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Dynamic Procurement, Quantity Discounts, And Supply Chain Efficiency

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**Vol. 17, No. 5, September–October 2008, pp. 543–550 doi 10.3401/poms.1080.0055
**

issn 1059-1478 eissn 1937-5956 08 1705 0543 © 2008 Production and Operations Management Society

**Dynamic Procurement, Quantity Discounts, and
**

Supply Chain Efﬁciency

Feryal Erhun

Department of Management Science and Engineering, Stanford University,

Stanford, California 94305, ferhun@stanford.edu

Pınar Keskinocak

School of Industrial and Systems Engineering, Georgia Institute of Technology,

Atlanta, Georgia 30332, pinar@isye.gatech.edu

Sridhar Tayur

Tepper School of Business, Carnegie Mellon University, Pittsburgh, Pennsylvania 15213,

stayur@andrew.cmu.edu

W e study a model with a single supplier and a single buyer who interact multiple times before the buyer

sells her product in the end-consumer market. We show that when the supplier uses a wholesale price

contract, even under perfect foresight, the supplier, the buyer, and the end consumers beneﬁt from multiple

trading opportunities versus a one-shot procurement agreement.

Key words: strategic interactions; advance capacity procurement; incremental quantity discounts; supply chain

coordination

History: Received: November 2004; Revised: December 2005, March 2007, and July 2007; Accepted:

October 2007 by M. Eric Johnson.

**1. Introduction that dynamic procurement beneﬁts the players even if
**

This paper studies the beneﬁts of trading more than the demand is deterministic, i.e., when the commonly

once while procuring/selling capacity. Consider a known and intuitive beneﬁts from risk hedging are

simple model with one supplier and one buyer. The not present.

buyer produces a product by using the capacity The paper that is closest to our work is by Allaz and

she buys from an uncapacitated supplier. Before the Vila (1993). The authors study a deterministic model

buyer’s selling season begins, there are N periods in where two Cournot duopolists trade in forward mar-

which the buyer can procure capacity. The supplier kets for delivery in a single period. The authors con-

uses a simple wholesale price contract; he charges a clude that even though producers are worse off by

unit capacity price of wn in period n = 1 N , which forward trading, in equilibrium they will trade for-

he determines dynamically. Once the buyer procures ward. In the limit, as the number of forward markets

the capacity, she can produce the product with no goes to inﬁnity, the competitive outcome is achieved

additional cost and sell it in an end-consumer market, in a duopoly setting. In our model, we look at vertical

where the market price of the product is determined interactions, as opposed to the horizontal competition

by the market clearance assumption. of Allaz and Vila.

Dynamic procurement, i.e., simple wholesale price In a setting similar to ours, Anand et al. (2008)

contracts repeated over time (possibly with different study a dynamic model of a procurement contract

prices), is a commonly observed practice in a ver- between a supplier and a buyer in a two-period, unca-

tical channel. To manage the demand risk, a buyer pacitated, deterministic demand game. The authors

may prefer to procure capacity dynamically over time. eliminate all the classical reasons for inventories, yet

Other commonly observed reasons for dynamic pro- show that the buyer’s optimal strategy in equilibrium

curement include spreading payments over a period is to carry inventories, and that the supplier is unable

of time; minimizing potential capacity risks (sup- to prevent this. The inventories arise for strategic rea-

plier’s or buyer’s); supplier’s decreasing cost over sons. Keskinocak et al. (2008, 2003) extend the model

time, which may translate to lower prices (e.g., as in of Anand et al. to limited capacity and limited capac-

the electronics industry); and forward buying. We dis- ity with backordering, respectively.

cuss yet another potential impact of dynamic procure- Burnetas and Gilbert (2001) study a broker’s pro-

ment, i.e., as a tool to inﬂuence future prices. We show curement decisions for a short-life-cycle product.

