Capacity Acquisition, Capacity Cost Allocation, and Pricing for New Product Introduction

Abstract

Using a two-product and two-period model, we investigate optimal capacity acquisition and capacity cost allocation for product costing and pricing decisions for existing and new products under long-term capacity commitment. The existing product is produced in both periods, while the new product is produced only in the second period. The insights we obtain differ from those in earlier literature and complement them. We find conditions under which the capacity charge for existing products when idle capacity exists can be more or less than the capacity charge when the firm introduces new products to better utilize the capacity. A necessary requirement for the capacity charge for the existing product in the first period when there is idle capacity to be greater than the capacity charge in the second period when the capacity is better utilized is that the demand for the two products be negatively correlated. The result provides a rationale for the variety of cost allocation schemes used in practice.