Coordinating the resource investment decision for a two-market, price-setting firm

We study the capacity investment decision of a two-product firm that is a price-setter for both products. The products are of varying complexities such that the resource that can be used to produce the higher level product can also be used to produce the lower level one, but not vice versa. Although the firm needs to make its capacity investment decision under demand uncertainty, it can utilize this limited (downward) resource flexibility, in addition to pricing, to more effectively match its supply with demand. As an example, consider a firm that owns a main plant, satisfying both end-product and intermediate-product demand, and a subsidiary, satisfying the intermediate-product demand only. We formulate this decision problem as a two-stage stochastic programming problem with recourse and analyze the impact of coordinated decision-making, when the resource flexibility is taken into account in the investment decision, and demand correlation on the firm's optimal investment strategy. Our results offer managerial principles on the firm's optimal resource investment strategy. (c) 2005 Elsevier B.V. All rights reserved.