ARTICLE IN PRESS

Int. J. Production Economics 119 (2009) 402–414

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Int. J. Production Economics

journal homepage: www.elsevier.com/locate/ijpe

Optimal control problems for a new product with word-of-mouth

Xiaoming Yan a,b,, Ke Liu a
a
Institute of Applied Mathematics, Academy of Mathematics and Systems Sciences, Chinese Academy of Sciences, Beijing 100190, PR China
b
School of Computer, Dongguan University of Technology, Guangdong, PR China

a r t i c l e i n f o abstract

Article history: In this paper, we consider a firm to maximize its profit by choosing a production
Received 13 September 2007 capacity and determining the production and sales policies for a new product during the
Accepted 6 March 2009 lifetime of the product. We extend Bass demand process into more general case
Available online 10 April 2009
including the negative effectiveness of word-of-mouth. Under some mild conditions, we
Keywords: show that the optimal sales policy is myopic, then we obtain the closed forms of the
Production capacity optimal production and sales policies in three cases. Furthermore, we can determine the
Negative word-of-mouth optimal production capacity by solving several equations.
New product & 2009 Elsevier B.V. All rights reserved.
Optimal policy

1. Introduction negative word-of-mouth denotes that the lost demand

When a new product is introduced, the firm needs to
set up its capacity and decide its inventory policy to
maximize its revenues over the new product’s life cycle.
There are two important procedures for the firm: how
much capacity to install and how to manage its opera-
tional decisions based on the installed capacity. Therefore,
the firm expects to find the jointly optimal policy, which
includes the optimal capacity and the optimal decisions,
to maximize its total profit in the new product’s life cycle.
In this paper, we consider the problem of the jointly
optimal policy.
Based on Bass (1969) demand, we consider a more
general case, which includes the negative effectiveness of
word-of-mouth. When there is restriction of production
capacity, the part of demand over the restriction will be
lost. Some potential customers have worried that their
demand cannot be satisfied from the lost part, therefore,
they will lose also, which is the negative effectiveness of
word-of-mouth from the lost demand. In this paper, the
 Corresponding author at: Institute of Applied Mathematics, Academy
of Mathematics and Systems Sciences, Chinese Academy of Sciences,
Beijing 100190, PR China. Fax: +86 010 62541689.
E-mail address: yanxiaoming325@126.com (X. Yan).
informs other potential customers the information of the
shortage, and the lost demand denotes the individuals
who have known the shortage of the product and given up
the adoption decisions. In the previous literature, it is
always assumed that the lost demand will not cause any
effect on the potential customers of the new product. In
reality, the lost demand can also cause word-of-mouth
just like the customers who have received the product.
However, the lost demand differs from the cumulative
sales (customers who have received the new product) in
that the former generates negative word-of-mouth which
spreads the information of shortage to potential custo-
mers, while the latter generates positive word-of-mouth
that is typically assumed in the Bass model. In this paper,
we study the effect both of negative and positive word-of-
mouth caused by the lost sales and cumulative sales,
respectively. Therefore, we consider the situation in which
the rapid growth of demand for the new product is due to
positive word-of-mouth and the rapid growth of lost sales
is due to the impact of capacity constraint and negative
word-of-mouth, respectively.
The potential customers who received the information
from lost demand will choose other product from the
social system, therefore, we assume that potential
customers affected by negative word-of-mouth will be
lost and join in the lost demand list in this paper. Bass

