Price and Lead Time Quotation for Contract and Spot Customers

Abstract

We study price and lead time quotation decisions in a make-to-order system with two customer classes: (1) contract customers whose orders are practically always accepted and fulfilled based on a contract price and lead time agreed on at the beginning of the time horizon, and (2) spot purchasers who arrive over time and are quoted a price and lead time pair dynamically. The objective is to maximize the long-run expected average profit per unit time, where profit from a customer is defined as revenues minus lateness penalties incurred because of lead time violations. We model the dynamic quotation problem of the spot purchasers as an infinite horizon Markov decision process, given a fixed price and lead time for contract customers. We analyze the impact of customer preferences (e.g., price and lead time sensitivity) on the optimal price and lead time decisions for spot purchasers and characterize the optimal policy. We explore the benefits of dynamic quotation compared to the use of fixed price and lead times, and provide recommendations for firms. Finally, we analyze the optimal contract terms given the dynamic quotation strategy for spot purchasers and discuss the profit improvements offered by the optimal mix of spot and contract customers.