Manufacturing Capacity Revenue Management

Contract (custom) manufacturers of components and manufactured materials such as steel sell capacity under different contract terms to different buyers. In a common practice, the supplier offers a market standard price and lead time combination for products listed in its catalog. At the same time, it strikes annual contracts with some high-volume customers who require recurring delivery of a custom product at a short notice, usually timed to meet the buyer’s production schedule. Whereas the manufacturer is contractually bound to satisfy demand from these customers, it can dynamically choose which transactional orders to accept. In this article, we analyze two scenarios to help the manufacturer extract more revenue from its production capacity, which is used to serve both markets. In the first scenario, the manufacturer produces contractual orders on a make-to-order basis, and in the second scenario, it maintains finished goods inventory for such orders. At each decision epoch, the manufacturer decides (a) how much capacity to allocate to the production of contractual and transactional items, and (b) which transactional orders to accept, in order to maximize its long-run expected profit. We establish the structure of the optimal policies, propose scalable heuristics when optimal policies are hard to compute/implement, and obtain bounds. Our models are then used to study the effect of capacity choices and demand uncertainty on the optimal profit. We also show how the amount of capacity available, relative to demand, changes the desirability of serving either transactional-only, or both markets.