0925-5273/$ - see front matter & 2009 Elsevier B.V. All rights reserved.
doi:10.1016/j.ijpe.2009.03.011
 ARTICLE IN PRESS
X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414
(1969) gave a basic assumption: ‘‘The probability that an
initial purchase will be mode at T given that no purchase
has yet been made is a linear function of the number of
previous buyers’’. We not only accept Bass assumption,
but also assume that the probability that an initial lost
demand will be mode at T given that no lost demand has
yet been made is a linear function of the number of
previous unsatisfied demand.
Negative word-of-mouth is commonplace in real life.
For example, in January, 2008, one customer intended to
buy a personal computer of ‘‘HP Compaq’’ and consulted
with his friends about this kind of personal computer.
However, one of his friends told him that this kind of
personal computer has been sold out recently and advised
him to buy other brands of computers. He received the
information of shortage from the web site of http://
www.21tx.com/notebook. Therefore, he purchased an-
other brand of personal computer subsequently. From
this example, we can conclude that a customer, who has
known the shortage of the product, maybe inform other
potential customers the information of shortage, such that
some potential customers will be lost.
When there is capacity constraint, we should distin-
guish the awareness process, the demand process and the
cumulative sales process in the paper: the awareness
process denotes the total number of customers who have
been aware of the new product, which includes the
customers who receive the information of the new
product from mass media, positive and negative word-
of-mouth; the demand process denotes the customers
who go to the store and try to buy the new product; the
cumulative sales process denotes the customers who have
received the new product. Therefore, the cumulative sales
is bounded by the minimum of the cumulative demand
and the cumulative production.
The firm’s objective is to determine the production
capacity before the sales horizon and the production and
sales policies during the lifetime of the product. For any
fixed production capacity, we can show that the optimal
sales policy is myopic under some mild conditions, where
the myopic policy is that the firm sells the product as
much as possible whenever there is product on hand.
Based on the optimality of myopic policy, we can
determine the optimal production capacity by solving
several equations. Furthermore, we compare demand
process caused by the optimal policies with Bass demand,
and obtain that the demand process caused by the optimal
policies is always less than Bass demand.
The rest of this paper is organized as follows. In Section 2,
we review some related literature. In Section 3, the model
formulation is presented. In Section 4, we determine the
optimal production and sales policies for any fixed capacity.
In Section 5, we determine the optimal capacity the firm
should install before the sales horizon. In Section 6, we give
some conclusions and future research directions.
2. Related literature
In the economics literature, Griliches (1957) and
Mansfield (1961) have proposed diffusion models for the
403
spread of technological innovation. These models have
been adopted by Bass (1969) in the marketing literature to
model the adoption of innovation products. Robinson and
Lakhani (1975) incorporated price in Bass model and then
derived the optimal pricing policy by using a static
analysis, that is, the marginal revenue is equal to the
marginal cost. Dolan and Jeuland (1981) and Kalish (1983)
extended Robison and Lakhani’s model to a general
framework that includes several previous results as
special cases and obtained the optimal policy by using
maximum principle in control theory. Thomposon et al.
(1984) analyzed an inventory model with simultaneous
price and production decisions. They obtained the strong
planning and strong forecast horizon which could be used
to decompose the original problem into several smaller
problems to solve. Cheryl (1988) was concerned with a
profit maximizing firm that derived the optimal price for
his level of output, level of inventory and composition of
productive capacity of over time. Several researchers in
marketing have worked on modifying the Bass model to
incorporate advertising. For example, Dodson and Muller
(1978) introduced a model of new product diffusion which
included advertising and word-of-mouth, and incorpo-
rated the effects of repeat purchasing. Krishnan and Jain
(2006) used an empirically proven diffusion demand
function that explicitly incorporates the advertising
component. Kalish (1985) introduced a framework for
modeling innovation diffusion that includes price, adver-
tising and uncertainty. He characterized the adoption of a
new product by two steps: awareness and adoption.
Awareness is the stage of being informed about the
product search attribute. Here, the awareness is always
positive since there is no lost sales and no capacity
constraint. However, when there is capacity constraint in
our model, the awareness is divided into two parts:
negative part affected by the lost demand and positive
part affected by the cumulative sales. Some other
modifications of Bass model including advertising and
pricing can be found in Mahajan et al. (2000). Bass (1969)
and subsequent related diffusion models formulated the
adoption of products without considering capacity con-
straint. However, capacity constraint is common for
availability of a new product in reality because there
often exists a maximal production rate defined by the
capacity of the firm. There are many works on new
product or capacity constraint, see Wanke (2008), Afonso
et al. (2008), Vlachos and George (2001), Iyer and Jain
(2004), Ishii and Nose (1996) and Brander et al. (2005)
and so on.
Fortunately, there has been a little literature about the
diffusion of new product under capacity constraint. Simon
and Sebastian (1987) noted that supply constraints may
distort the parameter estimates obtained by Bass model.
Jain et al. (1991) considered supply constraint and
presented a modified Bass model where customers who
have tried to buy but have been unsuccessful are
backlogging. They formulated that the level of capacity
grows with the number of backorders because it is in a
service environment and the lead time to expand capacity
is short. However, in most manufacturing environment,
the capacity is always constant because the lead time of
 ARTICLE IN PRESS
404 X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414
changing capacity is long. Therefore, the customer losses
are common. Cantamessa and Valentini (2000) presented
a simple mixed-integer linear programming model and
considered the decision of production capacity. However,
they just compared and discussed the optimal policies
from a numerical experiment. Ho et al. (2002) generalized
Bass model by allowing for a supply constraint. In their
model, the customers who have tried to buy but have
been unsuccessful join the waiting queue and potentially
abandon their adoption decision, resulting in lost sales.
They assumed that only the customers who have received
the product generate the positive word-of-mouth, and lost
demand does not generate any word-of-mouth. In our
model, we try to extend their model to incorporate the
negative word-of-mouth from the lost demand. Kumar
and Swaminathan (2003) considered a firm that sells an
innovation product with given market potential and
showed that a heuristic ‘‘build-up’’ policy is a robust
approximation to the optimal policy when there is not
negative word-of-mouth from the lost demand. The build-
up policy (Kumar and Swaminathan, 2003) is that the firm
first does not sell the product and stores them, and then
sells them along the demand when there is enough
products on hand. In our model, the build-up policy is no
longer optimal, but the myopic policy is optimal under
some mild conditions.
In the rest of this section, we will present Bass model
and Kumar and Swaminathan’s model because our model
is a generation of these two models. First, let us review
Bass model. In Bass model, the adoption of innovation
product by customers is driven by two sources: (a) direct
communication from manufacturers or advertisers which
is called innovation, and (b) positive word-of-mouth
spreading from previous adopters which is called imita-
tion. Thus, the instantaneous demand rate up to time t is
given by
dDðtÞ
dðtÞ ¼ ¼ ½N  DðtÞ½a þ bDðtÞ, (2.1)
dt
Rt
where DðtÞ ¼ 0 dðsÞ ds is the cumulative demand up to
time t, N is the fixed market potential, N  DðtÞ is the
potential customers who have not purchased the product,
a and b are constants that represent the relative effects of
mass media and positive word-of-mouth on the popula-
tion, respectively, and the conditional likelihood of
adoption is increasing linearly in the number of existing
adopters, i.e. a þ bDðtÞ.
It is easy to see that a shortcoming of Bass model is its
inability to capture supply constraints. Under supply
constraints, however, it is possible that when some
customers attempt to purchase the product, the product
may be unavailable. Thus, the cumulative sales up to time
t, SðtÞ, may be quite different from the cumulative
demand, DðtÞ. In this setting, the assumption that every-
one who attempted to purchase the product in the past
would have been successful or unsuccessful, would spread
the same positive word-of-mouth about the product, need
not be valid. In order to overcome this shortcoming,
Kumar and Swaminathan (2003) and Ho et al. (2002)
proposed a modification of Bass model that takes into
account supply constraints. In their model, the instanta-
neous demand at time t is given by
dðtÞ ¼ ½N  DðtÞ½a þ bSðtÞ, (2.2)
where the cumulative sales SðtÞ satisfies the supply
constraint, that is, SðtÞ is never more than the minimum
of cumulative demand and cumulative production up to
time t. The key feature of this model is that future demand
depends not only on past demand but also on past realized
sales, that is, it is only the realized sales that spread the
positive word-of-mouth. We can obtain in Kumar and
Swaminathan’s model that the lost demand does not have
any effect on other potential customers. However, just as
the discussions in the previous section, the lost demand
will often cause negative word-of-mouth to other poten-
tial customers. Hence, in this paper, we would like to take
into account the fact that the lost demand will make some
potential customers give up purchasing the product by
negative word-of-mouth.
3. Model formulation
Consider a firm which plans an introduction of a new
product. Before selling the product, the firm must decide
how much capacity to install, which is based on the trade-
off between the cost of supply shortages and the cost of
overcapacity. Once the production capacity q has been
installed and the diffusion demand process has started,
the firm will decide its production rate xðtÞ and its sale
rate sðtÞ at each time t. Obviously, xðtÞ and sðtÞ are bounded
by the capacity and demand rate, respectively, that is,
xðtÞpq and sðtÞpdðtÞ, where dðtÞ ¼ dDðtÞ=dt. dðtÞ is just the
number of customers who go to the store and try to buy
the product at time t, and DðtÞ denotes the cumulative
customers who have gone to the store and tried to
purchase the product up to time t. At each moment, a
customer who was previously not ready to adopt and have
been informed from mass media or positive word-of-
mouth may place an order. If the new product is available,
the customer receives the product immediately. If not,
he/she will abandon the adoption decision by canceling
the order. Consequently, the customer population can be
divided into three groups. The first group includes the
potential adopters who have not been affected by mass
media or word-of-mouth, we denote N  WðtÞ, where N is
the fixed market potential and WðtÞ, which is named
awareness process, denotes the total customers who have
been aware of the new product. The second group
includes individuals who have placed an order and
already received the new product, we denote SðtÞ. Then
SðtÞ also denotes the firm’s actual sales quantity up to time
t. The third group includes the customers who are the so-
called lost demand, WðtÞ  SðtÞ, which includes adopters
(denoted by DðtÞ  SðtÞ) who refuse to wait and hence
cancel their orders and potential customers (denoted by
WðtÞ  DðtÞ) who give up their order decisions because of
the impact of the negative word-of-mouth from the
previous lost demand. If the product capacity is unlimited,
there will be no lost demand. Thus, awareness process
WðtÞ, demand process DðtÞ and sales process SðtÞ coincide
with DðtÞ in Bass model. In the presence of capacity
constraint, potential adopters who are not able to obtain
 ARTICLE IN PRESS
X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414
the product immediately abandon the adoption and join
in the lost demand list WðtÞ  SðtÞ, and potential adopters
who are influenced and get the information from the lost
demand also join in the lost demand list WðtÞ  SðtÞ.
Therefore, under capacity constraint, the awareness
process and demand process can be described as:
dWðtÞ
¼ ½N  WðtÞ½a þ bSðtÞ þ bðWðtÞ  SðtÞÞ, (3.1)
dt
dDðtÞ
¼ ½N  WðtÞ½a þ bSðtÞ. (3.2)
dt
The awareness process of the new product is influenced by
three factors: the independent innovation dynamics a, the
interaction dynamics between adopters SðtÞ and potential
customers N  WðtÞ who have not been aware of the new
product, and the interaction dynamics between lost
demand WðtÞ  SðtÞ and potential customers N  WðtÞ. In
(3.1), the interaction dynamics between potential adop-
ters and lost demand will immediately join in the lost
demand list, and all individuals have the same factor of
word-of-mouth, b. The demand process itself, which
defines the arrival of customers orders, follows Kumar
and Swaminathan’s model. From expression (3.1), the
awareness diffusion process can be described as
dWðtÞ
¼ ½N  WðtÞ½a þ bWðtÞ.
dt
With boundary condition Wð0Þ ¼ 0. Following Mahajan et
al. (1990), the cumulative awareness up to time t can be
calculated as
a½eðaþbNÞt  1
WðtÞ ¼ a ðaþbNÞt . (3.3)
bþ e
N
Expression (3.3) implies that the awareness diffusion is
not related to sales policy, which can be interpreted by the
fact that the customers, who have been aware of the
product, have the same factor of word-of-mouth. The only
difference is that the customers, who have received the
product, cause the positive word-of-mouth, but the
customers, who have joined in the lost demand list, cause
the negative word-of-mouth. Substituting (3.3) into (3.2)
and simplifying, demand rate at time t can be described as
dDðtÞ a þ bN
¼ a ½a þ bSðtÞ, (3.4)
dt b þ eðaþbNÞt
N
which yields that the demand rate at time t can be
determined by the cumulative sale up to time t. Therefore,
once the sales policy is determined, then the demand
process is also determined.
From above discussions, the firm’s objective can be
divided into the following two-stage problem: in stage
one, the firm determines the production capacity before
the sales horizon; in stage two, the firm determines the
production and sales policies in accordance with the
production capacity installed in the first stage. The
optimization problem will be separated into two parts,
in the first part we optimize the production and sales
policies for any given capacity, then we optimize the
capacity in the second part.
405
For fixed value of production capacity q, the firm’s
purpose is to choose sales rate sðtÞ and production rate xðtÞ
to maximize life-cycle discounted profit
Z 1
JðqÞ ¼ max eyt ½psðtÞ  cxðtÞ  hðXðtÞ  SðtÞÞ dt
sðtÞX0;xðtÞX0 0
(3.5)
s.t.
dXðtÞ
¼ xðtÞ,
dt
dSðtÞ
¼ sðtÞ,
dt
a þ bN
sðtÞp a ½a þ bSðtÞ, (3.6)
b þ eðaþbNÞt
N
xðtÞpq, (3.7)
SðtÞpXðtÞ, (3.8)
Xð0Þ ¼ Sð0Þ ¼ 0, (3.9)
where p4c is the fixed unit selling price of the new
product, c is the fixed production cost per unit and h is the
inventory holding cost per unit per time, yX0 is the
discounted rate, they are all constant during the whole
horizon. The first two equations are self-explanatory.
Constraint (3.6) states that the sales rate cannot be
more than demand rate. Constraint (3.7) states that the
production rate is never more than production capacity.
Constraint (3.8) implies that sðtÞpxðtÞ whenever
SðtÞ ¼ XðtÞ, that is, the cumulative sale is never more than
cumulative production. Constraint (3.9) is assumed to be
satisfied in this paper. Once the optimal sales policy sðtÞ
and the optimal production policy xðtÞ are determined for
given capacity q, the firm then need to determine the
optimal capacity which can be selected by
maxfJðqÞ  qHg,
q40
where H is the variable cost of acquiring and maintaining
a unit of capacity. In this paper, we only consider the
linear cost of acquiring capacity because the general-
ization of the cost of installing capacity, such as HðqÞ, can
also be analyzed by a similar way.
4. The optimal production and sales policies
In the previous section, we have formulated the
mathematical model and known that the purpose of
the firm is to maximize its total profit by determining the
production capacity and the production and sales policies.
In this section, we concentrate on analyzing the structural
properties of the optimal production and sales policies for
any given capacity q, that is, we would like to study the
optimization problem of stage two with given capacity q.
Moreover, we present the sales process, demand process
and production process under the optimal policies and
further compare the demand process with Bass demand.
Kumar and Swaminathan (2003) have shown that the
build-up policy is an approximated optimal policy when
there is no negative word-of-mouth. In what follows,
however, we can show that when there is negative word-
of-mouth from the lost demand, the optimal sales policy
 ARTICLE IN PRESS
406 X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414

