Capacity Planning in a General Supply Chain with Multiple Contract Types – Single Period Model

A key element to a company’s success is its ability to match its supply to uncertain demand by utilizing different types of capacity contracts. We consider the design of a multi-product supply chain, for which each product requires one or more process capabilities and each process can get capacity from multiple resources. We present a single-period model to determine the capacity investments for these resources in the presence of demand uncertainty and option contracts. (We have also extended the model to a multi-period setting in a companion paper) We derive closed-form solutions to two important special cases of the problem and draw managerial insights about the optimal capacity planning strategy. We then develop a stochastic linear programming algorithm to solve the general single period problem and show that our algorithm outperforms alternative algorithms by means of an empirical study. Finally, with the model and algorithm, we study the effects of common processes and option contracts on capacity planning.