Customer order lead times for production based on lead time and tardiness costs

In practice decisions regarding customer order lead time and customer order processing are taken in different parts of the organization. Definite lead times are quoted by the sales department and job flow decisions are taken by the production department. This split up of decision responsibilities is in accordance with the differences in scope and control areas in complex organizations like job-shops or engineer-to-order firms. In this paper we present a simple economic model of sales and production in a job shop. Production aims at realizing the jobs by using its capacity to perform the operations of the jobs. Sales, using a model of the performance of production, aims at maximizing expected profit by quoting lead times to customer orders, given that penalties are put on quoting long lead times and on tardy deliveries. Analysis of the model shows that for any combination of penalties on lead times and tardiness, there exist job flow times distributions for which it is optimal for sales to quote unrealistically short customer order lead times. Specifically if the job flow time has a high mean value and/or a high variance sales tends to quote a lead time with zero lead time penalty. In practice we often observe that the job flow times are long and have a high variance. The research presented in this paper shows why this may stimulate sales to neglect flow time information and to quote unrealistically short lead times. Our model shows that under a wide range of economic conditions a job flow time distribution with a small mean and a small variance seems to be a necessary condition for sales to quote realistic customer order lead times.