Analysis of a Procurement Game with Option Contracts1

Bo Chen
University of Warwick, UK

When a firm faces an uncertain demand, it is common to procure supply using

some type of option in addition to spot purchases. A typical problem of this type
involves capacity being purchased in advance, with a separate payment made that
applies only to the part of the capacity that is needed. We consider a discrete
version of this problem in which competing suppliers choose a reservation price
and an execution price for blocks of capacity, and the buyer, facing known
distributions of demand and spot price, needs to decide which blocks to reserve.
We show how to solve the buyer's combinatorial optimization problem efficiently
and prove that suppliers can do no better than offer blocks at execution prices that
match their costs, making profits only from the reservation part of their bids.
Finally, we show that in an equilibrium the buyer selects the welfare maximizing
set of blocks, which is also group strategy-proof.

1
This talk is based on the following recent publication: E. Anderson, B. Chen, and L. Shao. “Supplier
competition with option contracts for discrete blocks of capacity”. Operations Research 65(4) (2017),
952–967.