Capacity Expansion with Lead Times and Correlated Random Demand

The combination of uncertain demand and lead times for installing capacity creates the risk of shortage during the lead time, which may have serious consequences for a service provider with dependent customers. This paper analyzes a model of capacity expansion with correlated random demand and a fixed lead time for adding capacity. We develop and prove the form of an optimal policy for expansion timing and size. We study the effects of demand correlation and randomness as well as the lead time length on the policy parameters. Correlation acts similarly to randomness in hastening expansions but has a smaller impact than randomness, especially when lead times are short. However, the failure either to recognize correlation or to accurately estimate its extent can cause substantial policy errors.