Journal Article

A portfolio approach to managing procurement risk using multi-stage stochastic programming

Chu, L K, Wu, F, Shi, Y, Sculli, D, Xu, Y H

2011

Overview

Procurement is a critical supply chain management function that is susceptible to risk, due mainly to uncertain customer demand and purchase price volatility. A procurement approach in the form of a portfolio that incorporates the common procurement means is proposed. Such means include long-term contracts, spot procurements and option-based supply contracts. The objective is to explore possible synergies among the various procurement means, and so be able to produce optimal or near optimal results in profit while mitigating risk. The implementation of the portfolio approach is based on a multi-stage stochastic programming model in which replenishment decisions are made at various stages along a time horizon, with replenishment quantities being determined by simultaneously considering the stochastic demand and the price volatility of the spot market. The model attempts to minimise the risk exposure of procurement decisions measured as conditional value-at-risk. Numerical experiments to test the effectiveness of the proposed model are performed using demand data from a large air conditioner manufacturer in China and price volatility data from the Shanghai steel market. The results indicate that the proposed model can fairly reliably outperform other approaches, especially when either the demand and/or prices exhibit significant variability.

• Publisher: Taylor & Francis,Palgrave Macmillan,Palgrave Macmillan UK,Taylor & Francis Ltd
• Subject: Applied sciences / Business and Management / Cost efficiency / Exact sciences and technology / Expected utility / Flexibility / General Paper / General Papers / Hedging / Inventory / Investment risk / Logistics / Management / Manufacturers / Mathematical programming / Operational research and scientific management / Operational research. Management science / Operations research / Operations Research/Decision Theory / Options contracts / Order quantity / portfolio procurement approach / Portfolio theory / Price fluctuations / Procurement / procurement risk / Profits / Purchasing / Revenue sharing / Risk management / risk mitigation / Risk theory. Actuarial science / stochastic programming / Studies / Suppliers / Supply / Supply chain management / Supply chains / Transaction costs / Unit costs