IIE Transactions (1998) 30, 705±713

Make-to-order versus make-to-stock in a

production±inventory system with general production times

ANTONIO ARREOLA-RISA1 and GREGORY A. DeCROIX2

1
Department of Information & Operations Management, Lowry Mays College & Graduate School of Business,
Texas A&M University, College Station, Texas 77843-4217, USA
E-mail: Tarreola@tamu.edu
2
Fuqua School of Business, Duke University, Durham, NC 27708-0120, USA
E-mail: decroix@mail.duke.edu

Received October 1996 and accepted September 1997

We study the optimality of make-to-order (MTO) versus make-to-stock (MTS) policies for a company producing multiple
heterogeneous products at a shared manufacturing facility. Manufacturing times are general i.i.d. random variables, and di€erent
products may have di€erent manufacturing-time distributions. Demands for the products are independent Poisson processes with
di€erent arrival rates. The costs of managing the production-inventory system are stationary and include inventory holding and
backordering costs. Backordering costs may be $ per unit or $ per unit per unit time. We derive optimality conditions for MTO and
MTS policies. We also study the impact of several managerial considerations on the MTO versus MTS decision.

1. Introduction base-stock (order-up-to) inventory policy has been shown

Competitive pressures and continuous improvement
e€orts have led many ®rms to review their production±
inventory practices. In particular, given the push toward
a ``zero-inventory'' goal, world-class companies have
begun a search for conditions that determine when it is
optimal to hold a ®nished goods inventory and when it is
not. If a ®nished goods inventory is held for a product, we
say that the product is produced make-to-stock (MTS);
otherwise, we say that the product is produced make-
to-order (MTO). Note that our designation of a product
as MTO merely indicates stockless production, and does
not mean that the product is made to order due to custom
speci®cations.
To address the optimality of MTS and MTO policies,
we consider a company that produces multiple products
facing random demands. A single manufacturing facility
produces the products one at a time, and successive
manufacturing times for each product comprise a se-
quence of general i.i.d. random variables. Di€erent
products may have di€erent manufacturing-time distri-
butions. Demands for the products are independent
Poisson processes with di€erent arrival rates. The costs of
managing the production±inventory system are station-
ary and include inventory holding and backordering
costs.
Although the form of the optimal production±inven-
tory policy for this system has not been established, a
to be optimal in a similar system under periodic review
[1]. Also, the base-stock inventory policy has commonly
been used in previous work analyzing other aspects of
systems similar to the one considered here [2±9]. For these
reasons we adopt a base-stock inventory policy for our
system. The other element that de®nes the production±
inventory policy is the scheduling rule ± i.e., if multiple
products are waiting to be manufactured, which product
should be produced ®rst? Some recent work [3±9] suggests
that dynamic scheduling rules may outperform the ®rst-
come ®rst-served (FCFS) rule. However, analysis of the
MTO/MTS decision for dynamic scheduling rules be-
comes intractable due to complex interactions among
products. Furthermore, the additional information and
coordination required at the production facility by dy-
namic scheduling rules may counter the inventory savings
over the FCFS rule. As a result and given that FCFS is
common in practice, we will adopt FCFS as the sched-
uling rule for our system. We believe that the insights
regarding the MTO/MTS decision obtained under the
FCFS scheduling rule should be suggestive of the be-
havior of systems with more general scheduling rules, and
in fact, we will show that this is the case for a number of
our results.
The paper makes several contributions. Optimality
conditions for MTO and MTS policies are established.
These conditions are derived for two backorder-cost
cases: $ per unit and $ per unit per unit time. The opti-

0740-817X Ó 1998 ``IIE''