is myopic under some mild conditions. In order to analyze bNÞ2 =4bÞ such that q0 tðq0 Þ ¼ Dðtðq0 ÞÞ, i.e.
the effect of production capacity on the optimal policies qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
and demand process, we first present the following result q0 ða þ bNÞ2  2bq0 þ ða þ bNÞ ða þ bNÞ2  4bq0
ln a
which summarizes some useful properties to analyze our a þ bN 2q0
model. N
a½eðaþbNÞtðq0 Þ  1
Lemma 4.1. If qXq0 , then ¼ a . (4.5)
b þ eðaþbNÞtðq0 Þ
N
a½eðaþbNÞt  1
a ðaþbNÞt pqt, From (4.4), we have
bþ e qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
N
ðaþbNÞtðq0 Þ
ða þ bNÞ2  2bq0 þ ða þ bNÞ ða þ bNÞ2  4bq0
holds for all tX0, where q0 is the unique solution of e ¼ a .
2q0
qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi N
ða þ bNÞ2  2bq0 þ ða þ bNÞ ða þ bNÞ2  4bq0 (4.6)
ln a
2q0 Substituting (4.6) into (4.5), we can derive (4.1). &
N
a Lemma 4.1 implies that when the capacity installed at
2bN þ
N q0 stage one is more than q0 , the cumulative demand DðtÞ
¼ ða þ bNÞ  qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi . (4.1)
q0
a þ bN þ ða þ bNÞ2  4bq0 and cumulative sales SðtÞ can be identical if the firm
chooses an appropriate production policy, which just
Proof. Based on Mahajan et al. (1990) and expression becomes Bass model. From the proof of Lemma 4.1, we
(2.1), the instantaneous demand rate and cumulative know that if the capacity installed is more than
demand up to time t under Bass model can be, ða þ bNÞ2 =4b, then the cumulative demand DðtÞ and
respectively, described as cumulative sales SðtÞ are not only identical if the firm
a  chooses an appropriate production policy, but the produc-
aða þ bNÞ þ b eðaþbNÞt tion and sales policies, which make the demand process,
dðtÞ ¼ N (4.2)
h a i2 sales process and production process identical, are also
b þ eðaþbNÞt
N optimal. Thus, we only consider the case of qpða þ bNÞ2 =
and 4b in this paper. In order to formulate the main results, we
need the following assumption:
a½eðaþbNÞt  1
DðtÞ ¼ a ðaþbNÞt : (4.3) Assumption 4.1. It is better for the firm to satisfy demand
bþ e at time tðqÞ with the products produced at the beginning
N
of the horizon than to make the demand lost at time tðqÞ.
Therefore, Bass demand is identical with the awareness
More precisely,
process (3.3). Note that dð0Þ ¼ aN and
   
1 bN ða þ bNÞ2 h h
maxfdðtÞg ¼ d ln ¼ , pcþ eytðqÞ  c  X0.
t40 a þ bN a 4b y y

then we obtain that when aNpqpða þ bNÞ2 =4b, dðtÞ ¼ q Remark 4.1. Since the surplus profit, caused by selling
has two solutions on ½0; 1Þ, which can be written as unit product at time tðqÞ with produced at time zero, can
qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi be described as
1 ða þ bNÞ2  2bq þ ða þ bNÞ ða þ bNÞ2  4bq
tðqÞ ¼ ln Z
a þ bN a tðqÞ
2q
N ðp  cÞeytðqÞ  c  h eyt dt
0
(4.4)
¼ ðp  cÞeytðqÞ  c  h=y½1  eytðqÞ 
 
and h ytðqÞ h
¼ pcþ e c .
qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi y y
1 ða þ bNÞ2  2bq  ða þ bNÞ ða þ bNÞ2  4bq
t 0 ðqÞ ¼ ln a ,
a þ bN 2q With the help of Assumption 4.1, we have
N
 
h h
where tðqÞXt 0 ðqÞ for aNpqpða þ bNÞ2 =4b; when q4 pcþ eytðqÞ  c  X0,
y y
ða þ bNÞ2 =4b, dðtÞ ¼ q has no solution on ½0; 1Þ. For
notational convenience, we denote which implies
f ðqÞ ¼ qtðqÞ  DðtðqÞÞ.  
h ytðqÞ h
0 0 0
Since f ðqÞ ¼ tðqÞ þ qt ðqÞ  dðtðqÞÞt ðqÞ and q ¼ dðtðqÞÞ, we p  2c þ e þ c  X0. (4.7)
0
y y
have f ðqÞ ¼ tðqÞ40, that is, f ðqÞ is strictly increasing with
q. Note that aNodðtÞ on ð0; tðaNÞÞ and dðtÞoða þ bNÞ2 =4b Next, we give three results which formulate the optimal
on ð0; tðða þ bNÞ2 =4bÞÞ, we have f ðaNÞo0 and production and sales policies in three different situations,
f ðða þ bNÞ2 =4bÞ40. Thus, there is only one q0 2 ðaN; ða þ respectively.
 ARTICLE IN PRESS
X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414 407

