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PRODUCTION AND OPERATIONS MANAGEMENT POMS

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.

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