CAPACITY INVESTMENT, PRICING, AND PRODUCTION ALLOCATION ACROSS INTERNATIONAL MARKETS WITH EXCHANGE RATE UNCERTAINTY

Abstract

In this paper, we investigate joint optimal capacity investment, pricing and production decisions for a multinational manufacturer who faces exchange rate uncertainties. We consider a manufacturer who sells its product in both domestic and foreign markets over a multiperiod season. Because of long-lead times, the capacity investment must be committed before the selling season begins. The exchange rate between the two countries fluctuates across periods and the demand in both markets are price dependent. Our model considers three scenarios: (1) early commitment to price and quantity with central sourcing, (2) postponement of prices and quantities with central sourcing, and (3) local sourcing. We derive the optimal capacity and the optimal prices for each scenario, and investigate the impact of the exchange rate parameters and the length of the selling season. We observe that while the price and production decisions in the domestic market are independent of the exchange rate under early commitment and local sourcing scenarios, the exchange rate between two countries directly impacts these decisions under the postponement setting. We identify thresholds and gain insights on capacity and production costs, exchange rate movement, and selling season length for the choice of entering a foreign market under all scenarios.