To wait or not to wait: Optimal ordering under lead time uncertainty and forecast updating

Abstract

AbstractThere has been a dramatic increase over the past decade in the number of firms that source finished product from overseas. Although this has reduced procurement costs, it has increased supply risk; procurement lead times are longer and are often unreliable. In deciding when and how much to order, firms must consider the lead time risk and the demand risk, i.e., the accuracy of their demand forecast. To improve the accuracy of its demand forecast, a firm may update its forecast as the selling season approaches. In this article we consider both forecast updating and lead time uncertainty. We characterize the firm's optimal procurement policy, and we prove that, with multiplicative forecast revisions, the firm's optimal procurement time is independent of the demand forecast evolution but that the optimal procurement quantity is not. This leads to a number of important managerial insights into the firm's planning process. We show that the firm becomes less sensitive to lead time variability as the forecast updating process becomes more efficient. Interestingly, a forecast‐updating firm might procure earlier than a firm with no forecast updating. © 2009 Wiley Periodicals, Inc. Naval Research Logistics, 2009