Mechanism Design for Capacity Planning Under Dynamic Evolutions of Asymmetric Demand Forecasts

Published in Management Science 59(4) pp. 987-1007, 2013

52 Pages Posted: 31 Dec 2009 Last revised: 14 Oct 2017

See all articles by Özalp Özer

Özalp Özer

Jindal School of Management - The University of Texas at Dallas

Sechan Oh

IBM Research

Date Written: December 30, 2009

Abstract

This paper provides a general framework to model the evolutions of forecasts generated by multiple decision makers who forecast demand for the same product. We also model the evolutions of forecasts when decision makers have asymmetric demand information and refer to it as the Martingale Model of Asymmetric Forecast Evolutions (MMAFE). This model helps us to study mechanism design problems in a dynamic environment. In particular, we consider a supplier's (principal's) problem of eliciting credible forecast information from a manufacturer (agent) when both firms obtain asymmetric demand information for the end product over multiple periods. The supplier uses demand information to better plan for a capacity investment decision. When the supplier postpones building capacity and screening the manufacturer's private information, the supplier and the manufacturer can obtain more information and update their forecasts. This delay, however, may increase (resp., or decrease) the degree of information asymmetry between the two firms, resulting in a higher (resp., or lower) cost of screening. The capacity building cost may also increase because of a tighter deadline for building capacity. Considering all such trade-offs, the supplier has to determine (i) when to stop obtaining new demand information and build capacity, (ii) whether to offer a screening contract to credibly elicit private forecast information or to determine the capacity level without information sharing, (iii) how much capacity to build, and (iv) how to design the overall mechanism so that both firms benefit from this mechanism. This paper provides an answer to these questions. It also provides a framework to quantify the option value of time for a strategic investment decision under the dynamic evolutions of asymmetric forecasts.

Keywords: Martingale Model of Forecast Evolution, Mechanism Design, Mechanism-Dependent Reservation Profit, Capacity Planning, Information Sharing, Optimal Stopping, Real Options

Suggested Citation

Özer, Özalp and Oh, Sechan, Mechanism Design for Capacity Planning Under Dynamic Evolutions of Asymmetric Demand Forecasts (December 30, 2009). Published in Management Science 59(4) pp. 987-1007, 2013. Available at SSRN: https://ssrn.com/abstract=1529820 or http://dx.doi.org/10.2139/ssrn.1529820

Özalp Özer (Contact Author)

Jindal School of Management - The University of Texas at Dallas ( email )

Jindal School of Management
800 W. Campbell Road
Richardson, TX 75080
United States

Sechan Oh

IBM Research ( email )

T. J. Watson Research Center
1 New Orchard Road
Armonk, NY 10504-1722
United States

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