Proposition 4.1. If qoaN, then the optimal production and caused by sales policy sðtÞ. Thus, policies (4.8) are feasible.
sales policies can be described as If bq  a2 p0, then gð0Þp0 and GðtÞ is strictly decreasing
8 with t on ½0; 1Þ. In the same argument of proving the case
>
> q; tpdðqÞ;
>
> of bq  a2 40, we can show that policies (4.8) are also
>
< Nða þ bNÞða þ bqdðqÞÞeðaþbNÞðtdðqÞÞ feasible. When sðtÞ ¼ dðtÞ for tXdðqÞ, expression (3.4)
x1 ðtÞ ¼ s1 ðtÞ ¼ (4.8)
> ðaþbNÞdðqÞ becomes
> bN þ ae
>
> ; t4dðqÞ
>
: ½bN þ aeðaþbNÞt 2 dSðtÞ a þ bN
¼ a ½a þ bSðtÞ for t4dðqÞ. (4.12)
dt b þ eðaþbNÞt
and the corresponding demand process is N
8
>
> a þ bN Solving Eq. (4.12) with variable a þ bSðtÞ, we obtain
>
>
>
> a ðaþbNÞt ða þ bqtÞ; 0ptpdðqÞ; Rt
>b þNe
>
< bðaþbNÞ=ðbþða=NÞeðaþbNÞs Þ ds
 a þ bSðtÞ ¼ ½a þ bSðdðqÞÞe dðqÞ
d1 ðtÞ ¼ Nða þ bNÞða þ bqdðqÞÞeðaþbNÞðtdðqÞÞ
>
>
> ¼ ½a þ bSðdðqÞÞeðaþbNÞðtdðqÞÞ
>
> bN þ aeðaþbNÞdðqÞ
>
> ; t4dðqÞ; bN þ aeðaþbNÞdðqÞ
> 
: ½bN þ a eðaþbNÞt 2  for t4dðqÞ. (4.13)
bN þ aeðaþbNÞt
where dðqÞ is the unique solution to the equation: With the help of boundary condition SðdðqÞÞ ¼ qdðqÞ, for
h a i tXdðqÞ sales rate can be described as
ða þ bNÞ½a þ bqd ¼ b þ eðaþbNÞd q. (4.9)
N dSðtÞ a þ bN
Proof. First, we prove that the production and sales ¼ ða þ bqdðqÞÞ a eðaþbNÞðtdðqÞÞ
dt b þ eðaþbNÞt
policies x1 ðtÞ and s1 ðtÞ, denoted as (4.8), are feasible. N
Policies (4.8) state that the firm first produces and sells bN þ aeðaþbNÞdðqÞ

the products along the capacity and then along the bN þ aeðaþbNÞt
demand when the demand rate is less than the capacity. ¼ Nða þ bNÞða þ bqdðqÞÞeðaþbNÞðtdðqÞÞ
For convenience, we define
bN þ a eðaþbNÞdðqÞ
 . (4.14)
a þ bN ½bN þ a eðaþbNÞt 2
GðtÞ ¼ a ðaþbNÞt ða þ bqtÞ. (4.10)
bþ e Next, we prove that the policies x1 ðtÞ and s1 ðtÞ are optimal.
N
For any feasible policies s1 ðtÞ and x1 ðtÞ, because expression
Differentiating both sides of (4.10) with respect to t and
(3.4) guarantees that demand rate dDðtÞ=dt is increasing
simplifying, we have
with cumulative sales quantity SðtÞ, and (4.8) implies
h a ðaþbNÞt i a 
 ða þ bNÞ2 ða þ bqtÞeðaþbNÞt s1 ðtÞ ¼ qXs1 ðtÞ on ð0; dðqÞÞ and s1 ðtÞ ¼ d1 ðtÞ on ½dðqÞ; 1Þ,
dGðtÞ bqða þ bNÞ b þ N e N 
¼ a . there is S1 ðtÞpS1 ðtÞ for any tX0. Therefore, for any feasible
dt ½b þ eðaþbNÞt 2
N policies s1 ðtÞ and x1 ðtÞ, we have
Z 1
For notational convenience, we denote eyt ½ps1 ðtÞ  cx1 ðtÞ  hðX 1 ðtÞ  S1 ðtÞÞ dt
0
a Z 1
gðtÞ ¼ bqða þ bNÞ½b þ eðaþbNÞt  p eyt ½ps1 ðtÞ  cx1 ðtÞ dt
N
a 0
Z 1
 ða þ bNÞ2 ða þ bqtÞeðaþbNÞt . (4.11)
N ¼ peyt S1 ðtÞj10 þ yp eyt S1 ðtÞ dt  c eyt X 1 ðtÞj1
0
0
Taking derivative of gðtÞ with respect to t and simplifying, Z 1
we have  cy eyt X 1 ðtÞ dt
Z 10
dgðtÞ a
¼  ða þ bNÞ2 ða þ bqtÞeðaþbNÞt o0, ¼ yeyt ½pS1 ðtÞ  cX 1 ðtÞ dt
dt N 0
Z 1
which implies that gðtÞ is strictly decreasing with t. From p y eyt ðp  cÞS1 ðtÞ dt
(4.11), we have gðtÞjt¼0 ¼ Nðbq  a2 Þða=N þ bÞ2 and limt!1 Z0 1
gðtÞo0. Therefore, if bq  a2 40, then gðtÞjt¼0 40 and there
p y eyt ðp  cÞS1 ðtÞ dt
exists unique t 0 such that gðt 0 Þ ¼ 0. From the definition of
Z0 1
gðtÞ, we have dGðtÞ=dt40 on ½0; t0 Þ and dGðtÞ=dto0 on
¼ eyt ðp  cÞs1 ðtÞ dt.
ðt 0 ; 1Þ, that is, GðtÞ is first increasing on ½0; t 0  and then 0
decreasing on ðt 0 ; 1Þ. Since Gð0Þ ¼ aN4q and The last equality of above expression is due to integration
limt!1 GðtÞ ¼ 0, there exists unique dðqÞ4t 0 such that by parts. Thus, the policies x1 ðtÞ and s1 ðtÞ are optimal. &
GðdðqÞÞ ¼ q, G0 ðdðqÞÞo0 and GðtÞoq for t4dðqÞ. From (4.10),
we have ða þ bNÞ½a þ bqdðqÞ ¼ ½b þ a=NeðaþbNÞdðqÞ q. Since Proposition 4.1 formulates the optimal production
the cumulative sales quantity caused by any sales policy is policy, sales policy and diffusion of demand under
never more than qt, we have from (3.4) that demand rate condition qoaN. The optimal production policy is the
caused by any feasible sales policy is less than GðtÞ. Note same as the optimal sales policy during the whole
that GðtÞoq for t4dðqÞ, any policies satisfying sðtÞ ¼ xðtÞ ¼ horizon, which can be described that the firm first
dðtÞ for t4dðqÞ are feasible, where dðtÞ is the demand rate produces and sells the product along the capacity and
 ARTICLE IN PRESS
408 X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414

350 where dðqÞ satisfies (4.9) and gðqÞ is the smaller positive
sales trajectory
demand function solution to the following equation:
300 Bass demand function

250 a½eðaþbNÞg  1
a ðaþbNÞg ¼ qg. (4.17)
bþ e
200 N

150 Proof. First, we prove that the production and sales

policies x2 ðtÞ and s2 ðtÞ are feasible. Since aNpqoq0 , there
100
αΝ exists a gðqÞ such that DðgðqÞÞ ¼ qgðqÞ, where t 0 ðqÞpgðqÞo
50 tðqÞ. From (4.2) and (4.3), gðqÞ satisfies expression (4.17)
and dðgðqÞÞ4q. Therefore, policies x2 ðtÞ and s2 ðtÞ are
0 feasible for 0ptpgðqÞ. Note that dðgðqÞÞ4q, we can show
0 5 δ(q)10 15 20 25 30 in the same argument of proving Proposition 4.1 that s2 ðtÞ
time t and x2 ðtÞ are also feasible for t4gðqÞ. Then there exists
Fig. 1. The optimal policies under qoaN.
unique dðqÞ such that dðdðqÞÞ ¼ q and

