Demand disruption risks as opportunity costs in JIT supply chain coordination

Abstract

Recently, an opportunity cost reflecting the buyer's loss of future flexibility from a finite contract commitment has been incorporated into the solution to the buyer-supplier jointly optimal production and delivery policies in a lot-splitting, Just-In-Time (JIT) supply chain. This cost plays a logical role in the model and is required to prevent an infinite contract quantity as the solution to the optimal joint policy. Current models in this area of Supply Chain Coordination (SCC) assume that this opportunity cost is given, with little or no guidance on setting an appropriate value. Demand disruption risks are cited as a major justification for the inclusion of this commitment cost in the model. This paper provides practitioners an easy-tounderstand interpretation and application of this recent conceptual addition to the joint buyer-supplier JIT model. Our work provides guidance for determining an appropriate minimum commitment cost for a common situation, where the probability of obsolescence of the contracted part is known, or can be estimated (e.g. from history or from industry norms) prior to the joint optimization of the relevant policy variables. A numerical example explores the impact of this commitment cost on the optimal decisions of both parties. © Springer-Verlag Berlin Heidelberg 2014.