Joint Pricing and Production Decisions in an Assemble-to-Order System

This paper studies coordinated pricing and production decisions in an assemble-to-order system. We first show that unlike in make-to-stock systems, a state-dependent base-stock list-price policy is optimal. The optimal state-dependent base-stock levels and list prices may increase or decrease as demand backlogs increase, whereas demand backlogs always improve the optimal expected profit. Because the problem easily becomes intractable under general system settings, we next develop a simple heuristic policy. The heuristic policy decouples inventory replenishment, pricing, and component allocation decisions in a coordinated way. We provide a sufficient condition that ensures the optimality of the heuristic policy, and present a numerical study to demonstrate its performance when the condition is not met. The numerical study also shows how the performance of the heuristic policy is affected by various market and operational conditions, and by the structure of the assemble-to-order system. By focusing on the simple W-model, we show how the heuristic pricing decisions are made in response to changes in inventory levels and various cost parameters.