Dynamic expansion of flexible capacity with and without pricing coordination

Abstract

This research presents an optimal multi-period dynamic capacity expansion framework for a shared flexible capacity producing two products. The framework allows modeling coordinated and non-coordinated capacity and marketing decisions under demand uncertainties. In our two-level decision process, the upper level considers the strategic capacity expansion and formulates multi-period uncertainty as a stochastic dynamic programming (DP) problem, and the lower level considers each period’s pricing and capacity allocation decisions in response to available capacity and market demand. We compare capacity expansion decisions under centralized pricing schemes that coordinate the pricing decisions of different products based on the overall interest of the firm and the decentralized pricing schemes based on the interests of individual product managers. Numerical results show that adopting a decision coordination strategy may help firms to maintain flexibility and reduce capacity expansion investment while enhancing overall profitability.