dSðtÞ
¼ Nða þ bNÞða þ bqdðqÞÞ eðaþbNÞðtdðqÞÞ
after some time at which the demand rate is equal to dt
production capacity, the firm then produces and sells bN þ a eðaþbNÞdðqÞ
 for t4dðqÞ,
the product along the demand rate. In Fig. 1, we present ½bN þ a eðaþbNÞt 2
the trajectories of optimal production and sales policies,
the corresponding demand process and Bass demand by a
numerical example. In this figure, we can see that due to where dðqÞ is defined as (4.9).
the impact of capacity constraint, the corresponding Before proving the optimality of policies x2 ðtÞ and s2 ðtÞ,
demand rate is much less than Bass demand rate and we prove that for any optimal production and sales
the total lost demand is large. When time t is large policies x ðtÞ and s ðtÞ, there is x ðtÞ ¼ s ðtÞ for all t4dðqÞ.
enough, the demand rate always approximates to zero. If x ðtÞ4s ðtÞ holds on some nonempty interval
½a; b  ðdðqÞ; 1Þ, then the firm produces more products
Proposition 4.2. If aNpqoq0 and Assumption 4.1 holds,
then the optimal production and sales policies can be than the sales quantity on ½a; b and sells the surplus at
described as some time t4b. ^ Because dðtÞoq always holds for t4dðqÞ,
8 the firm can reduce holding cost by producing the surplus
>
> q; 0ptpdðqÞ; ^ Therefore, we have x ðtÞps ðtÞ. If x ðtÞos ðtÞ
>
> at time t.
>
< Nða þ bNÞða þ bqdðqÞÞeðaþbNÞðtdðqÞÞ
holds on some interval ½a1 ; b1   ðdðqÞ; 1Þ, then part of
x2 ðtÞ ¼ (4.15)
>
> bN þ a eðaþbNÞdðqÞ products sold during ½a1 ; b1  are produced before time a1 .
>
>  ; t4d ðqÞ
>
: ½bN þ a eðaþbNÞt 2 Because dðtÞoq always holds for t4dðqÞ, we derive a
contradiction with the optimality of policies x ðtÞ and s ðtÞ.
and
Therefore, we only consider the policies which satisfy that
8 a 
> ðaþbNÞt production rate always equals sales rate for t4dðqÞ.
> aða þ bNÞ N þ b e
>
>
>
> h i ; 0ptpgðqÞ; Next, we prove that the policies x2 ðtÞ and s2 ðtÞ are
>
> a 2
>
> b þ eðaþbNÞt optimal. Choosing any feasible policies s2 ðtÞ and x2 ðtÞ with
>
> N
>
< x2 ðtÞ ¼ s2 ðtÞ for t4dðqÞ, from (3.4) and (4.16) we have that
s2 ðtÞ ¼ q; gðqÞotpdðqÞ; (4.16)
>
> S2 ðtÞpS2 ðtÞ holds for all tX0. From expressions (3.5), (4.15)
> Nða þ bNÞða þ bqdÞeðaþbNÞðtdðqÞÞ
>
>
> and (4.16), the profit function caused by policies x2 ðtÞ and
>
>
>
> bN þ a eðaþbNÞdðqÞ
>
> s2 ðtÞ satisfies the following expression:
>
:  ; t4dðqÞ;
½bN þ a eðaþbNÞt 2
Z 1
the corresponding demand process is eyt ½ps2 ðtÞ  cx2 ðtÞ  hðX 2 ðtÞ  S2 ðtÞÞ dt
8 a  0
Z gðqÞ
>
> aða þ bNÞ þ b eðaþbNÞt
>
> N ¼ eyt ½ps2 ðtÞ  cq  hðqt  S2 ðtÞÞ dt
>
> ; 0ptpgðqÞ;
>
> h a ðaþbNÞt i2 0
>
> b þ e Z Z
>
> dðqÞ 1
>
> N þ eyt ðp  cÞqdt þ eyt ðp  cÞs2 ðtÞ dt
>
>
< a þ bN gðqÞ dðqÞ

d2 ðtÞ ¼ a ðaþbNÞt ða þ bqtÞ; gðqÞotpdðqÞ; Z 1
> b þ Ne
>
> X eyt ½ps2 ðtÞ  cx2 ðtÞ  hðX 2 ðtÞ  S2 ðtÞÞdt
>
> 0
>
> Nða þ bNÞða þ bqdðqÞÞ eðaþbNÞðtdðqÞÞ Z
>
> dðqÞ
>
>
>
> bN þ a eðaþbNÞdðqÞ þ eyt fp½s2 ðtÞ  s2 ðtÞ  c½q  x2 ðtÞ
>
>
: ½bN þ a eðaþbNÞt 2 ; t4dðqÞ;
> 0
 h½qt  X 2 ðtÞ  S2 ðtÞ þ S2 ðtÞg dt. (4.18)
 ARTICLE IN PRESS
X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414 409

With the help of Assumption 4.1 and expression (4.7) in identical with Bass demand, the total lost demand is
Remark 4.1, we derive that decreasing with the production capacity.
Z dðqÞ
eyt fp½s2 ðtÞ  s2 ðtÞ  c½q  x2 ðtÞ
0 Proposition 4.3. If q0 pqpða þ bNÞ2 =4b and Assumption 4.1
 h½qt  X 2 ðtÞ  S2 ðtÞþ S2 ðtÞg dt holds, then the optimal production and sales policies can be
Z dðqÞ described as
X eyt fp½s2 ðtÞ  s2 ðtÞ  c½q  x2 ðtÞ
0 8 a 
 h½qt  X 2 ðtÞg dt >
> aða þ bNÞ þ b eðaþbNÞt
>
> N
>
> h ; 0ptoeðqÞ;
Xðp  cÞ½qdðqÞ  X 2 ðdðqÞÞeydðqÞ >
>
> a ðaþbNÞt i2
>
> b þ e
Z dðqÞ >
> N
<
 ðh  ycÞ eyt ½qt  X 2 ðtÞ dt x3 ðtÞ ¼ q; eðqÞptptðqÞ; (4.20)
0 >
>  
Xðp  cÞ½qdðqÞ  X 2 ðdðqÞÞ eydðqÞ > aða þ bNÞ a þ b eðaþbNÞt
>
>
>
>
Z dðqÞ >
> N ; t4tðqÞ
>
> h a ðaþbNÞt i2
 ðh  ycÞ½qdðqÞ  X 2 ðdðqÞÞ eyt dt >
>
: b þ e
  0
 N
h h
¼ p  c þ  c eydðqÞ þ c 
y y and
½qdðqÞ  X 2 ðdðqÞÞX0. (4.19)
a 
From expression (4.18), the policies x2 ðtÞ and s2 ðtÞ are aða þ bNÞ þ b eðaþbNÞt
s3 ðtÞ ¼ N , (4.21)
optimal under aNpqoq0. & h a i2
b þ eðaþbNÞt
N
Proposition 4.2 presents the optimal production policy,
sales policy and diffusion of demand under condition the corresponding demand process is
aNpqoq0 . The optimal production policy can be de-
scribed as that: the firm first produces the product along a 
the capacity q on interval ½0; dðqÞ, and then along the aða þ bNÞ þ b eðaþbNÞt

