Integrated optimisation of pricing manufacturing and procurement decisions of a make-to-stock system operating in a fluctuating environment

Abstract

Manufacturers experience random environmental fluctuations that influence their supply and demand processes directly. To cope with these environmental fluctuations they typically utilise operational hedging strategies in terms of pricing manufacturing and procurement decisions. We focus on this challenging problem by proposing an analytical model. Specifically we study an integrated problem of procurement manufacturing and pricing strategies for a continuous-review make-to-stock system operating in a randomly fluctuating environment with exponentially distributed processing times. The environmental changes are driven by a continuous-time discrete state-space Markov chain and they directly affect the system's procurement price raw material flow rate and price-sensitive demand rate. We formulate the system as an infinite-horizon Markov decision process with a long-run average profit criterion and show that the optimal procurement and manufacturing strategies are of state-dependent threshold policies. Besides that we provide several analytical results on the optimal pricing strategies. We introduce a linear programming formulation to numerically obtain the system's optimal decisions. We particularly investigate how production rate holding cost procurement price and demand variabilities customers' price sensitivity and interaction between supply and demand processes affect the system's performance measures through an extensive numerical study. Furthermore our numerical results demonstrate the potential benefits of using dynamic pricing compared to that of static pricing. In particular the profit enhancement being achieved with dynamic pricing can reach up to 15% depending on the problem parameters.