Dual Sourcing Using Capacity Reservation and Spot Market: Optimal Procurement Policy and Heuristic Parameter Determination

Karl Inderfurth (), Peter Kelle and Rainer Kleber ()
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Karl Inderfurth: Faculty of Economics and Management, Otto-von-Guericke University Magdeburg
Peter Kelle: Department of Information Systems and Decision Sciences, Louisiana State University
Rainer Kleber: Faculty of Economics and Management, Otto-von-Guericke University Magdeburg

No 110014, FEMM Working Papers from Otto-von-Guericke University Magdeburg, Faculty of Economics and Management

Abstract: This contribution focuses on the cost-effective management of the combined use of two procurement options: the short-term option is given by a spot market with random price, whereas the long-term alternative is characterized by a multi period capacity reservation contract with fixed purchase price and reservation level. A reservation cost, proportional with the reservation level, has to be paid for the option of receiving any amount per period up to the reservation level. A long-term decision has to be made regarding the reserved capacity level, and then it has to be decided - period by period - which quantities to procure from the two sources. Considering the multi-period problem with stochastic demand and spot price, the structure of the optimal combined purchasing policy is derived using stochastic dynamic programming. Furthermore, a simple heuristic procedure is developed to determine the respective policy parameters. Finally, we present a comprehensive numerical study showing that our heuristic policy performs very well.

Keywords: Dual sourcing; capacity reservation; spot market; procurement policy; stochastic dynamic programming (search for similar items in EconPapers)
JEL-codes: C61 M11 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2011-07
New Economics Papers: this item is included in nep-cmp
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