Reactive production with preprocessing restriction in supply chains with forecast updates

We study a two-mode production system that allows the supply chain to utilize a second (reactive) production opportunity after demand information is updated before the selling season. Such reactive production quantity, however, is limited by the required preprocessing of raw materials that must be decided before the demand information is updated. We analyze the problem for two cases: perfect and imperfect demand information updates. For the case of imperfect demand updates, whether to engage in preprocessing that provides an opportunity for future reactive production depends on the relative magnitude of the resolved demand uncertainty compared with the unresolved one. In the case of perfect demand updates, however, it is independent of the demand characteristics. To the best of our knowledge, this is the first study to provide guidance on when and how much to invest in preprocessing in a situation with a general demand forecast updating. We also present a coordinating Pareto-improving reservation contract and show how the manufacturer can extract more profit by setting a lower reservation fee. Counterintuitively, we find that the manufacturer in the case of perfect demand updates benefits more from a contract without a return policy than that with a return policy. Numerical examples demonstrate that when the preprocessing restriction exists, the benefit of the two-mode production can be as large as 104% as compared to the single-mode production.