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mality conditions turn out to be independent of manu-
facturing times in the ®rst backorder-cost case but not in
the second case. We identify special circumstances for the
second backorder-cost case where the MTO versus MTS
decision can be made entirely based on the ®rst moments
of the manufacturing-time distributions. We o€er evi-
dence that manufacturing-time diversity may or may not
favor a MTO policy, depending on how diversity is
conceptualized. Finally, these results are used to provide
insights into the impact of manufacturing-time random-
ness reductions e€orts on the MTO versus MTS decision.
A search of the inventory literature reveals that ana-
lytical treatments of the MTO versus MTS decision are
limited to Li [10] and Arreola-Risa [2]. Li has looked at
the optimality of MTO/MTS in a multi-®rm market
where companies compete for customers based on deliv-
ery time of orders. He considered the one-product case
and assumed that unit manufacturing times are expo-
nentially distributed. The inventory cost function is a
present value where the interest rate is compounded
continuously. Arreola-Risa has considered a production-
inventory system similar to the one in this paper, but
where manufacturing times for the di€erent products are
identical and gamma distributed, and backorder costs are
incurred $ per unit per unit time. He determined the value
of the squared coecient of variation of manufacturing
time at which the ®rm is indi€erent to produce a product
MTO or MTS.
The contents of the paper are organized as follows.
Section 2 contains a derivation of the cost model. In
Sections 3±5 we establish MTO/MTS optimality condi-
tions and also explore several factors that may a€ect the
MTO versus MTS decision. Section 3 deals with $ per
unit backorder costs and Sections 4 and 5 deal with $ per
unit per unit time backorder costs. In turn, Section 4
considers homogeneous manufacturing times while Sec-
tion 5 looks at the more general case of heterogeneous
manufacturing times. Conclusions and directions for
further research are summarized in Section 6.
2. The cost model
In this section we develop the cost model and note some
of its basic properties to be used for optimization pur-
poses. Let:
E‰
Š = expected value operator;
fA …
† = probability function of random variable
A;
FA …
† = distribution function of random variable
A;
n = number of di€erent products;
Di = demand per unit time for product i;
ki  E‰Di Š = average demand per unit time for
product i;
Arreola-Risa and DeCroix
Pn
k iˆ1 ki = average arrival rate of orders at the
manufacturing facility;
di  ki =k = fraction of orders at the manufacturing
facility coming from product i;
qi  P
ki E‰Mi Š = load o€ered by product i;
q  niˆ1 qi = capacity utilization of the manufacturing
process;
Mi = unit manufacturing time for product i;
hi = unit inventory holding cost rate;
OHi = on-hand inventory for product i;
K = average inventory holding and backor-
dering cost per unit time;
Ri = base-stock level for item i;
Ri = the value (or values) of Ri ; i ˆ 1; 2; . . . ; n,
which minimize K.
Inventory backordering costs may be incurred in a
variety of ways. For a discussion of backorder costing
the reader may consult, for example, Silver and Peterson
[11]. In this paper we will consider the following two
types of backorder costs: $ per unit, and $ per unit per
unit time. If inventory backordering costs are incurred $
per unit, for each product i, let pi denote the unit
backordering cost and BRi denote the backorders rate
(number of backorders per unit time).Then from basic
principles:
X
n
K …p† …R1 ; R2 ; . . . ; Rn † ˆ f hi E‰OHi Š ‡ pi E‰BRi Šg;
iˆ1
…p†
where K …
† is the average cost per unit time under $ per
unit backorder costs.
If inventory backordering costs are incurred $ per unit
per unit time, for each product i, let pi denote the unit
backordering cost rate and BLi denote the backorder
level. Again from basic principles:
X
n
K …p† …R1 ; R2 ; . . . ; Rn † ˆ f hi E‰OHi Š ‡ pi E‰BLi Šg;
iˆ1
…p†
where K …
† is the average cost per unit time under $ per
unit per unit time backorder costs.
Under a FCFS scheduling rule, the quantities E‰OHi Š,
E‰BRi Š, and E‰BLi Š are independent of Rj , for j 6ˆ i. This
independence also holds for any scheduling rule that is
independent of the base-stock levels. (The ``lowest-in-
ventory-level-®rst'' scheduling rule for homogeneous
products with equal base-stock levels [4,8,9] is an exam-
ple of such a rule.) Thus we can minimize K …p† …
† or
…p† …p†
K …p† …
† by minimizing Ki …Ri † or Ki …Ri †, respectively,
for each i, where:
…p†
Ki …Ri † ˆ hi E‰OHi Š ‡ pi E‰BRi Š;
…p†
Ki …Ri † ˆ hi E‰OHi Š ‡ pi E‰BLi Š:
Let OOi denote the number of orders outstanding for
product i. It is not dicult to show that E‰OHi Š ˆ