Sequential Solutions to Capacity-Planning and Pricing Decisions

Abstract

Ideally, firms should jointly solve capacity-planning and product-pricing problems. In practice, informational limitations and cognitive bounds may force firms to sequentially solve the two problems. For example, a firm may plan capacity using limited demand information, and update prices subsequently once additional demand information becomes available. In a simple setting, we characterize the economic loss due to such sequential planning. We use simulation experiments to assess the extent of this loss in more complex settings. We find a relatively low loss if the firm plans for capacity using limited demand information and subsequently adjusts product prices to reflect realized market conditions. However, even "reasonable" restrictions on the subsequent price adjustment (e.g., constraining adjusted prices to always exceed full cost) lead to significant economic loss.