d3 ðtÞ ¼ N ,
demand rate. The optimal sales policy can be described as h a i2
b þ eðaþbNÞt
that: On interval ½0; gðqÞ, the firm sells the product along N
the demand rate, which is equal to Bass demand rate; then
the firm sells the product along the capacity and demand for all tX0, where tðqÞ is defined as (4.4) and eðqÞ satisfies
rate on ðgðqÞ; dðqÞ and ðdðqÞ; 1Þ, respectively. In Fig. 2, we
present the trajectories of the optimal production and S3 ðtðqÞÞ  S3 ðeðqÞÞ ¼ q½tðqÞ  eðqÞ.
sales policies, the corresponding demand process and Bass
demand by a numerical example. From Fig. 2, we can
derive that the corresponding demand rate is less than Proof. From Lemma 4.1 and qXq0 , the production and sales
Bass demand rate after time gðqÞ. Comparing with Fig. 1, policies x3 ðtÞ and s3 ðtÞ are feasible. In what follows, we only
the deviation between the corresponding demand process prove that policies x3 ðtÞ and s3 ðtÞ are optimal. Before proving
and Bass demand in Fig. 2 is much smaller, that is, the the optimality of policies x3 ðtÞ and s3 ðtÞ, we first prove that
corresponding demand rate is increasing with the produc- any optimal policies x ðtÞ and s ðtÞ, under condition q4q0 ,
S
tion capacity. Since the awareness process is always satisfy x ðtÞ ¼ s ðtÞ for all t 2 ½0; eðqÞ ðtðqÞ; 1Þ. In the same
argument of proving Proposition 4.2, we can derive x ðtÞ ¼
s ðtÞ for t4tðqÞ. Then, we prove that x ðtÞ ¼ s ðtÞ holds for
350 t 2 ½0; eðqÞ. Assume that there exists a nonempty interval
production trajectory ½a2 ; b2   ½0; eðqÞ such that s ðtÞax ðtÞ, we can derive the
300 sales trajectory following conclusions: if x ðtÞos ðtÞ on ½a2 ; b2 , then part of
demand function products sold on ½a2 ; b2  are produced before time a2 . Because
250 Bass demand function s ðtÞoq always holds for t 2 ð0; eðqÞÞ, the firm can reduce
holding cost by choosing xðtÞ ¼ s ðtÞ on ½a2 ; b2 ; if x ðtÞ4s ðtÞ,
q = 200
then the firm produces more products than the sales quantity
150 on ½a2 ; b2  and sells the surplus after time b2 . Because there is
enough capacity to satisfy demand during ½b2 ; tðqÞ, the firm
100 can reduce the holding cost by producing the surplus after
αN S
time b2 . Then, x ðtÞ ¼ s ðtÞ always holds for t 2 ½0; eðqÞ
50 ðtðqÞ; 1Þ. Therefore, we only consider the policies which
S
0 satisfy xðtÞ ¼ sðtÞ for t 2 ½0; eðqÞ ðtðqÞ; 1Þ.
0 γ(q)δ 5 (q) 10 15 20 25 30 Choosing any feasible policies x3 ðtÞ and s3 ðtÞ with x3 ðtÞ ¼
S
s3 ðtÞ for t 2 ½0; eðqÞ ðtðqÞ; 1Þ, then from (3.4) and (4.21),
time t
we have s3 ðtÞps3 ðtÞ for any tX0. From expressions (3.5),
Fig. 2. The optimal policies under aNpqoq0. (4.20) and (4.21), the profit function caused by policies
 ARTICLE IN PRESS
410 X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414

x3 ðtÞ and s3 ðtÞ satisfies the following expression: and finally along the demand rate once more after time
Z 1 tðqÞ. In Fig. 3, we present the trajectories of the optimal
eyt ½ps3 ðtÞ  cx3 ðtÞ  hðX 3 ðtÞ  S3 ðtÞÞ dt production policy, sales policy and Bass demand by a
0
Z eðqÞ Z numerical example.
tðqÞ
¼ eyt ðp  cÞs3 ðtÞ dt þ eyt fps3 ðtÞ
0 eðqÞ
5. Determining the optimal production capacity
 cq  h½qt  S3 ðtÞ  qeðqÞ þ S3 ðeðqÞÞg dt
Z 1
þ eyt ðp  cÞs3 ðtÞ dt In the previous section, we have obtained the explicit
tðqÞ forms of the optimal production and sales policies for any
Z tðqÞ
given production capacity. In this section, we mainly
X eyt fps3 ðtÞ  cq  ps3 ðtÞ þ cx3 ðtÞ
eðqÞ concentrate on determining the optimal production
 h½qt  S3 ðtÞ  qeðqÞ þ S3 ðeðqÞÞ  X 3 ðtÞ þ S3 ðtÞg dt capacity, that is, we will analyze the problem of stage
Z 1 one based on the optimal policy obtained in the previous
þ eyt ½ps3 ðtÞ  cx3 ðtÞ  hðX 3 ðtÞ  S3 ðtÞÞ dt. section. As mentioned in Section 3, the optimal capacity
0
can be determined by
With the help of Assumption 4.1, we obtain that
Z maxfJðqÞ  qHg.
tðqÞ q40
y t
e fps3 ðtÞ  cq  ps3 ðtÞ þ cx3 ðtÞ
eðqÞ
Since the explicit forms of the optimal production and
 h½qt  S3 ðtÞ  qeðqÞ þ S3 ðeðqÞÞ  X 3 ðtÞ þ S3 ðtÞg dt
sales policies have been achieved in the previous section,
Xðp  cÞeytðqÞ f½S3 ðtðqÞÞ  S3 ðeðqÞÞ we can directly calculate the value of JðqÞ by substituting
Z tðqÞ
the optimal policies into objective function (3.5). In order
 ½S3 ðtðqÞÞ  S3 ðeðqÞÞg  h eyt dt
eðqÞ to determine the optimal capacity q, we first need to
½qt  S3 ðtÞ  qeðqÞ þ S3 ðeðqÞÞ analyze the structural properties of function JðqÞ. If JðqÞ is
 X 3 ðtÞ þ S3 ðtÞ þ X 3 ðeðqÞÞ  S3 ðeðqÞÞ concave in q, then the optimal capacity q is not only
   unique but also can be calculated by the first order
h ytðqÞ h
X pcþ e  f½S3 ðtðqÞÞ condition. Fortunately, we can prove that the function JðqÞ
y y
is concave with respect to q in the following analysis. For
 S3 ðeðqÞÞ  ½S3 ðtðqÞÞ  S3 ðeðqÞÞg. notational convenience, we define

Therefore, policies (4.20) and (4.21) are optimal. & 1

gðxÞ ¼ ðp  cÞð1  eyx Þ  ðp  cÞx eyx
y
Proposition 4.3 presents the optimal production
policy, optimal sales policy and the corresponding
a þ bNeðaþbNÞx
þ ðp  cÞyx
demand process under condition q0 pqpða þ bNÞ2 =4b.
a þ bN
Z 1
With the help of Assumption 4.1, the optimal sales policy, 1
 y=ðaþbNÞ ðbN þ auÞ
du  H,
the corresponding demand process and Bass demand are eðaþbNÞx u
   
identical. However, the optimal production policy can be h pc h
hðxÞ ¼ p  c þ x eyx  þ 2 ð1  eyx Þ,
described as that: the firm produces the product along the y y y
demand rate on ½0; eðqÞ, then along capacity on ðeðqÞ; tðqÞ,

Z tðxÞ
mðxÞ ¼ ceyeðxÞ ½tðxÞ  eðxÞ  H þ eyt fc  h½t  tðxÞg dt,
eðxÞ
350  
c h
sales trajectory A¼ þ 2
½eytðq0 Þ  1 þ ytðq0 Þ  H.
demand(Bass demand) function
y y
300
q=280 production trajectory

250 Lemma 5.1. If qoaN, the optimal capacity q can be

described as follows:
200

150 (1) If gðdðaNÞÞp0, then q satisfies gðdðq ÞÞ ¼ 0.

(2) If gðdðaNÞÞ40, then q ¼ aN, where dðqÞ is defined as
100 (4.9).
αN
50
Proof. From (4.8) and the first equality of expression
R dðqÞ
0 (4.13), we have S1 ðdðqÞÞ ¼ 0 s1 ðuÞ du ¼ qdðqÞ and
0 ε(q) 5 δ(q) 10 15 20 25 30 Rt
1 bðaþbNÞ=ðbþða=NÞeðaþbNÞu Þdu a
time t S1 ðtÞ ¼ ½a þ bqdðqÞ e dðqÞ 
b b
Fig. 3. The optimal policies under qXq0. for tXdðqÞ. (5.1)
 ARTICLE IN PRESS
X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414 411

