Budget allocation for permanent and contingent capacity under stochastic demand

We develop a model of budget allocation for permanent and contingent workforce under stochastic demand. The level of permanent capacity is determined at the beginning of the horizon and is kept constant throughout whereas the number of temporary workers to be hired must be decided in each period. Compared to existing budgeting models, this paper explicitly considers a budget constraint. Under the assumption of a restricted budget, the objective is to minimize capacity shortages. When over-expenditures are allowed, both budget deviations and shortage costs are to be minimized. The capacity shortage cost function is assumed to be either linear or quadratic with the amount of shortage, which corresponds to different market structures or different types of services. We thus examine four variants of the problem that we model and solve either approximately or to optimality when possible. A comprehensive simulation study is designed to analyze the behavior of our models when several levels of demand variability and parameter values are considered. The parameters consist of the initial budget level, the unit cost of temporary workers and the budget deviation penalty/reward rates. Varying these parameters produce several trade-off between permanent and temporary workforce levels, and between capacity shortages and budget deviations. Simulation results also show that the quadratic cost function leads to smooth and moderate capacity shortages over the time periods, whereas all shortages are either avoided or accepted when the cost function is linear.