Integration of long‐ and short‐term contracts in a market for capacity

Amar Sapra and Peter L. Jackson

Production and Operations Management, 2022, vol. 31, issue 7, 2872-2890

Abstract: Motivated by the potential growth of capacity markets due to 3‐D manufacturing, we examine the integration of long‐ and short‐term contracts for a capacity marketplace. In the marketplace, manufacturers and suppliers first participate in long‐term contracts in which manufacturers reserve capacity at one or more suppliers. Subsequently, manufacturers and suppliers trade in a spot market to fulfill residual demand and sell residual capacity, respectively; in the spot market, the equilibrium price is determined dynamically and endogenously by the balance of supply and demand for capacity. We build a model to derive insights on the decisions taken by the manufacturers and suppliers and on the equilibrium characteristics of the market. We show existence of equilibria in both long‐ and short‐term contract markets and establish a relationship between the equilibrium prices for the two types of contracts. We also find that when short‐term–only contracts are available, the expected backlog is lower compared to when integrated contracts are used for much of the planning horizon. Further, we find that the presence of long‐term contracts increases the volatility of spot prices. Our results will make practicing managers aware that contractual arrangement can influence spot price volatility.

Date: 2022
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