543

and Supply Chain Efﬁciency 544 Production and Operations Management 17(5). chain similar that of a centralized supply chain when We use backward induction and obtain the pure- the number of trading periods is sufﬁciently high. is the market potential. Proposition 1 characterizes this equilibrium. 2003. The unique pure-strategy SPNE for through a sequence of trades. They also assume nalizes the bargaining process that needs to be a part that the market price is ﬁxed and concentrate on the of a two-part tariff. and Song et al. the N -period dynamic procurement model is as follows. the supplier necessarily the only justiﬁcation for multiple trades. qn . and end consumers) ben. In the simplest case. N . 2008 use price-sensitive paper the terms of trade are set by both the supplier demand in their models. it naturally inter- known and increasing over time. Corbett and de Groote (2000). For example.. Quantity Discounts. of different variants of the quantity discount prob. one case is trivial. in our et al.) We assume that the buyer’s and the buyer. the efﬁciency of the sys. 543–550. the buyer chooses her production quantity QN and eﬁt. mation about demand. For tem can be improved by much simpler contracts. many researchers P QN is the per-unit market price of the product study the role of quantity discounts as a channel for QN . (qj . The supplier’s deci- problem.) The market is characterized by a linear and Shugan (1983) show that proﬁt sharing mecha. creasing the inefﬁciency. i. By adjusting the q1 = w1 = KN N 4Nb 2 . Keskinocak et al. been used frequently in the operations management Weng (1995). as a two-part tariff wherein the supplier charges a a 2 a ﬁxed fee plus a unit wholesale price. buyer. dynamic procure- optimal procurement policy and demonstrate how ment is more complex. Erhun. inverse demand function P QN = a − bQN . and the analysis follows. We refer readers to Benton and Park (1996) sions are the wholesale prices for each period. However. 2004. a two-part tariff allows a ﬂexi- costs and the beneﬁt of making ordering decisions ble allocation of proﬁts between the supplier and the with better information about demand. Dynamic procurement beneﬁts the players by de. and Chen literature in recent years. In this paper. determines the capacity price wn . the buyer determines her demand and wholesale price contracts. unit cost of production is equal to zero.e. Because the authors study the broker’s than a ﬂexible split as in a two-part tariff) between the problem. and a second trade occurs after The sequence of events in each period n of the receiving some update on demand. and ply chain. j = 1 n − 1). the The typical justiﬁcation for multiple trades for pro. pp. i. Cachon and Lariviere 1999. Since a − bQ Q − cQ = a − c − bQ Q. duction/selling season begins. analysis of a positive. broker’s procurement decisions only in an increasing- cost environment. j = 1 n − 1) and the additional trading periods in the case of deterministic current capacity price (wn ). The additional trading periods inherently create procures extra capacity. we can simply modify the demand intercept a such trade occurs while the parties have very limited infor- that â = a − c. The market clears the equivalent of a nonlinear pricing scheme. (We set Q0 = 0 lem from a marketing research standpoint. Jeuland and q0 = 0. strategy subgame perfect Nash equilibrium (SPNE). and (iii) in the last period ticipants (supplier. of the system. and to Dolan (1987) for a detailed survey ment quantities for each period. and results in a ﬁxed split of proﬁts (rather increases. leads to a lower proﬁt for any broker procurements tend to cluster just before price ﬁnite N . in N -period game is as follows: (i) Given previous capac- a vertical setting. they assume that the wholesale costs are supplier and the buyer. b is the price sensitivity.. e. In our paper. Keskinocak. Following their work. One could argue that rather than going Proposition 1. we are not questioning why ﬁrms develop a newsvendor-like characterization of the would not adopt a two-part tariff. and the production quantity. if necessary. such n = 1 N − 1. (The price-sensitive demand assumption has coordination mechanism under different settings. The authors buyer. we analyze a joint 2. Weng 1995. let n̄ = N − n. The supplier and the Research on quantity discounts also relates to our buyer maximize their proﬁts. and Munson and Rosenblatt (1998) for extensive (n = 1 N ). However. Then. et al. QN . Wang et al. (n = 1 N ). double marginalization. The buyer’s decisions are the procure- reviews. 2008. where a nisms with quantity discounts can coordinate the sup. wn . © 2008 Production and Operations Management Society There is a trade-off between higher procurement ﬁxed fee accordingly. The dynamic procurement model that we Emmons and Gilbert 1998. constant production cost (c < a) curement is risk hedging. procurement quantity qn . Anand count mechanism. In this paper. we show that risk hedging is not ity procurements. which only once at the end of the N th period. there is makes the performance of the decentralized supply only a single selling opportunity to end consumers. where all par. study effectively creates an incremental quantity dis. (ii) given previous We derive a Pareto-improving rationale for the use of capacity procurements (qj .g. Unlike the other literature.e.. and Tayur: Dynamic Procurement. 2008. Main Model supplier-buyer relationship in which the capacity We study a model where there are N possible peri- prices as well as the market price are decision ods for capacity procurement before the buyer’s pro- variables. (2001).

