Procurement and Distribution Policies in a Distributive Supply Chain in the Presence of Commodity Markets

Abstract

In this research we characterize optimal procurement and distribution policies of a commodity in a multiechelon supply chain. We consider a firm that procures and distributes a commodity from spot and forward markets under random fluctuating prices; the commodity is distributed downstream to a set of nonhomogeneous retailers to satisfy random demand. We model prices with a stochastic process that allows no arbitrage opportunities, and formulate procurement and distribution policies for this system. We explore the value of the commoditys market in providing (a) additional flexibility in procurement, and (b) information on price dynamics generated through the trading of futures contracts. Our results indicate the presence of the commodity market can lead to reductions in controllable costs of the order of 30%; however to obtain these benefits, both the spot procurement flexibility and the term structure of prices generated by the commodity market must be incorporated in the formulation of the operating policy. Managerial insights on the procurement strategy as a function of variability of prices and demand are also discussed.

Keywords: commodities procurement, commodity markets, marginal convenience yield, multi-echelon

JEL Classification: A12, C61, D30, E32, G13