Customer lead time management when both demand and price are lead time sensitive

In this paper, we model an operating system consisting of a firm and its customers, where the mean demand rate is a function of the guaranteed delivery time offered to the customers and of market price, where price itself is determined by the length of the delivery time. Economies of scale are present. The firm's objective is to maximize profits by selecting an optimal guaranteed delivery time taking into account that (i) reducing delivery time will require investment, and (ii) the firm must be able to satisfy a pre-specified service level. We show that it is imperative for managers to know whether customers are price or lead time sensitive based on the simultaneous dependence of price and demand on delivery time before selecting a time-based competitive strategy. We investigate the optimal policy and provide managerial insights based on our analysis. Examples where our insights are consistent with actual practical situations are also provided. We show that our model is different from those in the literature that assume price and delivery time to be independent decision variables and present conditions under which ignoring the relation between price and delivery time can lead managers to substantially sub-optimal decisions – with or without the presence of economies of scale.