Price, delivery time guarantees and capacity selection

This paper studies the impact of using delivery time guarantees as a competitive strategy in service industries where demands are sensitive to both price and delivery time. We assume that delivery reliability is crucial, and investment in capacity expansion is plausible in order to maintain a high probability of delivering the time guarantee. A mathematical framework is proposed to understand the interrelations among pricing, delivery time guarantee and capacity expansion decisions. Specifically, an optimization model is developed to determine the joint optimal selection of these three important decision variables, with an objective of maximizing the average net profit. We characterize the optimal decisions and study their qualitative behaviors as various parameters change. We further present a numerical example to illustrate how the results of our model can be used to provide useful managerial insights for selecting the best competing strategies for firms with different operating characteristics. Our model and results are also applicable to a make-to-order manufacturing environment.