An Analysis of Pricing and Leadtime Policies within the Marketing/Operations Interface

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Pekgun-Cakmak, Pelin
Keskinocak, Pinar
Griffin, Paul
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In this thesis, we analyze the impact of the decentralization of price and leadtime decisions made by the marketing and production departments, respectively, in a make-to-order firm. We first study a monopoly environment, and find that in the decentralized setting, the total demand generated is larger, leadtimes are longer, quoted prices are lower, and the firm profits are lower as compared to the centralized setting. We show that coordination can be achieved using a transfer price contract with bonus payments, where both departments receive a fraction of the total revenues generated as a bonus payment. In the second study, we extend this work to a duopoly environment, where two firms compete on the basis of their price and leadtime quotes in a common market. We find that under intense price competition, firms may suffer from a decentralized structure, particularly under high flexibility induced by high capacity, where revenue based sales incentives motivate sales/marketing for more aggressive price cuts resulting in eroding margins. We take the parameters of the demand models in the first two studies as constant, while estimating those parameters based on historical data is a very important problem in practice. In the last study of this thesis, we address the challenges encountered in estimating the price sensitivity of customers shifting focus to the passenger travel industry. We explore how to obtain better price elasticity estimates through an empirical study with an emphasis on the endogeneity problem, which arises as a result of the simultaneous determination of supply and demand. We show that if one does not account for endogeneity, price elasticities may induce an upward-sloping demand curve suggesting that high price produces high demand, or may be biased downward to the extent that elastic demand curves are incorrectly classified as inelastic. We show the improvement in price elasticities through an instrumental variable approach.
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