Dynamic Pricing and Lead‐Time Policies for Make‐to‐Order Systems*

Abstract

ABSTRACTMake‐to‐order firms use different approaches for managing their lead‐times and pricing in the face of changing market conditions. A particular firm's approach may be largely dictated by environmental constraints. For example, it makes little sense to carefully manage lead‐time if its effect on demand is muted, as it can be in situations where leadtime is difficult for the market to gauge or requires investment to estimate. Similarly, it can be impractical to change capacity and price. However, environmental constraints are likely to become less of an issue in the future with the expanding e‐business infrastructure, and this trend raises questions into how to manage effectively the marketing mix of price and lead‐time in a more “friction‐free” setting.We study a simple model of a make‐to‐order firm, and we examine policies for adjusting price and capacity in response to periodic and unpredictable shifts in how the market values price and lead‐time. Our analysis suggests that maintaining a fixed capacity while using lead‐time and/or price to absorb changes in the market will be most attractive when stability in throughput and profit are highly valued, but in volatile markets, this stability comes at a cost of low profits. From a pure profit maximization perspective, it is best to strive for a short and consistent lead‐times by adjusting both capacity and price in response to market changes.