Supplier Competition with Option Contracts for Discrete Blocks of Capacity

Forthcoming in Operations Research

49 Pages Posted: 21 Dec 2016

See all articles by Edward J. Anderson

Edward J. Anderson

University of Sydney Business School

Chen Bo

University of Warwick - Warwick Business School

Lusheng Shao

The University of Melbourne

Date Written: December 16, 2016

Abstract

When a firm faces an uncertain demand, it is common to procure supply using some type of option in addition to spot purchases. A typical version of this problem involves capacity being purchased in advance, with a separate payment made that applies only to the part of the capacity that is needed. We consider a discrete version of this problem in which competing suppliers choose a reservation price and an execution price for blocks of capacity, and the buyer, facing known distributions of demand and spot price, needs to decide which blocks to reserve. We show how to solve the buyer's (combinatorial) problem efficiently and also show that suppliers can do no better than offer blocks at execution prices that match their costs, making profits only from the reservation part of their bids. Finally we show that in an equilibrium the buyer selects the welfare maximizing set of blocks.

Keywords: supply options, competitive bidding, discrete blocks, submodularity, Nash equilibrium

Suggested Citation

Anderson, Edward J. and Bo, Chen and Shao, Lusheng, Supplier Competition with Option Contracts for Discrete Blocks of Capacity (December 16, 2016). Forthcoming in Operations Research. Available at SSRN: https://ssrn.com/abstract=2887899

Edward J. Anderson

University of Sydney Business School ( email )

Cnr. of Codrington and Rose Streets
Sydney, NSW 2006
Australia

Chen Bo

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

Lusheng Shao (Contact Author)

The University of Melbourne ( email )

198 Berkeley Street
Carlton, 3031
Australia

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