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Supply Contracts, Profit Sharing, Switching, and Reaction Options

Author

Listed:
  • Bardia Kamrad

    () (McDonough School of Business, Georgetown University, Washington, D.C. 20057)

  • Akhtar Siddique

    () (Risk Analysis Division, Office of the Comptroller of the Currency, Mail Stop 2-1, 250 E Street SW, Washington, D.C. 20219)

Abstract

A common theme in the studies of flexible supply contracts has been the producer's profit-maximization problem without regard to the suppliers' reactions. However, suppliers do react and protect their downside against producer's operating policies by revising their strategies in a manner consistent with their profitmaximization objectives. This fact motivates our work. Using a real-options (contingent claims) approach, we analyze and value supply contracts in a setting characterized by exchange rate uncertainty, supplier-switching options, order-quantity flexibility, profit sharing, and supplier reaction options. We also use basic diversification concepts, from portfolio theory, to analyze risk reduction in a unique framework. Given this setup, we explicitly model how flexibility can be mutually beneficial to both the producer and the suppliers. Using this model, we concurrently solve and examine the dual optimization problem for the suppliers and the producer. Our approach also endogenizes the extent and degree of profit sharing through the resulting optimal policies. We also analyze what induces the producer and the suppliers to accept flexibility in their contracts.

Suggested Citation

  • Bardia Kamrad & Akhtar Siddique, 2004. "Supply Contracts, Profit Sharing, Switching, and Reaction Options," Management Science, INFORMS, vol. 50(1), pages 64-82, January.
  • Handle: RePEc:inm:ormnsc:v:50:y:2004:i:1:p:64-82
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    File URL: http://dx.doi.org/10.1287/mnsc.1030.0157
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    References listed on IDEAS

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    Cited by:

    1. Inderfurth, Karl & Kelle, Peter & Kleber, Rainer, 2013. "Dual sourcing using capacity reservation and spot market: Optimal procurement policy and heuristic parameter determination," European Journal of Operational Research, Elsevier, vol. 225(2), pages 298-309.
    2. Inderfurth, Karl & Kelle, Peter, 2011. "Capacity reservation under spot market price uncertainty," International Journal of Production Economics, Elsevier, vol. 133(1), pages 272-279, September.
    3. Zhang, Jianxiong & Tang, Wansheng & Hu, Mingmao, 2015. "Optimal supplier switching with volume-dependent switching costs," International Journal of Production Economics, Elsevier, vol. 161(C), pages 96-104.
    4. Leng, Mingming & Parlar, Mahmut, 2009. "Lead-time reduction in a two-level supply chain: Non-cooperative equilibria vs. coordination with a profit-sharing contract," International Journal of Production Economics, Elsevier, vol. 118(2), pages 521-544, April.
    5. Hu, Xiangling & Motwani, Jaideep G., 2014. "Minimizing downside risks for global sourcing under price-sensitive stochastic demand, exchange rate uncertainties, and supplier capacity constraints," International Journal of Production Economics, Elsevier, vol. 147(PB), pages 398-409.
    6. Elizabeth Junqueira Durango-Cohen & Candace Arai Yano, 2006. "Supplier Commitment and Production Decisions Under a Forecast-Commitment Contract," Management Science, INFORMS, pages 54-67.
    7. Banerjee, Shantanu & Güçbilmez, Ufuk & Pawlina, Grzegorz, 2014. "Optimal exercise of jointly held real options: A Nash bargaining approach with value diversion," European Journal of Operational Research, Elsevier, vol. 239(2), pages 565-578.
    8. Tang, Ou & Nurmaya Musa, S., 2011. "Identifying risk issues and research advancements in supply chain risk management," International Journal of Production Economics, Elsevier, vol. 133(1), pages 25-34, September.
    9. Fotopoulos, S.B. & Hu, X. & Munson, C.L., 2008. "Flexible supply contracts under price uncertainty," European Journal of Operational Research, Elsevier, vol. 191(1), pages 253-263, November.
    10. Moon, Yongma & Yao, Tao & Park, Sungsoon, 2011. "Price negotiation under uncertainty," International Journal of Production Economics, Elsevier, vol. 134(2), pages 413-423, December.
    11. Tsekrekos, Andrianos E. & Yannacopoulos, Athanasios N., 2016. "Optimal switching decisions under stochastic volatility with fast mean reversion," European Journal of Operational Research, Elsevier, vol. 251(1), pages 148-157.
    12. Apostolos Burnetas & Peter Ritchken, 2005. "Option Pricing with Downward-Sloping Demand Curves: The Case of Supply Chain Options," Management Science, INFORMS, pages 566-580.
    13. Elena Katok & Diana Yan Wu, 2009. "Contracting in Supply Chains: A Laboratory Investigation," Management Science, INFORMS, pages 1953-1968.
    14. repec:pal:jintbs:v:48:y:2017:i:5:d:10.1057_s41267-016-0055-7 is not listed on IDEAS
    15. Burak Kazaz & Maqbool Dada & Herbert Moskowitz, 2005. "Global Production Planning Under Exchange-Rate Uncertainty," Management Science, INFORMS, pages 1101-1119.
    16. Gomez_Padilla, A. & Mishina, T., 2009. "Supply contract with options," International Journal of Production Economics, Elsevier, vol. 122(1), pages 312-318, November.
    17. Karl Inderfurth & Peter Kelle & Rainer Kleber, 2011. "Dual Sourcing Using Capacity Reservation and Spot Market: Optimal Procurement Policy and Heuristic Parameter Determination," FEMM Working Papers 110014, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.

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