Capacity Allocation Using Past Sales: When to Turn-and-Earn

Consider a supplier selling to multiple retailers. Demand varies across periods, but the supplier's capacity and wholesale price are fixed. If demand is high, the retailers' needs exceed capacity, and the supplier must implement an allocation mechanism to dole out production. How the choice of mechanism impacts retailer actions and supply chain performance is examined. In particular, turn-and-earn allocation, a method commonly used in the automobile industry, is examined. This scheme bases current allocations on past sales and thus enables retailers to influence their future allocations; they compete for scarce capacity even if they do not compete for customers. It is shown that turn-and-earn induces the retailers to increase their sales when demand is low and the supplier's capacity is otherwise underutilized. Supplier profits thus increase. The impact on the supply chain depends on how restrictive capacity is.