The role of production lead time and demand uncertainty in marketing durable goods

Firms often have to make their production decisions under conditions of demand uncertainty. This is especially true for product categories such as automobiles and technology goods where the lead time needed for manufacturing forces firms to make production decisions well in advance of the selling season. Once the firm has produced the goods, the available production volume affects the firm’s subsequent marketing decisions. In this paper, we study the relationship between the firm’s production and marketing decisions for a durable goods manufacturer. We develop a dynamic model of a durable product market in which the demand functions are developed from a micromodeling of consumer utility functions and an equilibrium analysis of consumer strategies. After taking into account the demand uncertainty as well as the potential for cannibalization of future sales, the manufacturer makes its production and sales decisions. We find that the firm’s optimal inventory level is U-shaped in the durability of the product and that the firm suffers a larger loss due to uncertainty when it is leases rather than sells its products. Furthermore, unlike the case for nondurables, for durable goods we find that the effect of uncertainty persists even after the uncertainty has been resolved.