Lingxiu Dong

On the Integration of Production and Financial Hedging Decisions in Global Markets

We study the integrated operational and financial hedging decisions faced by a global firm who sells to both home and foreign markets. Production occurs either at a single facility located in one of the markets or at two facilities, one in each market. The company has to invest in capacity before the selling season starts when the demand in both markets and the currency exchange rate are uncertain. The currency exchange rate risk can be hedged by delaying allocation of the capacity to specific markets until both the currency and demand uncertainties are resolved and/or by buying financial option contracts on the currency exchange rate when capacity commitment is made. A mean-variance utility function is used to model the firms risk aversion in decision making. We derive the joint optimal capacity and financial option decision, and analyze the impact of the delayed allocation option and the financial options on capacity commitment and the firms performance. We show that the firms financial hedging strategy ties closely to, and can have both quantitative and qualitative impact on, the firms operational strategy. The use, or lack of use of financial hedges, can go beyond affecting the magnitude of capacity levels by altering global supply chain structural choices, such as the desired location and number of production facilities to be employed to meet global demand.

Dynamic Pricing and Inventory Control of Substitute Products

We study dynamic pricing and inventory control of substitute products for a retailer who faces a long supply lead time and a short selling season. Within a multinomial logit model of consumer choice over substitutes, we develop a stochastic dynamic programming formulation and derive the optimal dynamic pricing policy. We prove that dynamic pricing converges to static pricing as inventory levels of all variates approach the number of remaining selling periods (assuming at most one customer arrival within each period). Our extensive numerical study of the effects of time and inventory depletion on the optimal pricing reveals two fundamental underlying driving forces of the complex price behavior: the level of inventory scarcity and the quality difference among products. We also compare the performance of three restricted pricing strategies: static, unified dynamic, and mixed dynamic pricing. We find that full-scale dynamic pricing is of great value in the presence of inventory scarcity, and initial inventory decisions are quite robust in the pricing scheme employed in the selling season. Based on the above insights, we propose a computationally efficient approach to the initial inventory decision, which delivers close-to-optimal inventory levels for all testing cases.

Managing Disruption Risk: The Interplay Between Operations and Insurance

Disruptive events that halt production can have severe business consequences if not appropriately managed. Business interruption (BI) insurance offers firms a financial mechanism for managing their exposure to disruption risk. Firms can also avail of operational measures to manage the risk. In this paper, we explore the relationship between BI insurance and operational measures. We model a manufacturing firm that can purchase BI insurance, invest in inventory, and avail of emergency sourcing. Allowing the insurance premium to depend on the firms insurance and operational decisions, we characterize the optimal insurance deductible and coverage limit as well as the optimal inventory level. We prove that insurance and operational measures are not always substitutes, and we establish conditions under which they can be complements; that is, insurance can increase the marginal value of inventory and can increase the overall value of emergency sourcing. We also find that the value of insurance is higher for those firms less able to absorb financially significant disruptions. As disruptions become longer but rarer, the value of emergency sourcing increases, and the value of inventory and the value of insurance increase before eventually decreasing. This paper was accepted by Martin Lariviere, operations management.

Equilibrium Forward Contracts on Nonstorable Commodities in the Presence of Market Power

Bilateral supply contracts are widely used despite the presence of spot markets. In this paper, we provide a potential explanation for this prevalence of supply contracts even when spot markets are liquid and without delivery lag. Specifically, we consider the determination of an equilibrium forward contract on a nonstorable commodity between two firms that have mean-variance preferences over their risky profits and negotiate the forward contract through a Nash bargaining process. We derive the unique equilibrium forward contract in closed form and provide an extensive analysis. We show that it is the risk-hedging benefit from a forward that justifies its prevalence in spite of liquid spot markets. In addition, while a forward does not affect production decisions due to the presence of spot markets, it does affect inventory decisions of the storable input factor due to its hedging effect against the inventory risk. We also show that price volatilities and correlations are important determinants of the equilibrium contract. In particular, the equilibrium forward price can be nonmonotonic in the spot price volatility and can decrease as the initial spot price increases.

Two-Wholesale-Price Contracts: Push, Pull, and Advance-Purchase Discount Contracts

The allocation of inventory ownership affects the inventory availability in a supply chain, which in turn determines the supply chain performance. In this paper, we consider a supplier-retailer supply chain in which the supplier starts production well in advance of the selling season, and the retailer is offered two ordering opportunities at different points in time. An early order is allowed before the suppliers production decision, and a late order is allowed after the completion of production and after observing the demand. When the two wholesale prices change, we illustrate how the inventory decision rights and ownership are shifted and/or shared between the two firms, resulting in push, pull, or advance-purchase discount contracts. We then characterize the complete set of Pareto-dominant contracts for any given two-wholesale-price contract. We find that Pareto improvement can be achieved when inventory ownership is shifted from individual to shared and sometimes vice versa. In the latter case, push contracts not only are more likely to offer Pareto improvement, but also can achieve higher supply chain efficiency than pull contracts. We also identify conditions that enable Pareto improvement by introducing a new ordering opportunity to firms that had been bound by a single ordering opportunity without renegotiating the existing wholesale price, and we demonstrate through a numerical study that the adoption of the new ordering opportunity can significantly improve supply chain efficiency. We show that such Pareto improvement is more likely to happen when demand is more volatile.