as follows: As N tends to inﬁnity. Keskinocak. QN tends to a/ 2b . and Supply Chain Efﬁciency Production and Operations Management 17(5). Since wj qj is equal for all j. 543–550. we can write the sum of the costs in the last i periods duction quantity is QN = Nn=1 qn = a/ 2b − a/ 4b KN . Quantity Discounts. i Proof. At step (i + 1). and Tayur: Dynamic Procurement. wN −j+1 qN −j+1 = iwN −i+1 qN −i+1 j=1 First. the buyer’s problem at step (i + 1) is as ment quantities and the prices for the last i periods follows: are as follows: 2 2 Ki b a max −wN −i qN −i − i − TN −i+1 1 a qN −i ≥0 2 2b qN −i+1 = − TN −i+1 (1) . Therefore. The proof of Proposition 1 is in two parts. the structure for the procure. The pro. Ki2 b a =i − TN −i+1 (5) For the ﬁrst part of the proof. pp. We want to prove by backward induction that at the end of step i. we prove the structure in the proposition is a 2 SPNE. © 2008 Production and Operations Management Society 545 2n̄ + 1 2n̄ at the end of step (i + 1). Second. we prove that this SPNE is unique. the buyer’s qn+1 = qn wn+1 = wn 2n̄ 2n̄ + 1 cost is the sum of her costs in the last i periods and the −1 cost of the current period. where K1 = 1 and KN = Nk=1 2k + 1 / 2k + 2 . assume that there are 2 2b N periods.Erhun.

Therefore. the problem is equivalent to a two. and wN = wN −i+1 = Ki2 i − bTN −i+1 j=1 2 i − j + 1 Ki i 2 1 if i = 1 a = Ki − bTN −i+1 Ki = i−1 2 2k + 1 otherwise. 2a − Ki a Ki Ki + + TN −i + qN −i When i = 1. P QN = a − bQN = Observe that if this structure holds. the maximization problem can be rewritten as follows: 2j + 1 2j qN −j+1 wN −j+1 = q w = qN −j wN −j 2 2j 2j + 1 N −j N −j iKi2 b a max −wN −i qN −i − − TN −i − qN −i qN −i ≥0 2 2b Hence. In this case. the buyer’s costs (or. we know that wN −i+1 = 2 Ki2 i a/2 − bTN −i+1 and wN −j+1 = 2j/ 2j + 1 wN −j . wN −j+1 = wN −j (4) 2j + 1 2 i − j i−1 1 a where j = i − 1 1. We can rewrite TN −i+1 1 2 i − 1. 2k + 2 If we substitute wN to QN . 4b 2 2 . 2j Hence. we get QN = 2a − Ki a / k=1 4b + Ki /2 TN −i+1 . the supplier’s revenues) are equal for periods N − i + 1 to N . TN −i+1 = q1 + q2 + · · · + qN −i . as TN −i+1 = TN −i + qN −i . 2i 2b +QN a − bQN 2j + 1 qN −j+1 = qN −j (2) a − wN 2j where QN = 2b a wN −i+1 = Ki2 i − bTN −i+1 (3) By induction assumption. then for j = 2a + Ki a /4 − bKi /2 TN −i+1 .

= −wN −i + iKi2 − iKi2 bTN −i − iKi2 bqN −i 2 We assume that the structure holds at the end of 2a b 2 b step i and will show that the structure stays the same + Ki − Ki TN −i − Ki2 qN −i 4 2 2 . Ki a Ki a bKi bKi + + − T − q wards induction is the same as we obtain from Equa. From the solution of the two-period unca. where the ﬁrst N − 1 periods corre. bKi a Ki a Ki Ki Unless the wholesale price in one of the earlier peri. Therefore. 2a + Ki a bKi bK spond to period 1. − − + TN −i + qN −i 2 2b 4b 2 2 ods is equal to zero. 2 2 4 2 N −i 2 N −i tions (1) through (4). TN ≤ a/ 2b and the values above a are all nonnegative. we pacitated model. the structure we obtain through the back. and the structure holds for i = 1. we get get the following: a a T a − wN a wN = − bTN qN = − N and QN = 0 = −wN −i + iKi2 b − TN −i − qN −i 2 4b 2 2b 2b Therefore. period model. From the ﬁrst-order condition with respect to qN −i . the ﬁrst period’s procurement equals TN . and the last period corresponds · − TN −i − i qN −i 4 2 2 to period 2.

