INVESTING IN HUMAN CAPITALPREAMBLETHE CASE OF AUTOMANUFACTURINGDESIGN LEVERS FOR ANALYSISUNCERTAINTY FACTORSCOMPARING TWO DESIGNSDECISION ANALYSIS: SETUPDECISION ANALYSIS: RESULTSBINOMIAL LATTICE ANALYSIS: SETUPBINOMIAL LATTICE ANALYSIS: RESULTSSlide 11DISCUSSIONInvesting in Human Capital 1INVESTING IN HUMAN CAPITALESD.71 Final Application Portfolio PresentationDecember 6, 2007Marie-Claude NadeauInvesting in Human Capital 2PREAMBLEIn a number of industries, quality of the workforce is a key factor in determining a product’s position in the marketInvesting in human capital earlier in a product’s lifetime may yield higher future revenuesThis effect becomes even more significant as competition for skilled workforce becomes stronger and wages increaseInvesting in Human Capital 3THE CASE OF AUTOMANUFACTURINGThe car manufacturing industry is no exception to these trendsSeeing an increase of knowledge intensity in both product and workforceThis poses the problem of decision-making in a context where workforce size and experience has an overall impact on product quality and thus, potential market shareInvesting in Human Capital 4DESIGN LEVERS FOR ANALYSISThe performance of the system analyzed can be improved by changing:Number of workers hiredPeriod when they are hiredHiring an employee has both a one-time initial cost, and a cost per period (wages)In addition, initial plant size can be varied, for more or less economies of scaleCan build more capacity than workforce can currently produce → flexibility to hire and augment production in the futureInvesting in Human Capital 5UNCERTAINTY FACTORSTwo main sources of uncertainty:Future demand for the productWorkers’ wagesThis changes in both these parameters could occur because of technical innovation, environmental regulation, labour regulations, etc.The analysis presented will focus on uncertainty in future demand, but similar methods could be applied for other factorsInvesting in Human Capital 6COMPARING TWO DESIGNSFixed workforce strategy:Fixed number of workers, all hired at year 0Plant size corresponding to production capacity of these workersFlexible workforce strategyFewer workers hired at year 0, with possibility to hire more laterLarger plant built initially to have the flexibility of increasing production laterInvesting in Human Capital 7DECISION ANALYSIS: SETUPTwo stages of five yearsAt each chance node:Demand assumed to follow a geometric Brownian motion with average growth rate 1.7%, volatility 2%Two stages are simulated 2000 times and bucketed in “high”, “medium” or “low” outcomesAt each decision node, there is a choice between hiring more workers or notExpected value is calculated after each nodeInvesting in Human Capital 8DECISION ANALYSIS: RESULTSValue higher for the fixed plan ($1.3G) than for the flexible plan ($1.2G), but flexible plan better under “maximin” objectiveInvesting in Human Capital 9BINOMIAL LATTICE ANALYSIS: SETUPDemand has average growth rate 1.7%, volatility 5%, over 6 yearsLattice parameters:u=1.0512711 d=0.9512294 p=0.67Year 0 1 2 3 4 5 6Outcomes: 1860.00 1955.36 2055.62 2161 .01 2271.81 2388.29 2510.74 1769.29 1860.00 1955 .36 2055.62 2161.01 2271.81 1683.00 1769 .29 1860.00 1955.36 2055.62 1600.92 1683.00 1769.29 1860 .00 1522.84 1600.92 1683 .00 1448.57 1522 .84 1377.92Investing in Human Capital 10BINOMIAL LATTICE ANALYSIS: RESULTSProbability distribution function:Investing in Human Capital 11BINOMIAL LATTICE ANALYSIS: RESULTSDecision to exercise flexibility:Year 0 1 2 3 4 5 6 YES YES YES YES YES YES NO NO YES YES YES YES NO NO YES YES YES NO NO YES YES NO YES YES NO YES NOExpected present value of flexible design ($2.18G) is higher than for fixed design ($1.99G)Value of flexibility is $192MInvesting in Human Capital 12DISCUSSIONValue of flexibility depends on a number of analysis parameters: method, objective, definition of uncertainty, discount rate, project lifetimeDecision analysis may be more appropriate for options on building a plant, and lattice for options on hiring workforceProblem can scale rapidly with added uncertainty
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