Multiechelon Procurement and Distribution Policies for Traded Commodities

Abstract

We consider a firm that procures and distributes a commodity from spot and forward markets under randomly fluctuating prices; the commodity is distributed downstream to a set of nonhomogeneous retailers to satisfy random demand. We formulate a model that allows one to compute approximate, but near optimal, procurement and distribution policies for this system, and we explore the value of the commodity's market in providing managers with (a) additional flexibility in procurement and (b) information on price dynamics generated through the trading of futures contracts. Our results indicate that the presence of the commodity market and the information that it conveys may lead to significant reductions in inventory-related costs; however, to obtain these benefits, both the spot procurement flexibility and the term structure of prices generated by the commodity market must be incorporated in the formulation of the operating policy. Managerial insights on the procurement strategy as a function of variability in prices and demand are also discussed. This paper was accepted by John Birge, focused issue editor.

Coordinating operational policy with financial hedging for risk-averse firms

“…Apart from the multi-period inventory problems, the above modeling framework may also be applied to describe many other operational activities, such as production planning (Ding et al 2007), product sourcing (Caldentey and Haugh 2009), and materials distribution (Goel and Gutierrez 2011). Moreover, it is also possible to extend our model by introducing some capacity constraints on the decision vector k x (Birge 2000).…”

“…Consequently, the hedging-consistent operational decisions can be made via maximizing the expected value of the profit with the risk-neutral probability measure (Goel and Gutierrez 2011). Thus, this approach is referred to as the EV-based approach (expected-value-based approach) in this paper. The EV-based approach is appealing because it can help substantially reduce the number of decision variables when financial hedging is involved -the decision variables regarding the hedging positions are entirely eliminated from the Bellman equation.…”

OM Forum—Operations and Finance Interactions

“…9 capacity investment cost. Many other operations management studies (see, e.g., Devalkar et al 2011;Goel and Gutierrez 2011;Lai et al 2010Lai et al , 2011Secomandi 2010a, b;Secomandi and Wang 2012;Wu et al 2012) also take advantage of this valuation methodology in characterizing operational policies in the presence of financial markets.…”

Optimal procurement of long-term contracts in the presence of imperfect spot market

“…Li et al [18] compared two pure strategies: purchasing from spot market and signing a longterm contract with a single supplier, and developed a stochastic dynamic programming model to incorporate mixed strategies. Goel and Gutierrez [8] studied procurement and distribution policies for a firm that procures and distributes a commodity from spot and forward markets. Besides forward contract, the optimal procurement strategy of option contract and spot buying has also been investigated in literature.…”

“…(6)- (8), which equals the expected profit when the buyer only trades in the spot market and thus can be seen as the benefit of the spot market. The other terms in Eqs.…”