Centre for Supply Chain Management
CMA Canada Supply Chain Management Seminar Series: Information Acquisition for Capacity Planning via Pricing and Advance Selling: When to Stop and Act?
published: 2005 | Research publication | CMA Canada Supply Chain Manageme
ABSTRACT: We study a firm producing and selling a short-life-cycle product in a price sensitive, uncertain demand environment. The firm has to invest in capacity before the sales season, the cost of which increases as the sales season is approached. A common uncertainty reduction strategy in such environments is to acquire demand information through advance selling. We consider a scenario in which the firm dynamically adjusts prices prior to the sales season and collects advance purchase commitments. The response of the market to advance selling (i.e., amount of advance purchase commitments) provides the firm with additional information on the demand potential of the product, and helps manufacturer plan capacity according to more accurate information. At the beginning of each period the firm also has the option to stop advance selling, set the market price and go ahead with the capacity investment. We formulate this problem as an optimal stopping problem (with embedded optimal pricing and capacity
decisions). We first determine the optimal market price, capacity level, and expected profit in the event the firm decides to stop advance selling and invest in capacity in a given period. Through a dynamic program, we then establish the optimality of a threshold policy. We illustrate the structure of the optimal prices, commitment threshold levels, as well as the capacity levels and firm profits. Through numerical experiments and comparative studies, we explore the value of information acquisition via advance selling and pricing, and identify conditions under which this practice is most likely to be beneficial for the firm.
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revised May 17/05