The Value of Information and Flexibility with Temporal Commitments

46 Pages Posted: 15 Oct 2019 Last revised: 11 May 2021

See all articles by Pol Boada-Collado

Pol Boada-Collado

Northwestern University - Department of Industrial Engineering and Management Sciences

Sunil Chopra

Northwestern University - Kellogg School of Management

Karen Smilowitz

Northwestern University - Department of Industrial Engineering and Management Sciences

Date Written: April 6, 2020

Abstract

Problem definition: We study the combined value of partial demand visibility and flexible capacity, two hedging mechanisms against demand uncertainty, when signing capacity contracts with temporal commitment. Academic/Practical Relevance: With new technological innovations, short commitment contracts are found in dynamic environments like distribution, processing and manufacturing; a trend likely to grow in the future. In contrast to classic procurement, where commitments are long, short commitments lead to new dynamics in which demand visibility allows companies to use flexible resources more efficiently by adapting to demand observations. Methodology: We incorporate flexible capacity and demand visibility simultaneously using a multi-period newsvendor network model with two nodes that are supplied using dedicated and flexible capacity contracts with temporal commitment. Results: The optimal commitment to capacity contracts adapts within bounds to the observed demand at each node. The ability to adapt to visible demand becomes more valuable when flexible capacity contracts are available. This allows us to show that demand visibility and flexible capacity can act as complements. Managerial Implications: In contrast to conventional wisdom, when contracts have short commitment, companies can enhance the value of demand visibility if flexible capacity is also available as an option.

Keywords: advance demand information, flexible capacity, newsvendor network, demand visibility, capacity planning, capacity pooling, procurement

Suggested Citation

Boada-Collado, Pol and Chopra, Sunil and Smilowitz, Karen, The Value of Information and Flexibility with Temporal Commitments (April 6, 2020). Available at SSRN: https://ssrn.com/abstract=3452915 or http://dx.doi.org/10.2139/ssrn.3452915

Pol Boada-Collado (Contact Author)

Northwestern University - Department of Industrial Engineering and Management Sciences ( email )

2145 Sheridan Road
Room C210
Evanston, IL 60208
United States

Sunil Chopra

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

Karen Smilowitz

Northwestern University - Department of Industrial Engineering and Management Sciences ( email )

Evanston, IL 60208-3119
United States

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