A purchasing framework for B2B pricing decisons and risk-sharing in supply chains

Decision Sciences, Fall 2002 by Arcelus, F J, Pakkala, T P M, Srinivasan, G

A Purchasing Framework for B2B Pricing Decisions and Risk-sharing in Supply Chains

ABSTRACT

This paper presents a common modelling structure for (i) the implementation of operational policies by individual purchasing managers of risk-sharing agreements among supply-chain partners, and (ii) the integration of brick and click purchasing policies in a 13213. The problem of price uncertainty created within these two environments is modelled as a stochastic repetitive-sales problem, applicable to any probability distribution. The model identifies sufficient conditions for regenerative ordering cycles, which allows for the use of the renewal reward theorem. The end result is a two-price purchasing policy, which may substantially ease implementation problems across a global corporation's purchasing managers world-wide and across B2B markets.

Subject Areas: Global Operations Management, Inventory Management, Stochastic Processes, and Supply Chain Management.

INTRODUCTION

This paper focuses on two specific problems observed by the authors to occur while putting into practice solutions to issues arising from the interface of e-commerce and supply chains. One of these problems arises when attempting to operationalize risk-sharing agreements between two components of the supply chain. The other is salient in the process of coordinating pricing policies for an Internet-based (or "click") and for a more traditional (or "brick") B2B market. Those two problems, to be detailed next, give rise to a common structure that leads to the development of the stochastic repetitive-sales problem, subject of this paper.

A Foreign-Exchange Risk-sharing Problem

The first problem takes place within a floating-exchange regime, where long-term supply contracts create operating exposure to the parties, as the effective purchase price of a given component at the time of execution may fluctuate due to the change in the relative value of the currencies. To mitigate such an effect, supply chain partners often enter into risk-sharing agreements, whereby "the buyer and the seller agree to share or split currency movement impacts on payments between them" (Eiteman et al., 2001, p. 219). In this way, the parties share the favourable/ adverse effects of changes in exchange rates as long as the fluctuations remain within agreed-upon limits. Otherwise, a new risk-sharing agreement must be negotiated, as it often happens when dealing in countries with hyperinflation conditions (see Austin, 1990). The basic rationale for the use of risk-sharing contracts is well known in international finance, since floating exchange rates have been a fixture in world markets since the 1970s and even before the 1950s (see Eiteman et al., 2001, p. 220). Nonetheless, their impact on operations has been largely neglected up to the last few years, even if reports of their saliency in Global Supply-Chain Management were being published as early as the late '80s (see Carter & Vickery, 1988; Dornier et al., 1998). Even today, the literature on global supply-chain issues in general (see Cohen & Huchzermeir, 1999; Cohen & Mallik, 1997) and on supply-chain contracts in particular (see Tsay et al., 1999) emphasise the development of multi-sourcing models, with hedging mechanisms designed to shift the risk to the other parties, rather than intended to share the risk among the members of the chain. Examples include contracts with quantity flexibility (Li & Kouvelis, 1999; Tsay & Lovejoy, 1999), special sourcing strategies (see Kouvelis, 1999), price protection (Lee et al., 2000) and options (Huchzermeir & Loch, 2001).

Nevertheless, for the numerous purchasing managers of a global manufacturing concern, the presence of risk-sharing agreements still implies purchasing price uncertainty, even if there exists a contract at an agreed-upon purchase price in the buyer's home currency. However, letting individual purchasing managers deal continuously with a whole range of uncertain prices without appropriate methodological support tends to seriously undermine the salutary (at least for the firm) effect of risk-sharing contracts. Furthermore, the nature of exchange rate induced uncertainties is normally similar across purchasing managers world-wide. Hence, as part of the process to standardise the operationalization of these risksharing contracts, a standard two price structure is often developed for favourable and adverse exchange-rate situations, whereby a higher (lower) standard unit purchase price of C^sub U^ (C^sub L^) may be set if the current exchange rate exceeds (is below) a predetermined exchange rate. As the actual exchange rate is random, so is the occurrence of C^sub U^ and C^sub L^. Hence, when designing the cost-minimising ordering policies for the acquisition of the components dictated by the production plan, the purchasing manager may take into account the exchange-rate uncertainty through the consideration of a simple two-price structure.

A Brick and Click Pricing Problem

The second problem giving rise to this paper deals with the issue of B2B pricing and with the development of brick and click pricing policies (see Gulati & Garino, 2000). Even if the emergence of the Internet is changing the landscape of the B2B marketplace, online technology has not proven itself to be the panacea to cure all of the world's ills, nor are the traditional brick-and-mortar stores as hopelessly outdated as it was once thought. Today the picture is more balanced (see Taylor, 2001). Hence the trend is to mix these two types of distribution modes. The development of joint pricing policies is part of this integration process. Based on the type of goods (what is bought) and the type of sourcing (how it is bought), Kaplan and Sawhney (2000) identify four different types of B2B hubs. Of interest here are the on-line exchanges (e.g., redtagbiz.com, isolve.com), widely expected to solve or at least alleviate some of the distribution problems that were created through the traditional methods (see Booker, 1999) and hence result in low-cost and efficient way of displaying merchandise, attract customers and handle purchase orders (see Copacino, 2000). More importantly for the purpose at hand, these surplus-inventory websites provide information flow of temporary excess supply readily available online and hence the opportunity for the retailer to buy at a price lower than the regular purchase price either directly from the wholesalers or more and more through these e-exchanges (see Booker, 1999; Brynjolfsson & Smith, 2000). As before, this process results in a two-price, (C^sub U^, C^sub L^), structure, where the retailer normally buys at the regular "brick" price of C^sub U^, as stipulated in the traditionally long-term contract existing in supply chains, but takes periodic advantage of the lower, C^sub L^, click prices if the situation so warrants.