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Analysis of supply contracts with quantity flexibility

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  • Lian, Zhaotong
  • Deshmukh, Abhijit

Abstract

This paper explores a class of supply contracts under which a buyer receives discounts for committing to purchases in advance. The further in advance the commitment is made, the larger the discount. As time rolls forward, the buyer can increase the order quantities for future periods of the rolling horizon based on updated demand forecast information and inventory status. However, the buyer pays a higher per-unit cost for the incremental units. Such contracts are used by automobile and contract manufacturers, and are quite common in fuel oil and natural gas delivery markets. We develop a finite-horizon dynamic programming model to characterize the structure of the optimal replenishment strategy for the buyer. We present heuristic approaches to calculate the order volume in each period of the rolling horizon. Finally, we numerically evaluate the heuristic approaches and draw some managerial insights based on the findings.

Suggested Citation

  • Lian, Zhaotong & Deshmukh, Abhijit, 2009. "Analysis of supply contracts with quantity flexibility," European Journal of Operational Research, Elsevier, vol. 196(2), pages 526-533, July.
    • Handle: RePEc:eee:ejores:v:196:y:2009:i:2:p:526-533
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    References listed on IDEAS

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    1. Mordechai Henig & Yigal Gerchak & Ricardo Ernst & David F. Pyke, 1997. "An Inventory Model Embedded in Designing a Supply Contract," Management Science, INFORMS, vol. 43(2), pages 184-189, February.
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    3. Andy A. Tsay, 1999. "The Quantity Flexibility Contract and Supplier-Customer Incentives," Management Science, INFORMS, vol. 45(10), pages 1339-1358, October.
    4. Lian, Zhaotong & Deshmukh, Abhijit & Wang, Jin, 2006. "The optimal frozen period in a dynamic production model," International Journal of Production Economics, Elsevier, vol. 103(2), pages 648-655, October.
    5. Suresh Chand & Vernon Ning Hsu & Suresh Sethi, 2002. "Forecast, Solution, and Rolling Horizons in Operations Management Problems: A Classified Bibliography," Manufacturing & Service Operations Management, INFORMS, vol. 4(1), pages 25-43, September.
    6. A. A. Tsay & W. S. Lovejoy, 1999. "Quantity Flexibility Contracts and Supply Chain Performance," Manufacturing & Service Operations Management, INFORMS, vol. 1(2), pages 89-111.
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