Price Versus Production Postponement: Capacity and Competition

Abstract

T his article presents a comparative analysis of possible postponement strategies in a two-stage decision model where firms make three decisions: capacity investment, production (inventory) quantity, and price. Typically, investments are made while the demand curve is uncertain. The strategies differ in the timing of the operational decisions relative to the realization of uncertainty.We show how competition, uncertainty, and the timing of operational decisions influence the strategic investment decision of the firm and its value. In contrast to production postponement, price postponement makes the investment and production (inventory) decisions relatively insensitive to uncertainty. This suggests that managers can make optimal capacity decisions by deterministic reasoning if they have some price flexibility. Under price postponement, additional postponement of production has relatively small incremental value. Therefore, it may be worthwhile to consider flexible ex-post pricing before production postponement reengineering. While more postponement increases firm value, it is counterintuitive that this also makes the optimal capacity decision more sensitive to uncertainty. We highlight the different impact of more timely information, which leads to higher investment and inventories, and of reduced demand uncertainty, which decreases investment and inventories. Our analysis suggests appropriateness conditions for simple make-to-stock and make-to-order strategies. We also present technical sufficiency and uniqueness conditions. Under price postponement, these results extend to oligopolistic and perfect competition for which pure equilibria are derived. Interestingly, the relative value of operational postponement techniques seems to increase as the industry becomes more competitive.

Game Theory in Supply Chain Analysis

“…To separate out credible threats from noncredible, Selten [82] introduced the notion of a subgame-perfect equilibrium. See Hall and Porteus [43] and Van Mieghem and Dada [98] for solutions involving subgameperfect equilibria in dynamic games.…”

“…These options introduce the behavior that is observed in practice but cannot be modeled within the static game (see Netessine et al [74] for detailed analysis) because firms' inventory decisions affect their demand in the future. Among other applications of stochastic games are papers by Cachon and Zipkin [24] analyzing a two-echelon game with the wholesaler and the retailer making stocking decisions, Bernstein and Federgruen [10] analyzing price and service competition, Netessine and Rudi [70] analyzing the game with the retailer exerting sales effort and the wholesaler stocking the inventory, and Van Mieghem and Dada [98] studying a two-period game with capacity choice in the first period and production decision under the capacity constraint in the second period.…”

Game Theory in Supply Chain Analysis

“…To separate out credible threats from non-credible, Selten (1965) introduced the notion of a subgame-perfect equilibrium. See Hall and Porteus (2000) and van Mieghem and Dada (1999) for solutions involving subgame-perfect equilibria in dynamic games.…”

Competition through capacity investment under asymmetric existing capacities and costs

“…In our view this is only an appropriate model in cases where a firm has no option to make production decisions before discovering its rival's capacity choices (such as may occur if there are long lead times for major components); or, needs to maintain high capacity utilization because of high fixed costs of starting and stopping the production process; or, has available some mechanism to make a credible full production commitment to preempt the market (Hayes et al, 2005). Hence even though we use the terminology of a clearance strategy, as is normal in the operations management literature (see Van Mieghem and Dada, 1999), we do not mean to imply that a firm necessarily makes a choice about the strategy to use. It is more likely that a clearance strategy is a consequence of industry structure (Lieberman, 1987b;Goyal and Netessine, 2007).…”

“…When decisions on production quantities are made at a later time, it is often not possible to commit to a certain production level at the time when the capacity investment is made. In such cases firms may well choose to produce at a lower level than their maximum capacity (Hayes et al, 2005) and we refer to this as a holdback strategy following the operations management literature (see Van Mieghem and Dada, 1999). Note that we view the production policy, either holdback or clearance, as a fixed characteristic of the industry, but in practice the situation can be more complicated as firms need to make adjustments over time in response to market conditions.…”