To Share or Not to Share? Capacity Reservation in a Shared Supplier

43 Pages Posted: 17 Aug 2018 Last revised: 10 Jun 2019

See all articles by Anyan Qi

Anyan Qi

University of Texas at Dallas - Naveen Jindal School of Management

Hyun-Soo Ahn

University of Michigan, Stephen M. Ross School of Business

Amitabh Sinha

University of Michigan, Stephen M. Ross School of Business

Date Written: June 7, 2019

Abstract

When a supplier serves multiple buyers, the buyers often reserve the supplier's capacity in advance to secure the supply to fulfill their demand. In this paper, we analyze two common types of capacity reservation: exclusive and first-priority reservations. Both reservations give a buyer first access to its reserved capacity, but the reservations differ in how the leftovers (if any) are used. In most cases, as long as the buyer gets to use the reserved capacity first, it does not pay attention to how the leftover capacity is utilized, leaving that to the supplier's discretion (first-priority). However, in a number of cases, buyers prohibit discretionary use of the reserved capacity ("no one touches my leftovers") and implement the restriction by placing an employee at the supplier or installing monitoring devices (exclusive). One potential benefit of first-priority capacity is resource pooling: allowing access to one another's leftovers can reduce the amount of capacity reserved by the buyers while enabling the supplier to satisfy buyers' orders better in some cases. The Operations Management literature suggests that the benefit of resource pooling is greater when the demand correlation is negative and smaller when the correlation is positive. We investigate the capacity reservation type and level that each buyer chooses facing uncertain (and correlated) demand. We investigate how the reservation price and demand correlation affect the equilibrium outcome. We also examine the supplier's decision to set the optimal reservation prices. We find that at least one firm reserves first-priority capacity in equilibrium as long as the supplier offers a discount for first-priority capacity (or charges a premium for exclusive capacity). Depending on the reservation price difference and demand correlation, we find that the equilibrium outcome is inefficient (i.e., not Pareto optimal) for the buyers when they settle in a free-rider or a prisoner's dilemma equilibrium. We show that the supplier always induces both buyers to reserve a large amount of exclusive capacity so that the supplier can make profits from both capacity reservation and production. While this seems like the best scenario for the supplier, we show that, allowing bilateral capacity transfer (e.g., the buyers trading their reserved capacity) can improve not only the buyers' profits but also the supplier's profit.

Keywords: capacity reservation, exclusive capacity, first-priority capacity, transferrable capacity, demand correlation

JEL Classification: D24, L24

Suggested Citation

Qi, Anyan and Ahn, Hyun-Soo and Sinha, Amitabh, To Share or Not to Share? Capacity Reservation in a Shared Supplier (June 7, 2019). Available at SSRN: https://ssrn.com/abstract=2909260 or http://dx.doi.org/10.2139/ssrn.2909260

Anyan Qi (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

Hyun-Soo Ahn

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan St
R5456
Ann Arbor, MI 48109-1234
United States

Amitabh Sinha

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

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