and the ﬁfth equality follows from the fact 2 2 2 that qN −i = 1/ 2 i + 1 a/ 2b − TN −i : 1 − bKi2 qN −i i + 2 a wN −i+1 = Ki2 i − bTN −i − bqN −i Note that the buyer’s objective function is concave 2 with respect to qN −i . and Supply Chain Efﬁciency 546 Production and Operations Management 17(5). Quantity Discounts. and Tayur: Dynamic Procurement. pp. 2 a b a = Ki i − bTN −i − − TN −i a wN −i 2 2 i + 1 2b qN −i = − − TN −i 2b Ki2 b i + 1/2 a a b = Ki2 i − bTN −i − + TN −i Given the buyer’s reaction function and Equation (5). 543–550. 2 4 i + 1 2 i + 1 the supplier’s problem in period (i + 1) is as follows: 2 a 2i + 1 2i + 1 = Ki i − bTN −i a w 4 i + 1 2 i + 1 max wN −i − 2 N −i − TN −i wN −i ≥0 2b Ki b i + 1/2 2i + 1 a 2i + 1 wN −i = Ki2 i − bTN −i = i 2 . hence. © 2008 Production and Operations Management Society Ki2 1 1 Note that the second equality follows from Equa- = −wN −i + a i+ − bKi2 TN −i i + tion (2). Erhun. Keskinocak.

2 i + 1 2 2 i + 1/2 2 K 2 ib wN −i + i i 2i 2 Ki2 b i + 1/2 = w = w i + 1/2 N −i 2i + 1 N −i From the ﬁrst-order condition. a 2 i + 1/2 − i = − TN −i − wN −i Hence. = − TN −i − − bTN −i 2b i + 1 Ki2 b i + 1/2 2 From Proposition 1. information. the results of the main 1 2i + 1 a 2i + 1 = − TN −i model are not sensitive to a discount factor. wN −i has the same uniqueness of the SPNE. Next. and the efﬁciency increases. w1 = KN2 N a/2 . the production quantity for the N -period model is QN = a/ 2b − a/ 4b KN . the a Ki2 i + 1/2 2 a SPNE is unique in the class of SPNE. it is easy to see that wN = w1 / KN N . Therefore. by construction. We respect to wN −i . When we 2i 4b i + 1 2 i + 1 incorporate a discount factor ≤ 1 into our analysis. This completes the ﬁrst part i+1 2 of the proof. approaching that of the centralized solution. 1 2i + 1 a 2i + 1 wholesale prices become w n = N −n wn n = 1 N . i +1/2 a 1 a = 1− −TN −i = −TN −i As N increases. and the seventh equality follows from the fact 0= − 2 − TN −i + 2 2b Ki b i + 1/2 Ki b i + 1/2 2 that wN −i = Ki2 i + 1/2 2 / i + 1 a/2 − bTN −i . a strategy proﬁle of a multistage game The next step is to determine whether qN −i keeps with observed actions is SPNE if it satisﬁes back- the structure: ward induction (Fudenberg and Tirole 1991). There- fore the relations for qj and wj are also preserved. ization effect decreases. each step of backward induction preserves the 2b Ki2 b i + 1/2 2 structure. capacity price at the end of know that QN = a − wN / 2b . and the K 2 i + 1/2 2 a wN −i = i − bTN −i equality follows directly. the structure for qN −i is the same as Equa. we showed that at each stage of the backward qN −i = − − TN −i induction. Hence. we show the 2 Ki+1 i + 1 a/2 − bTN −i . 2i 2i + 2 2b 2i N −i . the strategy for a player is the unique best 2b Ki2 b i + 1/2 response at that point. Even though our model = − TN −i − + does not include a discount factor because of our inter- 2i 2b 4b i + 1 2 i + 1 pretation of these N periods. Similar to the argument of Allaz and Vila (1993). Note that the supplier’s problem is concave with Next. In a ﬁnite game of perfect structure as Equation (3). = − TN −i = q The quantities maintain their original values. and the production i +1 2b 2 i +1 2b quantity increases. In the a wN −i proof. As wj+1 = 2 N − j / the (i + 1)st step is as follows: 2 N − j + 1 wj . Therefore. tion (1) and is preserved. Hence. and hence wN = KN a/2 . but rather that procure- 1 a a TN −i ment occurs more frequently. the double marginal- Hence. Note that Ki+1 = Ki 2i + 1 / 2i + 2 and wN −i = In the second part of the proof. we prove that QN = a/ 2b − aKN / 4b . a higher N 1 a qN −i+1 = − TN −i − qN −i does not necessarily imply that the capacity procure- 2i 2b ment is over a longer horizon. KN decreases. we get the following: Note that the second equality follows from Equa- a 2wN −i iwN −i tion (3).

