Prescribing product upgrades, prices and production levels over time in a stochastic environment

Competitive pressures cause the price of high-technology products to erode over time. The purpose of this paper is to describe a decision support tool to maximize profit by prescribing three related decisions: product upgrading, pricing and production levels. A stochastic dynamic programming (DP) model prescribes when to upgrade a product and what new technologies to incorporate to maintain product competitiveness and profit margins. It deals with the two major sources of risk: demand and the lead time required to complete an upgrade. The objective of the DP model is to maximize expected profit over a given planning horizon. Decision variables prescribe which alternative upgrades to implement and when, pricing, and production levels. Benchmarking computational tests are described along with an example demonstrating model application. Managers can use this DP model to coordinate decisions related to product upgrading, pricing, and operations management to better meet business objectives.