Technical note: Option-based costing and the volatility portfolio

Suzanne de Treville, Kyle Cattani, Lauri Saarinen

Research output: Contribution to journalArticleScientificpeer-review


It has been clearly established that a cost premium for responsiveness may be justified for profitable time-sensitive products, and that this cost premium may suffice to render production in a high-cost environment competitive. Time-insensitive products considered in isolation seldom justify a cost premium, leading many decision makers to conclude that their production does not belong in a high-cost environment. This leads to a manufacturing-location decision in which profitable and time-sensitive products are produced in a high-cost environment and time-insensitive products are transferred to a low-cost environment. Responsiveness, however, requires a capacity buffer that provides the option to meet a demand peak for a profitable, time-sensitive product. Leftover capacity can then be ideally deployed to manufacture time-insensitive products to stock. We propose that the cost of the capacity buffer be considered as an option cost and assigned to the time-sensitive product: “option-based costing”. We then demonstrate use of demand volatility to create a portfolio of products that are time sensitive and insensitive to generate profit and increase competitiveness. Option-based costing combined with a volatility portfolio reveals opportunities to produce competitively in high-cost environments that have typically been considered unfeasible.
Original languageEnglish
JournalJournal of Operations Management
Publication statusPublished - 31 Mar 2017
MoE publication typeA1 Journal article-refereed


  • Operations
  • Volatility portfolio
  • Option-based costing
  • Local capacity


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