Procurement strategies in the presence of the spot market - an analytical framework

This paper investigates a problem in which a buyer can procure from a regular supplier as well as from a supplier in a spot market, possibly formed over the Internet. The contract with the regular supplier specifies a predetermined order volume and price, while the spot market has unlimited supply but a varying spot price. We analyse this problem from a buyer/ supplier perspective, and an analytical model is developed to analyse two distinctive procurement strategies: the pure procurement system ( PS) and the mixed procurement system of regular supplier with a supplier in spot markets ( MS). Without loss of generality, we obtained a closed- forms solution that enabled us to provide numerical analysis on the procurement strategies, and allowed us to compare further the different characteristics between PS and MS. The results of our analysis demonstrate that the use of spot market could effectively mitigate the risk associated with demand uncertainty facing the buyer. The results also show that adopting MS can generate a higher buyer's profit than the PS, and significant supply- chain profit improvements can indeed be achieved through buyer/ supplier coordination. Furthermore, spot price volatility leads to the facilitation of the use of spot markets, improving the buyer and the supply- chain profitability.