decreases over time. and the market price of the approximately 36% of the total proﬁts in the presence product (following the relationship P QN = a − bQN ) of additional capacity procurement periods. and Tayur: Dynamic Procurement.Erhun. pp.18 34. the buyer and the supplier can jointly periods. the quantity that the buyer pro. That is.43 61. Even though the quantity in the ﬁrst period the inefﬁciency considerably.77 6. and end consumers) Figure 1 The Distribution of Proﬁts Between the Supplier. decide on an appropriate N value a priori. dynamic procurement decreases · · · a/2).73 62. we 100 made several simplifying assumptions in our model. We show because she knows that by doing so. the buyer the inefﬁciency is already less than 10% (compared procures capacity in each period.64 34. In our analysis. and Supply Chain Efﬁciency Production and Operations Management 17(5). increases (a/ 4b 5a/ 16b 11a/ 32b the total proﬁts. As N increases.00 9. Keskinocak.56 61.00 58.e. For example. and (2) as N goes to inﬁnity.. N (ii) . it is an input to the game. the marginal beneﬁt of each additional trading period cures in each period increases and the capacity price and the possible cost of each trade.40 2. the Number of Periods N mance of the decentralized supply chain approaches that of the centralized supply chain. © 2008 Production and Operations Management Society 547 Table 1 Capacity Prices and Quantities for Different N Values Under Dynamic Procurement Prices Quantities N n=1 n=2 n=3 n = 4 ··· n=1 n=2 n=3 n = 4 ··· QN a a a 1 2 4b 4b 9a 3a a 3a 5a 2 ←−−− −−−→ 16 × 3 2 8 8b × 3 2 16b 16b 75a 15a 5a a 5a 5a 11a 3 ←−−− ←−−− −−−→ −−−→ 128 × 5 4 32 × 3 2 16 12b × 5 4 48b × 3 2 32b 32b 1225a 525a 105a 35a a 7a 35a 35a 93a 4 ←−−− ←−−− ←−−− −−−→ −−−→ −−−→ 2048 × 7 6 1024 × 5 4 256 × 3 2 128 16b × 7 6 96b × 5 4 384b × 3 2 256b 256b Table 1 summarizes the prices and quantities in and the buyer’s proﬁts both increase (see Figure 1). trading with 25% for N = 1).42 35. QN .23 62. the Buyer.52 Supplier 50.30 35. the perfor- and the Double Marginalization (DM) Effect vs. and the buyer’s proﬁt converges to 93a/ 256b · · · a/ 2b ). the best response that as N increases.83 (i) (N = 2) (N = 2) Number of periods.83 2. strictly beneﬁt. As N increases.64 33. the 1225a/2048 · · · ). we assume that N is exogenously cure capacity at a given period (at a higher price) determined.85 1.44 2. The buyer is willing to pro. 543–550. the double marginalization effect decreases and the supplier’s 3. Hence. so do the proﬁts of both play- for the supplier is to lower the price in the subsequent ers. occurs in all N periods.65 capacity Multiplicative Exponential dependent distribution) Buyer 25. Extensions Our main result has two parts: (1) as N increases. The total production quan.15 35. Even for decreases (3a/4 11a/16 21a/32 163a/256 small values of N . while the ﬁrst period plus to the supplier and the buyer such that both par- capacity price increases (a/2 9a/16 75a/128 ties beneﬁt. 40 30 Table 2 Robustness of the Two Parts of the Main Result Under 20 Different Extensions 10 Price-sensitive demand 0 Newsvendor setting 1 3 5 7 9 11 13 15 17 19 Limited Effort. different periods for the SPNE. for N = 3.09 1.59 60.45 62.00 31. However. 90 80 We next discuss the implications of these assump- tions on our main result and how they can be relaxed. Percentage of profits 70 60 Table 2 summarizes the robustness of the two parts 50 of the main result under different extensions. Independent of the values of a and b. supplier’s proﬁt converges to approximately 64% of tity.94 35.92 62.06 4.61 62. the Dynamic procurement not only increases the supply last period’s capacity price decreases (a/2 3a/8 chain efﬁciency but also naturally allocates the sur- 5a/16 35a/128 · · · 0). decreases as N increases q1 = a/ 4Nb . based on For a ﬁxed N . i. Quantity Discounts.38 34. buyer. all participants (supplier.39 3. (uniform demand DM loss 25.

