Communication and Inventory as Substitutes in Organizing Production

Abstract

A major organizational design decision for manufacturing firms is the extent to which production should be to stock versus to order: inventories and communication with customers are substitutes. We show that profits are convex in the share of the market supplied from inventory. Thus firms will tend to specialize in one mode of organization. We examine how this choice depends on market size, the level and variability of demand, the costs of communication, price levels, production costs, and the costs of expanding product lines. The results are consistent with observed patterns in several industries.