Then the profit function caused by the optimal policies Differentiating both sides of (5.3) with respect to q and
2 2
(4.8) can be described as simplifying, d PðqÞ=dq can be described as
Z dðqÞ Z 1
2 3
PðqÞ ¼ qðp  cÞeyt dt þ eyt ðp  cÞs1 ðtÞ dt  qH
2
0
 
dðqÞ d PðqÞ 6 ða þ bNÞbdðqÞ 7 ddðqÞ
1 2
¼ yðp  cÞ41  a 5
¼ qðp  cÞ  eyt j0dðqÞ þ ðp  cÞ eyt S1 ðtÞj1 dðqÞ
dq b þ eðaþbNÞdðqÞ dq
y N
Z 1 Z 1 Rt
bðaþbNÞ=ðbþða=NÞ eðaþbNÞu Þdu
þ yðp  cÞeyt S1 ðtÞ dt  qH  eyt e dðqÞ dt
dðqÞ dðqÞ
  a
1 1 ¼ yðp  cÞ
¼ qðp  cÞ  eydðqÞ þ  ðp  cÞeydðqÞ S1 ðdðqÞÞ a þ bqdðqÞ
y y Z 1 Rt
aðp  cÞ a þ bqdðqÞ yt bðaþbNÞ=ðbþða=NÞeðaþbNÞu Þdu ddðqÞ
 e ydðqÞ
þ yðp  cÞ  e e dðqÞ dt .
b b dðqÞ dq
Z 1 Rt ðaþbNÞu Þ du (5.6)
bðaþ bNÞ=ðbþða=NÞe
 eyt e dðqÞ dt  qH. (5.2)
dðqÞ
The second equality of expression (5.6) is due to
Taking first derivative of PðqÞ with respect to q and
a þ bN=ðb þ ða=NÞeðaþbNÞdðqÞ Þ ¼ q=ða þ bqdðqÞÞ. Taking deri-
simplifying, we have
vative of both sides of dðdðqÞÞ ¼ q with respect to q, we
0
dPðqÞ 1 have d ðdðqÞÞddðqÞ=dq ¼ 1. From the proof of Proposition
¼ ðp  cÞð1  eydðqÞ Þ  ðp  cÞdðqÞeydðqÞ
dq y 4.1, we have G0 ðdðqÞÞo0. Note that dðtÞ ¼ GðtÞ for tpdðqÞ
8 0
> and dðtÞoGðtÞ for t4dðqÞ, we can derive d ðdðqÞÞo0. Hence,
< ddðqÞ 0
þ ðp  cÞydðqÞ þ ðp  cÞqy there is ddðqÞ=dq ¼ 1=d ðdðqÞÞo0. From expression (5.6),
> dq 2 2
: we have d PðqÞ=dq o0, that is, PðqÞ is strictly concave in q.
9 Hence, the results hold. &
>
ða þ bqdðqÞÞða þ bNÞ ddðqÞ=
ðp  cÞy a ðaþbNÞdðqÞ dq > ; Lemma 5.1 states that the optimal profit function is
bþ e
N concave with respect to q on the interval ½0; aN. Therefore,
Z 1 Rt
bðaþbNÞ=ðbþða=NÞeðaþbNÞu Þdu the value of optimal capacity can be obtained from the
 eyt e dðqÞ dt  H.
dðqÞ first order condition of profit function PðqÞ. Expression
(5.5) implies that the first order condition of PðqÞ is
Since dðqÞ satisfies Eq. (4.9), we have a þ bN=ðbþ directly related with function dðqÞ instead of q, therefore,
ða=NÞeðaþbNÞdðqÞ Þ ¼ q=ða þ bqdðqÞÞ. Then dPðqÞ=dq can be we need appeal to dðqÞ to determine the optimal capacity
reduced to the following expression: q , where dðqÞ can be solved from (4.9).
dPðqÞ 1
¼ ðp  cÞð1  eydðqÞ Þ  ðp  cÞdðqÞeydðqÞ  H
dq y Lemma 5.2. If aNpqoq0 and Assumption 4.1 holds, the
þ ðp  cÞydðqÞ optimal capacity q can be described as follows:
Z 1 Rt
bðaþbNÞ=ðbþða=NÞeðaþbNÞu duÞ
 eyt e dðqÞ dt. (5.3)
dðqÞ (1) If gðdðaNÞÞX0 and gðdðq0 ÞÞ þ hðgðq0 ÞÞo0, then q satis-
fies gðdðq ÞÞ þ hðgðq ÞÞ ¼ 0.
From (4.13) and (5.1), we have
(2) If gðdðaNÞÞp0, then q ¼ aN.
Rt
bðaþbNÞ=ðbþða=NÞeðaþbNÞu Þ du (3) If gðdðq0 ÞÞ þ hðgðq0 ÞÞX0, then q ¼ q0 .
½a þ bqdðqÞe dðqÞ
bN þ a eðaþbNÞdðqÞ
¼ ½a þ bqdðqÞeðaþbNÞðtdðqÞÞ ,
bN þ aeðaþbNÞt
Proof. From (3.5), the profit function caused by policies
that is,
(4.15) and (4.16) can be described as
Rt
bðaþbNÞ=ðbþða=NÞeðaþbNÞu Þ du Z gðqÞ
e dðqÞ ¼ ½a þ bN eðaþbNÞdðqÞ 
ðaþbNÞt P 1 ðqÞ ¼ eyt ½ðp  cÞs2 ðtÞ  hðqt  S2 ðtÞÞ dt
e 0
 . (5.4) Z Z
bN þ a eðaþbNÞt dðqÞ 1
þ qðp  cÞey dt þ eyt ðp  cÞs2 ðtÞ dt  qH
Substituting (5.4) into (5.3) and simplifying, we have gðqÞ dðqÞ
Z gðqÞ
¼ eyt ½ðp  cÞs2 ðtÞ  hðqt  S2 ðtÞÞ dt
0
dPðqÞ 1 Z gðqÞ
¼ ðp  cÞð1  eydðqÞ Þ  ðp  cÞdðqÞ eydðqÞ  H  qðp  cÞeyt dt
dq y 0
þ ðp  cÞydðqÞ½a þ bNeðaþbNÞdðqÞ  Z dðqÞ Z 1
Z 1 þ qðp  cÞeyt dt þ eyt ðp  cÞs2 ðtÞ dt  qH
eðaþbNyÞt 0 dðqÞ
 dt ¼ gðdðqÞÞ. (5.5)
dðqÞ bN þ aeðaþbNÞt ¼ DPðqÞ þ PðqÞ, (5.7)
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412 X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414

where PðqÞ is defined as (5.2) and DPðqÞ is defined as Proof. From (3.5), the profit function caused by policies
(4.20) and (4.21) can be described as
Z gðqÞ
DPðqÞ ¼ eyt ½ðp  cÞs2 ðtÞ  hðqt  S2 ðtÞÞdt
0 Z 1 Z eðqÞ Z 1
Z gðqÞ P 2 ðqÞ ¼ eyt ps3 ðtÞ dt  eyt cs3 ðtÞ dt  eyt cs3 ðtÞ dt
yt
 qðp  cÞe dt. 0
Z
0 tðqÞ
0 tðqÞ
 eyt ½qc þ hðqt  S3 ðtÞ  qeðqÞ þ S3 ðeðqÞÞÞ dt  qH
eðqÞ
2 2 Z Z tðqÞ
Because Lemma 5.1 has obtained d PðqÞ=dq o0, we ¼
1
eyt ðp  cÞs3 ðtÞ dt þ eyt fcs3 ðtÞ
concentrate on analyzing the characterizations of DPðqÞ 0 eðqÞ
in the following analysis. Taking derivative of DPðqÞ with  qc  h½qt  S3 ðtÞ  qeðqÞ þ S3 ðeðqÞÞgdt  qH.
respect to q and simplifying, we have

dDPðqÞ dgðqÞ
¼ eygðqÞ ðp  cÞ½s2 ðgðqÞÞ  q
dq dq Taking first and second derivatives of P 2 ðqÞ with respect to
Z gðqÞ q and simplifying, we have
yt
 e ½ht þ ðp  cÞ dt. (5.8)
0

