Risk-Averse, Integrated Contract, and Open Market Procurement with Quantity Adjustment Costs

Santosh Mahapatra (), Santosh Kar and Shlomo Levental
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Santosh Mahapatra: Reh School of Business, Clarkson University, Potsdam, NY 13676, USA
Santosh Kar: Community Hospital, Munster, IN 46321, USA
Shlomo Levental: Department of Statistics, Michigan State University, E. Lansing, MI 48824, USA

JRFM, 2024, vol. 17, issue 12, 1-33

Abstract: This paper examines the issue cost-effective procurement of a commodity product when its spot (open) market prices are stochastic, contract prices are previously determined, and there are costs associated with adjusting (i.e., switching) the procurement quantities from an alternative. Spot (open) market and contract as sole modes of procurement could present risks of high magnitude and uncertainty of expenses for the buyer. To address these risks, a risk-averse buyer may consider simultaneous use of both alternatives with adjustment of the purchase quantities from both the alternatives over time. Scenarios when the switching costs depend on the relative prices of the two alternatives are considered. The problem being analytically intractable, a mixed method decision model combining analytical and computational techniques to analyze the problem is proposed. The model helps identify expected optimal contract and spot market procurement quantities with respect to unknown spot prices and known contract prices over the planned procurement horizon when procurement quantity adjustment costs are influenced by the spends. The analysis reveals that it is cost-effective to continue purchasing with an existing pattern of procurement from the two alternatives until the contract to spot market price ratio reaches a threshold level and then to change the proportion of quantity purchased from the two alternatives. Using numerical analysis, we illustrate the theoretical and managerial significance of this stickiness to continue with an existing pattern until an adjustment.

Keywords: purchasing strategy; price uncertainty; contracts; spot market; risk aversion; quantity adjustment costs (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2024
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