Sourcing Flexibility, Spot Trading, and Procurement Contract Structure
We analyze the structure and pricing of option contracts for an industrial good in the presence of spot trading. We combine the analysis of spot trading and buyers' disparate private valuations for different suppliers' products, and we jointly endogenize the determination of three major di...
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| Format: | Article |
| Language: | en_US |
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Institute for Operations Research and the Management Sciences
2012
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| Online Access: | http://hdl.handle.net/1721.1/69921 https://orcid.org/0000-0002-4650-1519 |
| _version_ | 1826206372019044352 |
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| author | Pei, Pamela Pen-Erh Simchi-Levi, David Tunca, Tunay I. |
| author2 | Massachusetts Institute of Technology. Department of Civil and Environmental Engineering |
| author_facet | Massachusetts Institute of Technology. Department of Civil and Environmental Engineering Pei, Pamela Pen-Erh Simchi-Levi, David Tunca, Tunay I. |
| author_sort | Pei, Pamela Pen-Erh |
| collection | MIT |
| description | We analyze the structure and pricing of option contracts for an industrial good in the presence of spot trading. We combine the analysis of spot trading and buyers' disparate private valuations for different suppliers' products, and we jointly endogenize the determination of three major dimensions in contract design: (i) sales contracts versus options contracts, (ii) flat-price versus volume-dependent contracts, and (iii) volume discounts versus volume premia. We build a model in which a supplier of an industrial good transacts with a manufacturer who uses the supplier's product to produce an end good with an uncertain demand. We show that, consistent with industry observations, volume-dependent optimal sales contracts always demonstrate volume discounts (i.e., involve concave pricing). However, options are more complex agreements, and optimal option contracts can involve both volume discounts and volume premia. Three major contract structures commonly emerge in optimality. First, if the seller has a high discount rate relative to the buyer and the seller's production costs or the production capacity is low, the optimal contracts tend to be flat-price sales contracts. Second, when the seller has a relatively high discount rate compared to the buyer but production costs or production capacity are high, the optimal contracts are sales contracts with volume discounts. Third, if the buyer's discount rate is high relative to the seller's, then the optimal contracts tend to be volume-dependent options contracts and can involve both volume discounts and volume premia. However, when the seller's production capacity is sufficiently low, it is possible to observe flat-price option contracts. Furthermore, we provide links between production and spot market characteristics, contract design, and efficiency. |
| first_indexed | 2024-09-23T13:28:07Z |
| format | Article |
| id | mit-1721.1/69921 |
| institution | Massachusetts Institute of Technology |
| language | en_US |
| last_indexed | 2024-09-23T13:28:07Z |
| publishDate | 2012 |
| publisher | Institute for Operations Research and the Management Sciences |
| record_format | dspace |
| spelling | mit-1721.1/699212022-09-28T14:29:05Z Sourcing Flexibility, Spot Trading, and Procurement Contract Structure Pei, Pamela Pen-Erh Simchi-Levi, David Tunca, Tunay I. Massachusetts Institute of Technology. Department of Civil and Environmental Engineering Massachusetts Institute of Technology. Operations Research Center Simchi-Levi, David Simchi-Levi, David We analyze the structure and pricing of option contracts for an industrial good in the presence of spot trading. We combine the analysis of spot trading and buyers' disparate private valuations for different suppliers' products, and we jointly endogenize the determination of three major dimensions in contract design: (i) sales contracts versus options contracts, (ii) flat-price versus volume-dependent contracts, and (iii) volume discounts versus volume premia. We build a model in which a supplier of an industrial good transacts with a manufacturer who uses the supplier's product to produce an end good with an uncertain demand. We show that, consistent with industry observations, volume-dependent optimal sales contracts always demonstrate volume discounts (i.e., involve concave pricing). However, options are more complex agreements, and optimal option contracts can involve both volume discounts and volume premia. Three major contract structures commonly emerge in optimality. First, if the seller has a high discount rate relative to the buyer and the seller's production costs or the production capacity is low, the optimal contracts tend to be flat-price sales contracts. Second, when the seller has a relatively high discount rate compared to the buyer but production costs or production capacity are high, the optimal contracts are sales contracts with volume discounts. Third, if the buyer's discount rate is high relative to the seller's, then the optimal contracts tend to be volume-dependent options contracts and can involve both volume discounts and volume premia. However, when the seller's production capacity is sufficiently low, it is possible to observe flat-price option contracts. Furthermore, we provide links between production and spot market characteristics, contract design, and efficiency. National Science Foundation (U.S.) (contract CMMI-0758069) National Science Foundation (U.S.) (contract DMI-0245352) 2012-04-04T15:13:51Z 2012-04-04T15:13:51Z 2011-06 2010-08 Article http://purl.org/eprint/type/JournalArticle 0030-364X 1526-5463 http://hdl.handle.net/1721.1/69921 Pei, P. P.-E., D. Simchi-Levi, and T. I. Tunca. “Sourcing Flexibility, Spot Trading, and Procurement Contract Structure.” Operations Research 59.3 (2011): 578–601. https://orcid.org/0000-0002-4650-1519 en_US http://dx.doi.org/10.1287/opre.1100.0905 Operations Research Creative Commons Attribution-Noncommercial-Share Alike 3.0 http://creativecommons.org/licenses/by-nc-sa/3.0/ application/pdf Institute for Operations Research and the Management Sciences Simchi-Levi via Anne Graham |
| spellingShingle | Pei, Pamela Pen-Erh Simchi-Levi, David Tunca, Tunay I. Sourcing Flexibility, Spot Trading, and Procurement Contract Structure |
| title | Sourcing Flexibility, Spot Trading, and Procurement Contract Structure |
| title_full | Sourcing Flexibility, Spot Trading, and Procurement Contract Structure |
| title_fullStr | Sourcing Flexibility, Spot Trading, and Procurement Contract Structure |
| title_full_unstemmed | Sourcing Flexibility, Spot Trading, and Procurement Contract Structure |
| title_short | Sourcing Flexibility, Spot Trading, and Procurement Contract Structure |
| title_sort | sourcing flexibility spot trading and procurement contract structure |
| url | http://hdl.handle.net/1721.1/69921 https://orcid.org/0000-0002-4650-1519 |
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