Product Line Pricing in a Supply Chain

A vertically integrated channel would prefer to coordinate the pricing of its products. In this paper, we investigate drivers of product line pricing decisions in a bilateral monopoly where a manufacturer produces and sells two substitutable or complementary products to a retailer. In a two-stage game, each firm commits credibly in the first stage to a pricing scheme within its own organization: product line pricing (PLP) or nonproduct line pricing (NPLP). In the second stage, depending on the relative balance of power in the supply chain, the firms engage in either a Nash or a leader-follower pricing game. We study the equilibrium of the two-stage game under a general symmetric demand function. With strategic interaction between firms, a firm may choose NPLP as the equilibrium pricing strategy. In particular, when the second stage is a leader-follower game, the price leader chooses PLP, and the follower may choose NPLP only if the inefficiency of using NPLP empowers the follower by increasing the demand sensitivity to the leaders margin. When the second stage is a vertical Nash game, whether NPLP occurs in equilibrium depends on the nature of coupling between demand interdependence and vertical strategic dependence: NPLP can be an equilibrium onlyif products are demand substitutes (complements) and vertical strategic dependencies are complementary (substitutable). We find that prisoners dilemma exists in the first stage for both types of second-stage pricing games. In those cases, one firm may have the incentive to commit to a pricing scheme in the first stage prior to its channel partner and steer the supply chain away from prisoners dilemma.

Global Facility Network Design with Transshipment and Responsive Pricing

This paper considers the facility network design problem for a global firm that sells to two markets: the domestic market and a foreign market. Although the firm has to invest in capital-intensive production facilities and produce outputs in the face of demand and exchange rate uncertainties, it can postpone the transshipment, localization, and distribution of the output until after uncertainties are resolved. The key network design decisions faced by the firm are in which of the two markets to locate the capital-intensive production facilities and what the corresponding output levels should be. We provide the complete characterization of the optimal global facility network configuration for two types of global firms: a newsvendor with exogenously given selling prices and a firm with the flexibility of pricing responsively after uncertainties are resolved. Our studys focus is on the impact of exchange rate uncertainty and responsive pricing on facility network decisions. Compared with a newsvendor facing demand uncertainty only, the introduction of exchange rate uncertainty or the use of responsive pricing can increase the attractiveness of centralized production. A responsive-pricing firms optimal network design differs from that of a newsvendor firm as follows. (1) The firms network preference is less susceptible to the increase of localization costs. (2) The firm is less likely to switch from a network of regional production to a network of centralized production in response to the increasing size of one market. (3) Demand and exchange rate uncertainties can have opposite effects on its optimal centralized output when the nature of the random shocks they introduce to the firms demand function is different: under the linear demand function, the optimal centralized output increases in the demand volatility when demand shock is additive, but it may decrease in the exchange rate volatility because the corresponding price shock is multiplicative. Interestingly, common to both types of firms, their network preferences, although sensitive to costs and mean demand and exchange rate, are robust to the demand and exchange rate volatilities, suggesting that transshipment-enabled output substitutability between the two markets diminishes the impact of increasing market volatilities on the network design decision.

The Value of Operational Flexibility in the Presence of Input and Output Price Uncertainties with Oil Refining Applications

Refining is indispensable to almost every natural-resource-based commodity industry. It involves a series of complex processes that transform inputs with a wide range of quality characteristics into refined finished products sold to end markets. In this paper, we take the perspective of a profit-maximizing refiner that considers upgrading its existing simple refinery to include intermediate-conversion flexibility, i.e., the capability of converting heavy intermediate components to light ones. We present a stylized two-stage stochastic programming model of a petroleum refinery to investigate the value drivers of conversion flexibility and the impact of input and output market conditions on its economic potential. Conversion flexibility adds value to refineries by either transforming a nonprofitable situation into a profitable one (referred to as purchase benefit) or improving profitability of an already profitable situation (referred to as unit revenue benefit). In a real-data-calibrated numerical study, w...

The Handbook of Integrated Risk Management in Global Supply Chains: Kouvelis/Risk Management Handbook

A comprehensive, one-stop reference for cutting-edge research in integrated risk management, modern applications, and best practices In the field of business, the ever-growing dependency on global supply chains has created new challenges that traditional risk management must be equipped to handle. Handbook of Integrated Risk Management in Global Supply Chains uses a multidisciplinary approach to present an effective way to manage complex, diverse, and interconnected global supply chain risks.

Global facility network design in the presence of competition

We study the facility network design problem for a global firm that is a monopolist seller in its domestic market but faces local competition in its foreign market. The global firm produces in the face of demand and exchange rate uncertainty but can postpone localization and distribution of the output until after uncertainties are resolved. The competitor in the foreign market, however, enjoys the flexibility of postponing all production activities until after uncertainties are resolved. The two firms engage in an ex-post Cournot competition in the foreign market. We consider three potential network configurations for the global firm. Under a linear demand function, we provide the necessary and sufficient condition that one of the three networks is the global firm’s optimal choice, and explore how the presence of foreign competition affects the sensitivity of the global firm’s design to various cost parameters and market uncertainties.