Proposition 2 shows that dynamic procurement continues to increase the Proof. the performance lower valuations. −1 where K1 = 1 and KN = Nk=1 2k + 1 / 2k + 2 .) tion to price. pp. we study an N -period model production cost of the buyer is zero. The details of 2n̄ + 1 2n̄ the analysis for the limited capacity case are avail. D P e = a − P + e (cost of the effort Both multiplicative and exponential demand func. To verify our intuition. can be modeled by QN = qn = ū 1 − KN /2 p − c /p n=1 a downward-sloping demand curve. form demand).. The proof of Proposition 3 follows directly quantity that the buyer procures as the supplier from the proof of Proposition 1 after observing that is willing to decrease the wholesale price over the buyer’s objective function under effort-dependent time. the split of proﬁts between the buyer and of the centralized supply chain. © 2008 Production and Operations Management Society Limited capacity: We can relax the unlimited capac. 543–550. 2N p 2 plier and the buyer trade only once.1 of the Online Supplement. Proposition 3 shows that dynamic procurement tions lead to dynamics that are similar to those in continues to beneﬁt both parties. Erhun. i. qn+1 = qn wn+1 = wn 2n̄ 2n̄ + 1 able in §A. when the supplier’s capacity is tight (less than Q1 ). Proposition 2 (Newsvendor setting with uni- ity assumption easily and show that when the capac. buyer. The pro- Alternative price-sensitive demand functions: For most duction quantity is of the insights. we can no longer assume that the dependent demand. for both where demand is a function of the sales effort in addi- cases we assume that the unit production cost is c. even Proposition 3 (Effort-dependent demand). 2n̄ Q ity N times before the demand is realized (we wn+1 = wn e∗ = N assume that there is no forecast update between 2n̄ + 1 2 periods). QN tends to ū p − c /p . For n = 1 N − 1. it allows the with a = p − c and b = p/ 2ū . but dynamic procure. the market duction quantity is QN = Nn=1 qn = 2a/3 − a/3 KN . Finally. and an exponential demand function where D P = Effort-dependent demand: To understand the impact a exp −P for a two-period model. result continues to hold in a newsvendor setting with ment will continue to occur as long as demand is uniform demand distribution. When N demand is price-sensitive. we study a distribution leads to the same proﬁt split as in the multiplicative demand function where D P = aP −2 linear inverse demand case. from the proof of Proposition 1. The proof of Proposition 2 follows directly she can proﬁtably sell to a larger set of end con. there is no beneﬁt ū p − c p−c q1 = w1 = KN2 N because of the additional trading periods.e. we continue to show that all participants (sup. Therefore. QN tends to 2a/3. of dynamic procurement in the case of effort- plicative model. and hence. Newsvendor setting: To test the robustness of our a 2 a 2n̄ + 1 q1 = w1 = K N N qn+1 = qn results to price-sensitive demand assumption. let plier. Hence. We analyze the case wherein demand is −1 where K1 = 1 and KN = Nk=1 2k + 1 / 2k + 2 . Then. is e2 ). Keskinocak. under a different demand of the decentralized supply chain approaches that curve. the intuition is as follows: the purchasing power of each additional As N tends to inﬁnity. duction cost is c < p per unit. we 3N 2 2n̄ study a setting wherein a newsvendor procures capac. the sup. same as her objective function under the main model mental quantity discount). if the buyer can reduce her marginal cost for each additional unit. and Tayur: Dynamic Procurement. Proof. demand becomes exactly the same as her objective . after observing that sumers. curement model is the following. hence. the supplier sells all N -period dynamic procurement model is the following. i.e. N increases. and Supply Chain Efﬁciency 548 Production and Operations Management 17(5). the linear inverse demand function. Dynamic procurement allows the supplier to the buyer’s objective function under newsvendor set- charge lower prices as the number of units purchased ting with uniform demand and c > 0 is exactly the by the buyer increases (as in the case of an incre. As price is ﬁxed at p per unit. let n̄ = N − n.org/journal/supplements. Furthermore. (For the multi. Quantity Discounts. end consumer is then lower.. the uniform price-sensitive. The though we cannot verify the second part of our main unique pure-strategy SPNE for the N -period dynamic pro- result. located at http://www. The pro- uniformly distributed between 0 and ū. and the buyer’s pro- N tends to inﬁnity. number of periods. The unique pure-strategy SPNE for the ity is below a certain threshold. Therefore. we believe that the linear inverse demand function is not a critical assumption. buyer to proﬁtably sell to those end consumers with Furthermore. our main the supplier will be different.poms. For his capacity and coordination is achieved in a ﬁnite n = 1 N − 1. as N goes to inﬁnity. Then. and end consumers) strictly beneﬁt as n̄ = N − n. Clearly.

