Coordinating production quantities and demand forecasts through penalty schemes

In this paper, we study coordination mechanisms through penalty schemes bet ween manufacturing and marketing departments which enable organizations to match demand forecasts with production quantities. This research was motiva ted by our interactions with a leading electronics and computer manufacture r. We consider two possible organizational structures - centralized and dec entralized. In the decentralized case we model a single period problem wher e demand is uncertain and the marketing department provides a forecast to m anufacturing which in turn produces a quantity based on the forecast and th e demand distribution. In the centralized case, marketing and manufacturing jointly decide on the production quantity. Among other results we show tha t by setting suitable penalties one can generate the same result in a decen tralized system as that obtained from a centralized system. We also show th at setting the correct penalty for marketing is essential for coordination. Subsequently, we analyze models where the marketing department has the abi lity to change the distribution of demand based on efforts (through promoti on, advertising and personal relationship with customers). An interesting r esult indicates that it is possible to set penalties so that a coordinated decentralized system outperforms a centralized system when there are no tan gible costs to the firm for the efforts expended by the marketing departmen t.