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Managing Flexible Capacity in a Make-to-Order Environment

Department of Industrial and Systems Engineering, Virginia Polytechnic Institute and State University, Blacksburg, Virginia
Mechanical and Industrial Engineering Department, University of Massachusetts, Amherst, Massachusetts, and Departamento de Economia e Historia Económica, Universidad de Salamanca, Salamanca, Spain
Manufacturing Systems Research Laboratory, General Motors Research and Development Center, Warren, Michigan
ebru{at}vt.edu
muriel{at}ecs.umass.edu
stephan.biller{at}gm.com

Flexible capacity has been shown to be very effective to hedge against forecast errors at the investment stage. In a make-to-order environment, this flexibility can also be used to hedge against variability in customer orders in the short term. For that purpose, production levels must be adjusted each period to match current demands, to give priority to the higher margin product, or to satisfy the closest customer. However, this will result in swings in production, inducing larger order variability at upstream suppliers and significantly higher component inventory levels at the manufacturer. Through a stylized two-plant, two-product capacitated manufacturing setting, we show that the performance of the system depends heavily on the allocation mechanism used to assign products to the available capacity. Although managers would be inclined to give priority to higher-margin products or to satisfy customers from their closest production site, these practices lead to greater swings in production, result in higher operational costs, and may reduce profits.

Key Words: resource flexibility; capacity allocation; supply chain performance; demand uncertainty; operational hedging
History: Received: December 6, 2000;

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