2 of the Online 45 Supplement. Dynamic Procurement When N = 20 P Q20 = 100 − Q20 Furthermore. with a probability 0 10 20 30 40 of . ing position was reversed. According to the supplier. and Supply Chain Efﬁciency Production and Operations Management 17(5). mimic the linear inverse demand function. despite improving the system performance 55 for a large range of parameters. Interestingly. both the effort (a) 1. the result in Unit cost 50 part (1) can be reversed under asymmetric informa- tion. with a probability of 1 − . During our discussions with a con- sulting ﬁrm for a major manufacturer of ﬁnished she could leverage her supply when the manufacturer goods. our main result states that as the number concluded that higher inventory levels at the man.) Under asymmetric information. When the manu- on raw material costs when the manufacturer used facturer felt strong enough to walk away. Quantity Discounts. 1. It can be viewed economics of the manufacturer’s business such that as a sequence of bilateral negotiations between the . on the other hand. we show that all the parties beneﬁt from was expressed by many of the manufacturer’s pur. depend. the buyer can afford to invest more in the sales effort (as her average procurement cost decreases) and decrease the price of the product. Contrary to their result.” al . In this paper. knows the exact value of the market potential. The Quantity buyer. the negotiat- the multiple-period sourcing approach. our research shows that this 0 10 20 30 40 may not be the only reason companies use dynamic Quantity procurement. Hence. of trading periods increases. multiple trading periods. the buyer is 500 closer to the end-consumer market and may have more information about the demand compared to the supplier. the additional trad- ing period is not always beneﬁcial. Because of dynamic procurement. as N goes to inﬁnity. we observed a strong indication of an impact had immediate shortage concerns.e. we consider information asymmetry between the supplier and the buyer regarding mar- ket potential.000 therefore. demand for this particular manufacturer and the sup- ply of the material was constrained. and Tayur: Dynamic Procurement. 60 ing on the relative values of al and ah . as well as the improvement in sys- tem performance. i.” procurement is similar to an incremental quantity dis- The raw material supplier tended to know the inven.. that multiple-period sourcing helped to reduce prices however. 40 4. where the supplier sets the prices and the tory position of the manufacturer and understood the buyer sets the breakpoints (Figure 2). Based on a data Similar to the efﬁciency result of Allaz and Vila analysis over a four-year horizon.Erhun. Information asymmetry: In practice.500 level and the production quantity approach those of the centralized supply chain. (For simplicity. i = l h. we analyzed there was very little uncertainty in the ﬁnished good this phenomenon with a stylized model.” ah . A likely reason centralized supply chain. 543–550. or “low. demand for the product increases. Quantities Under replaced with its optimal value e∗ = QN /2. the market 0 potential can either be “high. pp. In equilibrium. count. we assume that bi = (b) 1. © 2008 Production and Operations Management Society 549 function under the main model with b = 3/4 once e is Figure 2 The Total and Unit Capacity Costs vs. The details of the analysis for the asymmetric information case is available in §A. The divi- Total cost sion of the proﬁts. the total output of the ufacturer showed strong correlations with reduced supply chain increases and approaches that of the sourcing costs on a per-unit basis. Keskinocak. the consulting ﬁrm (1993). dynamic chasers as “being able to walk away from the table. However. Conclusion Dynamic procurement is commonly used to mitigate 35 demand risk. the buyer and the supplier may engage in dynamic procurement. However.