dP2 ðqÞ
Taking first derivative of both sides of S2 ðgðqÞÞ ¼ qgðqÞ with ¼ ceyeðqÞ ½tðqÞ  eðqÞ  H
dq
respect to q, we derive Z tðqÞ
þ eyt ½c  ht þ htðqÞ dt,
dgðqÞ dgðqÞ eðqÞ
s2 ðgðqÞÞ ¼ gðqÞ þ q . 2  
dq dq dP2 ðqÞ h dtðqÞ
2
¼ cþ ½eyeðqÞ  eytðqÞ 
dq y dq
Then, dgðqÞ=dq ¼ gðqÞ=dðgðqÞÞ  q40. Substituting dgðqÞ= deðqÞ yeðqÞ
dq ¼ gðqÞ=dðgðqÞÞ  q into (5.8), we have  ðh þ ycÞ½tðqÞ  eðqÞ e o0,
dq
Z gðqÞ
dDPðqÞ
¼ eygðqÞ ðp  cÞgðqÞ  eyt ½ht þ ðp  cÞ dt that is, P2 ðqÞ is concave in q. Note that q0 tðq0 Þ ¼ Dðtðq0 ÞÞ,
dq 0
  by the definition of eðqÞ, we know that eðq0 Þ ¼ 0. There-
h
¼ pcþ gðqÞ eygðqÞ fore, we have
y
 
pc h
 þ 2 ð1  eygðqÞ Þ ¼ hðgðqÞÞ. (5.9)    
y y dP2 ðqÞ h c h c h
¼ cþ tðq0 Þ  H   2 þ þ 2 eytðq0 Þ
dq q¼q0 c y y y y
Differentiating both sides of (5.9) with respect to q and  
c h
simplifying, we derive ¼ þ 2 ½eytðq0 Þ  1 þ ytðq0 Þ  H ¼ A.
y y
(5.10)
dDP 2 ðqÞ dgðqÞ
2
¼ ½yðp  cÞ  hgðqÞeygðqÞ .
dq dq
If Ap0, then dP2 ðqÞ=dqjq¼q0 p0 and the optimal capacity is
q0 ; if A40, then dP 2 ðqÞ=dqjq¼q0 40 and the optimal
2
Since dgðqÞ=dq ¼ gðqÞ=dðgðqÞÞ  q40, then dDP 2 ðqÞ=dq o0, capacity q satisfies
that is, DPðqÞ is strictly concave with respect to q on
2
interval ½aN; q0 Þ. Combining dDP2 ðqÞ=dq o0 with dDP 2 ðqÞ= Z tðq Þ
2
ceyeðq Þ ½tðq Þ  eðq Þ  H þ

dq o0, P 1 ðqÞ is strictly concave with respect to q on eyt
eðq Þ
interval ½aN; q0 Þ. Since gðaNÞ ¼ 0, we can get dDPðqÞ=
dqjq¼aN ¼ 0. Therefore, by the same argument of proving ½c  ht þ htðq Þ dt ¼ mðq Þ ¼ 0.
Lemma 5.1, the results hold. &
The proof is completed. &
Lemma 5.2 formulates the characterizations of the
optimal capacity under condition aNpqoq0 . Because of Lemma 5.3 formulates the optimal production capacity
the concavity of the profit function with respect to q, we under condition qXq0 . Because the profit function is
can solve the optimal capacity q in accordance with the concave with respect to q, we can solve the optimal
first order condition of the profit function. capacity from the first order condition of function P2 ðqÞ. In
order to obtain the optimal production capacity among
Lemma 5.3. If q0 pqpða þ bNÞ2 =4b and Assumption 4.1
the interval ð0; ða þ bNÞ2 =4b, we first give the following
holds, the optimal production capacity q can be described as
lemma which formulates the first derivative of profit
follows:
function at point q0 .

(1) q ¼ q0 if Ap0. Lemma 5.4. If Assumption 4.1 holds, then we have

(2) q satisfies mðq Þ ¼ 0 if A40. P 1 ðqÞ=dqjq¼q0 XP 2 ðqÞ=dqjq¼q0 .
 ARTICLE IN PRESS
X. Yan, K. Liu / Int. J. Production Economics 119 (2009) 402–414 413

Proof. From (5.7), (5.3) and (5.9), we can derive the of-mouth from the lost demand. We not only show that
following expression: the optimal sales policy is myopic under some mild
conditions, but also present the explicit forms of the
dP1 ðqÞ dPðqÞ dDPðqÞ
¼ þ optimal production and sales policies. The optimality of
dq dq dq
myopic policy can be interpreted by the effect of negative
1
¼ ðp  cÞð1  eydðqÞ Þ  ðp  cÞdðqÞ eydðqÞ word-of-mouth on the awareness diffusion. That is,
y Z 1 Rt because of the impact of negative word-of-mouth, the
bðaþbNÞ=ðbþða=NÞeðaþbNÞu Þ du
þ ðp  cÞydðqÞ eyt e dðqÞ dt firm should avoid shortage of the product as far as
dðqÞ possible. When there is capacity constraint, the demand
   
h pc h process under the myopic policy is always less than Bass
þ pcþ gðqÞeygðqÞ  þ 2
y y y demand and the total lost demand is decreasing with the
ð1  eygðqÞ Þ  H. (5.11) production capacity. After the explicit forms of optimal
production and sales policies have been obtained, we can
When q ¼ q0 , by Proposition 4.3, we have that the
determine the optimal production capacity by solving
awareness process WðtÞ, the corresponding demand
several equations.
process DðtÞ and cumulative sales process S3 ðtÞ
In what follows, we present three possible extensions
under policies (4.20) and (4.21) all coincide with Bass
of our model for the future research. The first possible
demand. Thus, from the definitions of tðqÞ, dðqÞ and
extension is to include advertising decision which can
gðqÞ, we can derive gðq0 Þ ¼ dðq0 Þ ¼ tðq0 Þ. Note that conversely influence the parameter a. Because the diffu-
Rt
bðaþbNÞ=ðbþða=NÞeðaþbNÞu Þ du
e dðqÞ X1 holds for any tXdðqÞ, we sions of demand and awareness will be influenced by the
have advertising policy, we intuitively think that some results
  may no longer hold with the advertising decision, for
dP1 ðqÞ h example, the structure of demand process and the
X p  c þ tðq0 Þeytðq0 Þ
dq q¼q0 y structure of optimal sales policy, et al. However, we can
h study the structure of optimal advertising policy and
 ð1  eytðq0 Þ Þ  H. (5.12)
y2 analyze the effect of advertising decision on other
operational decisions in the future research. The second
From (5.10), (5.12) and Assumption 4.1, we obtain
   possible extension is to treat the production cost c as the
dP 1 ðqÞ dP2 ðqÞ h ytðq0 Þ h function of production level xðtÞ. In general, we assume
 X pcþ e c
dq q¼q0 dq q¼q0 y y that production cost cðxÞ is nonnegative, convex, and
c ytðq0 Þ increasing function. The third possible extension is to
tðq0 Þ þ ð1  e ÞX0,
y study a situation in which the cumulative sales and lost
that is, dP 1 ðqÞ=dqjq¼q0 XdP 2 ðqÞ=dqjq¼q0 . The proof is com- demand have different influence factors under capacity
constraint. We can analyze the effect of different influence
pleted. &
factors on the structure of optimal policies.
Therefore, we have the following main result.

Theorem 5.1. If Assumption 4.1 holds, the optimal produc- Acknowledgments

tion capacity q satisfies:
(1) If gðdðaNÞÞp0, then q satisfies gðdðq ÞÞ ¼ 0.
(2) If gðdðaNÞÞ40 and gðdðq0 ÞÞ þ hðgðq0 ÞÞp0, then q satis-
fies gðdðq ÞÞ þ hðgðq ÞÞ ¼ 0.
(3) If gðdðq0 ÞÞ þ hðgðq0 ÞÞ40 and Ap0, then q ¼ q0 .
(4) If gðdðq0 ÞÞ þ hðgðq0 ÞÞ40 and A40, then q satisfies
Z tðq Þ
ceyeðq Þ ½tðq Þ  eðq Þ þ

eyt
eðq Þ
½c  ht þ htðq Þ dt  H ¼ 0.
Proof. From Lemmas 5.1, 5.2, 5.3 and 5.4, we can derive
the results straightforwardly. &
6. Conclusion
In this paper, we study a firm which maximizes its total
profit by determining production capacity, production
policy and sales policy. After the production capacity has
been installed, we present a new diffusion model about
new product, which captures the effects of positive word-
of-mouth from the cumulative sales and negative word-
The authors would like to thank Asian-Pacific Region
Editor T.C. Edwin Cheng and two anonymous referees for
their helpful comments. This research was partially
supported by National Natural Science Foundation of
China under Grants 60674082, 70731003 and 70221001.
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