OPTIMAL PRICING AND GUARANTEED LEAD TIME WITH LATENESS PENALTIES

Abstract

This paper studies the price and guaranteed lead time decision of a supplier that offers a fixed guaranteed lead time for a product. If the supplier is not able to meet the guaranteed lead time, the supplier must pay a lateness penalty to customers. Thus, the expected demand is a function of the price, guaranteed lead time and lateness penalty. We first develop a mathematical model for a given supply capacity to determine the optimal price, guaranteed lead time and lateness penalty to maximize the total profit. We then consider the case where it is also possible for the supplier to increase capacity and compute the optimal capacity.