Time-dependent and independent control rules for coordinated production and pricing under demand uncertainty and finite planning horizons

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Abstract

We address the effect of uncertainty on a manufacturer’s dynamic production and pricing decisions over a finite planning horizon. The demand for products, which depends on their price, is characterized by two stochastic processes: potential demand and customer price sensitivity. An optimal policy for coordinating production and pricing is a time-dependent feedback rule with respect to the state of the manufacturer’s inventories. We show that when the volatility of customer sensitivity to the product price is negligible, the optimal policy can be obtained analytically. Moreover, our simulations demonstrate that the volatility of stochastic customer price sensitivity does not have a strong effect on the manufacturer’s expected profit. Therefore, the solution derived for the case of customer price sensitivity with zero volatility can serve as a good approximation heuristic for the optimal policy if the true volatility of customer price sensitivity is within 40 % of its mean and the volatility of potential demand is within 25 % of its mean. Moreover, under these conditions, a simplified, time-independent control rule deteriorates expected profits by only 1.5 %.

Original languageEnglish
Pages (from-to)195-216
Number of pages22
JournalAnnals of Operations Research
Volume223
Issue number1
DOIs
StatePublished - Dec 2014

Bibliographical note

Publisher Copyright:
© 2014, Springer Science+Business Media New York.

Keywords

  • Closed-loop control
  • Dynamic pricing
  • Stochastic processes

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