Combined Pricing and Portfolio Option Procurement

I n this paper, we study a single-product periodic-review inventory system that faces random and price-dependent demand. The firm can purchase the product either from option contracts or from the spot market. Different option contracts are offered by a set of suppliers with a two-part fee structure: a unit reservation cost and a unit exercising cost. The spot market price is random and its realization may affect the subsequent option contract prices. The firm decides the reservation quantity from each supplier and the product selling price at the beginning of each period and the number of options to exercise (inventory replenishment) at the end of the period to maximize the total expected profit over its planning horizon. We show that the optimal inventory replenishment policy is order-up-to type with a sequence of decreasing thresholds. We also investigate the optimal option-reservation policy and the optimal pricing strategy. The optimal reservation quantities and selling price are shown to be both decreasing in the starting inventory level when demand function is additive. Building upon the analytical results, we conduct a numerical study to unveil additional managerial insights. Among other things, we quantify the values of the option contracts and dynamic pricing to the firm and show that they are more significant when the market demand becomes more volatile.