This article considers the single-period, multiple-supplier procurement problem using option contracts, with capacity constraints and fixed ordering costs. The buyer can procure from suppliers by signing option contracts to meet future uncertain demand, or purchase from the market for prompt delivery at an uncertain price. The objective is to find the optimal portfolio of option contracts with minimal total expected procurement cost....[ Read more ]

This article considers the single-period, multiple-supplier procurement problem using option contracts, with capacity constraints and fixed ordering costs. The buyer can procure from suppliers by signing option contracts to meet future uncertain demand, or purchase from the market for prompt delivery at an uncertain price. The objective is to find the optimal portfolio of option contracts with minimal total expected procurement cost.

We discuss three cases with respect to the constraints on production capacity of suppliers and the existence of ordering costs. For the case where option suppliers have limited capacity constraints, we characterize an optimal procurement process and show that the solution procedure has intuitive geometrical interpretation and can be solved by graphical search. For the case where the setup cost for each order is nonzero, we restrict the feasible solution set to a special area where the optimal solution lie, and provide the shortest monotone path algorithm to search for the optimal solution. When both the capacity constraints and fixed ordering cost exist, we use dynamic programming to build the cost function with strong K-convex property and characterize the structure of the optimal procurement policy.