Koc University

We study a manufacturing rm that builds a product to stock to meet a random demand. Production time is deterministic, so that if there is a backlog, customers are quoted a lead time that is proportional to the backlog. In order to represent the customers ' response to waiting, we introduce a defection function | the fraction of customers who choose not to order as a function of the quoted lead time. Unlike models with backorder costs, the defection function is related to customer behavior. Using a continuous ow control model with linear holding cost and Markov modulated demand, we show that the optimal production policy has a hedging point form. The performance of the system under this policy is evaluated, allowing the optimal hedging point to be found