Auctioning Supply Contracts

A ̄rm's operations require an input that can only be procured from outside. There are multiple potential suppliers, who privately observe their marginal production costs. The ̄rm faces a revenue function that is increasing and concave in the input quantity. The objective is to identify a procurement strategy that maximizes the ̄rm's expected pro ̄ts. It is known that an optimal strategy can be achieved by embedding a supply contract in an auction. This paper shows that an existing approach to constructing an optimal strategy is sensitive to the auction format used, and establishes an alternative approach that is not. The new approach has other attractive features as well. The paper goes on to discuss the bene ̄ts of risk pooling, the value of perfect demand information, and the impact of quantity decision rights in a newsvendor problem with supply-side competition.