Using risk-management tools on B2Bs: An exploratory investigation

Business-to-Business exchanges (B2Bs) have given procurement managers of certain non-commodity products and services such as chemicals, semi-conductors, or bandwidth access to spot markets and risk management tools such as futures or forward contracts. Our goal in this paper is to show how managers can integrate B2Bs and the risk management tools they provide with the traditional practice of signing long-term contracts with preferred suppliers. Specifically, we model a scenario where a manager has two procurement channels: the preferred supplier with an exogenously determined contract price and the B2B with an uncertain spot price. The manager can, however, buy forward contracts (for a cost) to mitigate price volatility. Facing uncertain demand, our model helps managers decide on the optimal "portfolio" of procurement options, i.e., the quantity to buy from the preferred supplier, number of forward contracts to write, and when necessary, use the spot market to satisfy demand. (C) 2007 Elsevier B.V. All rights reserved.