stage, we model the optimal investment decision of the OEM in tool development and capacity acquisition using real options theory. Unlike the traditional options literature, we consider the option value determined from the first stage model and decide on the optimal amount for investment. (C) 2006 Published by Elsevier B.V.