Capacity Reservation under Spot Market Price Uncertainty

Abstract

The traditional way of procurement, using long-term contract and capacity reservation, is competing with the escalating global spot market. Considering the variability of the spot prices, the flexibility of combined sourcing can be used to benefit from occasional low short-term spot price levels while the long-term contract is a means to hedge the risk of high spot market price incidents. This contribution focuses on the cost-effective management of the combined use of the above two procurement options. The structure of the optimal combined purchasing policy is complex. In this paper we consider the capacity reservation - base stock policy to provide a simple implementation and comparison to single sourcing options. Our analysis shows that in case of large spot market price variability the combined sourcing is superior over spot market sourcing even in case of low average spot market price and also superior over long-term sourcing even in case of high average spot market price.