Multiechelon Procurement and Distribution Policies for Traded Commodities

Authors:
Ankur Goel;Genaro J. Gutierrez
Affiliations:
Weatherhead School of Management, Case Western Reserve University, Cleveland, Ohio 44106;McCombs School of Business, University of Texas at Austin, Austin, Texas 78712
Venue:
Management Science
Year:
2011

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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.