Managing High‐Tech Capacity Expansion via Reservation Contracts

Abstract

We study capacity reservation contracts between a high‐tech manufacturer (supplier) and her OEM customer (buyer). The supplier and the buyer are partners who enter a ‘design‐win” agreement to develop the product, and who share the stochastic demand information. To encourage the supplier for more aggressive capacity expansion, the buyer reserves capacity upfront by paying a deductible fee. As capacity expansion demonstrates diseconomy of scale in this context, we assume convex capacity costs. We show that as the buyer's revenue margin decreases, the supplier faces a sequence of four profit scenarios with decreasing desirability. We examine the effects of market size and demand variability to the contract conditions. We propose two channel coordination contracts, and discuss how such contracts can be tailored for situations where the supplier has the option of not complying with the contract, and when the buyer's demand information is only partially updated during the supplier's capacity lead‐time.

Manufacturing High-Tech Products Subject to Rapid Obsolescence

“…Two recent surveys on this topic are the papers by Van Mieghem [8] and by Erkoc and Wu [9]. Both papers focus on optimal production and capacity decisions.…”

Capacity reservation under supply uncertainty

“…Various types of supply contracts involving advance capacity purchases have been investigated, generally based on a singleperiod framework. Erkoc and Wu [20] model the negotiations between a manufacturer and a supplier when the supplier has to make a costly investment in additional production capacity. Jin and Wu [21] analyze capacity reservation contracts between a single supplier and multiple buyers with reservation fees deductible from the purchase price paid in delivery.…”

Capacity reservation contracts for high-tech industry

“…We do not consider capital expansion decisions in this context because capacity reservation is a means of order management, while physical expansion (e.g., building new facilities, procuring capital equipment) requires long-term strategic planning under multi-period market scenarios [14]. Physical expansion typically involves strategic decisions, which require different cost and demand information and thus different model settings [12]. We will focus on outsourcing, which is a growing trend in the high-tech industry since the mid 1990s [18].…”