| Production and Operations Management
September – October 2011
The Manufacturer's Incentive to Reduce Lead Times
It is generally a well acknowledged fact that, ceteris paribus, reducing the lead times between downstream and upstream parties in a supply chain is desirable from an overall system perspective. However, an upstream party (e.g., a manufacturer) may have strong disincentives to offer shorter lead times, even if lead time reduction came at no cost. This paper investigates a manufacturer's incentive to reduce lead times. We consider a setting in which the downstream party has the ability to exert a costly effort to increase demand (e.g., through sales promotions, advertising, etc.) during the selling season and compare two situations: one where there is zero lead time (i.e., all demand can be satisfied after observing the demand realization), and one where orders need to be made before demand is realized. In our analysis, the latter situation corresponds to a newsvendor model with the additional decision of choosing a sales effort to increase demand at a convex increasing cost after observing demand. We identify two interacting effects that may inhibit shorter lead times. A so-called "safety stock effect" can be observed when a lower risk of stocking out under short lead times induces the downstream party to alter its order quantity. A second effect, termed as "effort effect," arises if shorter lead times impact the downstream party's optimal sales effort and, as a consequence, lead to different order quantities. We provide a formal characterization of both effects, insight into how these effects interact, and information on which conditions the manufacturer has an incentive to offer shorter lead times.
Demand and Consumers;
Order Taking and Fulfillment;
Supply Chain Management;