Supply Contracts with Financial Hedging

Abstract

We study the performance of a stylized supply chain where two firms, a retailer and a producer, compete in a Stackelberg game. The retailer purchases a single product from the producer and afterward sells it in the retail market at a stochastic clearance price. The retailer, however, is budget constrained and is therefore limited in the number of units that he may purchase from the producer. We also assume that the retailer's profit depends in part on the realized path or terminal value of some observable stochastic process. We interpret this process as a financial process such as a foreign exchange rate or interest rate. More generally, the process can be interpreted as any relevant economic index. We consider a variation (the flexible contract) of the traditional wholesale price contract that is offered by the producer to the retailer. Under this flexible contract, at t = 0 the producer offers a menu of wholesale prices to the retailer, one for each realization of the financial process up to a future time . The retailer then commits to purchasing at time a variable number of units, with the specific quantity depending on the realization of the process up to time . Because of the retailer's budget constraint, the supply chain might be more profitable if the retailer was able to shift some of the budget from states where the constraint is not binding to states where it is binding. We therefore consider a variation of the flexible contract, where we assume that the retailer is able to trade dynamically between zero and in the financial market. We refer to this variation as the flexible contract with hedging. We compare the decentralized competitive solution for the two contracts with the solutions obtained by a central planner. We also compare the supply chain's performance across the two contracts. We find, for example, that the producer always prefers the flexible contract with hedging to the flexible contract without hedging. Depending on model parameters, however, the retailer might or might not prefer the flexible contract with hedging.

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).…”

“…In another contribution, Ding et al (2007) have investigated the implications of a global manufacturer's financial hedging activity against currency risk on its operational decisions. For other examples regarding the impacts of financial hedging on operational policies, see Caldentey and Haugh (2006), Caldentey and Haugh (2009), and references therein. However, these papers typically assume a newsvendor setting in their models (i.e., single-period problems), which may have limitations in practice.…”

Joint logistics and financial services by a 3PL firm

“…The operations management literature has been prolific on newsvendor models (see Chen and Bell (2009);Chung et al (2009);Hu et al (2010); Lau and Lau (1999); Parlar and Weng (2003); Zhou and Wang (2009)) on which our model is based; however, most studies on the interface between operations and financial management have been recent (Caldentey and Haugh, 2009). The existing literature has focused on the budget-constrained firm's production, inventory, capacity, and debt decisions, and seeks to demonstrate that it is important to incorporate financial decisions into operational decisions.…”

Buy-back and Revenue-Sharing Contracts in Global Supply Chain

“…Since the financial hedging is a financial topic, this literature in the global supply chain environment is relatively lacking. Caldentey and Haugh (2009) consider the flexible contract with hedging in a decentralized global supply chain. Ding, Dong and Kouvelis (2007) discusses the financial hedging and the operational hedging at the same time in a global supply chain network.…”