The Manufacturer's Incentive to Reduce Lead Times

Abstract

Although, ceteris paribus, reducing lead times may be desirable from an overall system perspective, an upstream party (e.g., a manufacturer) may have strong disincentives to offer shorter lead times, even if this came at no cost. We consider a setting in which the downstream party has the ability to exert a costly effort to increase demand (e.g., through sales promotions, advertising, etc.) during the selling season, and compare two situations: one where there is zero lead time (i.e., all demand can be satisfied after observing the demand realization), and one where orders need to be made before demand is realized. We identify two interacting effects that may inhibit shorter lead times. A so‐called “safety stock effect” can be observed when a lower risk of stocking out under short lead times induces the downstream party to alter her order quantity. A second effect, termed as “effort effect,” arises if shorter lead times impact the downstream party's optimal sales effort, and, as a consequence, lead to different order quantities. We provide a formal characterization of both effects, insight into how these effects interact, and show under which conditions the manufacturer has an incentive to offer shorter lead times.