Procurement Risk Management using
Options and the Spot Market
Qi Fu (fuqi@ust.hk)
Chung-Yee Lee (cylee@ust.hk)
Department of Management Sciences
Department of Industrial Engineering and Logistics
Management
One
of the greatest challenges confronting many manufacturers these days is the
daunting task of matching demand for the product and supply of the key inputs.
Product demand is extremely hard to predict in an increasingly crowded and
competitive environment. There are both volume and price uncertainties at the
supply end as well. In such situations, to mitigate the demand risk, option
contracts have been widely used by acquisition project practitioners, because
these contacts ensure the buyer certain capacity available in the future while
providing flexibility in adjusting the order quantity. There usually exists a
pool of suppliers competing on both price and flexibility. Besides, the buyer can also purchase from the
spot market at the last minute to meet its demand.
However,
the spot price is often quite uncertain, because it is essentially determined
by supply and demand. In industries where supply is growing and demand is
scarce, it is possible that the spot market has a lower price than the contract
market. Hence, to cope with supply risk and gain competitive advantages, firms
have begun to incorporate flexibility in procurement strategy that maintains a
spectrum of supply alternatives to eliminate a single point of failure…