Financial and operational instruments for commodity procurement in quantity competition

We analyze a commodity procurement problem under uncertain future procurement prices and product demands. An optimization model is presented that finds the best mix of advance procurement, spot market procurement, and financial options to satisfy demand in an asymmetric and duopolistic sales market. One firm can only procure just-in-time whereas the other can additionally procure in advance via inventories or option contracts. We show that even under arbitrage-free procurement prices, inventories and option contracts both provide an advantage in comparison to pure just-in-time procurement. However, inventories turn out to dominate option contracts due to a stronger capacity commitment. (C) 2010 Elsevier B.V. All rights reserved.