The capacity investment decision for make-to-order production systems with demand rate control

Abstract

Abstract In this paper we study the capacity investment decision for make-to-order manufacturing firms that utilize a fixed capacity, operate in a stochastic, stationary market, and can influence their demand rate by increasing or decreasing their sales effort. We consider manufacturing situations that differ in sales contribution, in market elasticity to sales effort, work-in-process costs, and demand sensitivity to lead time. If demand is insensitive to lead time we find that for situations with a low sales contribution and high work-in-process costs (for example the manufacturing of capacity equipment that is at the end of the innovative life cycle, such as food processing machines and textile printing machines), using a dynamic demand rate policy can bring substantial improvements in profit. Moreover, when using the optimal demand rate policy, the profit is quite insensitive to the initial capacity investment. If demand is sensitive to lead time, using a dynamic demand rate policy brings substantial increases in profit in all situations considered. The profit again is quite insensitive to the initial capacity investment. Consequently, without much loss in profit, for all cases the capacity investment decision can be based on the stochastic model with stationary demand, neglecting the possibility of influencing the demand rate. However, the profit that results from this investment, and the return-on-investment, should be determined from a model that includes the optimal demand rate policy, since the stationary stochastic model can significantly underestimate the profit and could lead to the abandonment of the investment.