The value of demand postponement under demand uncertainty

Abstract

Resource or capacity investment has a high impact on the firm profitability. However, this decision must be made earlier when demand is uncertain and it is very difficult to change later on. Many firms search for other strategies to deal with uncertainty in order to gain more profit and stay in a business. Postponement strategy is one of the strategies that many companies use to hedge against the uncertainty. A firm can increase its profitability when it can postpone some decisions or activities to the time later until the more information is obtained. In this paper, we consider a firm producing two substitutable products. The firm needs to make two decisions: the capacity investment and production quantity. The objective of this work is to study how the demand postponement affects the firm's capacity investment and its profitability under demand uncertainty and how degrees of substitution impact our findings. Based on this framework, we model the problem as a two-stage stochastic programming. We characterize the optimal investment capacity and production quantity under different postponement strategies. In addition, the necessary and sufficient conditions for investment in flexible capacity are obtained.