Pricing and lead time decisions for make-to-order firms with contingent orders

Make-to-order (MTO) firms have few standard products and volatile, difficult-to-predict demand. A production order usually stems from a successful bid, which presents the MTO firm's terms (including price and lead time) to satisfy a prospective customer's stated requirements. The customer may decide to accept, reject, or modify these terms. Until the customer decides, the tendered bid is a contingent demand on the MTO firm's future production capacity. In the short run, this capacity may be relatively fixed and, if the customer awards the contract to another bidder, it may simply go to waste. To hedge against this possibility, the MTO firm can bid on other projects that require the same capacity. However, this strategy introduces a new source of lead time uncertainty. If two or more booked orders must contend for the same resources, some work will inevitably be ‘bumped’ to later time periods. Thus, a hedging strategy carries the risk of penalties for late deliveries. In this paper we model this little-discussed source of lead time uncertainty and introduce a technique that simultaneously optimizes pricing and lead time decisions for MTO firms with contingent orders. We illustrate the procedure with a simple numerical example.