K. 44(2) 276–283.. P. The authors thank Department Editor Eric Johnson. L. P. Management Sci. 29(1) 23–36. Management 2008. mining the lot size under quantity discounts.. Managing channel proﬁts. University of procurement with inventory and backordering options. C. A.. Federgruen. 2008. J. Li. D. 979–992. S. Coordination mecha- nism for a distribution system with one supplier and multiple in addition to those discussed above. Lariviere. 1991. S. Shugan. Channel coordination and quantity discounts. and Supply Chain Efﬁciency 550 Production and Operations Management 17(5). M. There are several extensions to this simple model. tic demand model and competition between buyers. Oper. plier. Texas A&M Keskinocak. The authors also thank seminar participants at keting Sci. A classiﬁcation of literature on deter. Erhun. Purdue University. hold. Keskinocak. Stanford. J. de Groote. University of Southern Cal. S. Dynamic pricing in Cournot duopoly with two pro- Acknowledgments duction periods. X. References Munson. Quantity discounts: Managerial issues and research opportunities. Structural properties of buyback vertical contracts. Shen. Management Sci. the Fudenberg. tive comments and suggestions that signiﬁcantly improved Jeuland. K. Chen. 2000. unknown demand and increasing costs. Ray. 2008. Forthcoming. 47(5) 693–708. . S. Theories and realities of Allaz. CA. 2001. Wang. Y. contracts for price-setting newsvendors. Future capacity procurements under 34–47. retailers. 1996. 40(8) 733–748. Theory 59(1) 1–16. Grifﬁn.. 1999. Li. Managerial Deci- sion Econom. © 2008 Production and Operations Management Society supplier and the buyer. Z. H. Vila. M. 45(5) 685–703. P. and the second Erhun. J. Charnsirisakskul. Supply chain University. A. Atlanta. Park. and efﬁciency. 41(9) 1509–1522. Dolan. MIT Press. Keskinocak. Eur. London Business School. M. Management Sci.. 2008. J. Zheng. Manufacturing Service Benton.. and University of Texas at Austin. Anupindi. Gilbert. A supplier’s optimal quantity dis- is not known by the buyer.. and it provides incentives to Cachon. Cournot competition. Working paper. 2003. P. senior editor. sales: When to turn-and-earn. Georgia Institute of Technology. Management Sci. C. Department of Management Science and Engineering. P. Strategic inven- tory in capacitated supply chain procurement. Other possible extensions are to study a stochas. Y. University of British Columbia. Tirole. Cambridge. signment contract with revenue sharing. A. J. S. F. 543–550. and investigate whether our results would still 46(3) 444–500. Y. Grifﬁn. ing paper. 2007.. Charnsirisakskul. G. Res. J. R. J. The role of return policies in pric- which are the focus of parallel works (Erhun et al. 2(3) 239–272. Oper. P. R. 1993. Anand. Stanford University. Dynamic procurement in a capacitated supply chain facing uncertain demand.. Channel performance under con- 92(2) 219–238. Game Theory. Econom.. W. School of Industrial and Systems Engineering. Management Sci. Erhun 2007). P. 1983. ifornia. K. forward markets quantity discounts: An exploratory study. 2004. 2001. author was supported by NSF Career Award DMII-0093844. pp. nor possibly by the sup. 1987. Sci. C. The ﬁrst author was partially supported by National Science Foundation (NSF) Award DMI-0400345. Gilbert. Strategic inventories in Song. S. Erhun. IIE Trans. B. 50(1) Burnetas. Management Sci.. Emmons.. sider a case wherein the number of trading periods Corbett. ing and inventory decisions for catalogue goods. J. We can con. Tayur. 1998. S. Capacity allocation using past both parties to increase the total supply chain proﬁts. F. Work- North Carolina at Chapel Hill. Rosenblatt.. 1995. L. 6(1) 1–23. Mar- this paper. K. Bassok. and the two anonymous referees for construc. 47(7) Weng.. Management Sci.. 2008. Management 10(1) 1–18. Y. count policy under asymmetric information. Keskinocak. MA. Management 7(4) 352–369. and Tayur: Dynamic Procurement. Production Oper. A. 1998. Marketing Sci. F.. M. Quantity Discounts. Z.

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