Capacity Planning and Pricing Under Uncertainty

Abstract

This paper analyzes a capacity‐planning and pricing problem of a monopolist facing uncertain demand. The model incorporates “soft” and “hard” capacity constraints (soft constraints can be relaxed at a cost while hard constraints cannot be relaxed) and demand uncertainty. The firm receives additional demand information within the plan‐ning horizon. The solution to the planning problem depends crucially on what is known about demand at the time of the capacity decision as well as the pricing decision. Historical acquisition costs of capacity are relevant for pricing whenever the same information is available for capacity planning and pricing. However, when the firm re‐ceives additional demand information before making the pricing decision, only marginal cost is relevant for pricing. Different types of capacity constraints, i.e., soft vs. hard, affect how much capacity the firm obtains, but not how the firm sets prices.