Dual sourcing using capacity reservation and spot market: Optimal procurement policy and heuristic parameter determination

This contribution focuses on the cost-effective management of the combined use of two procurement options: the short-term option is given by a spot market with random price, whereas the long-term alternative is characterized by a multi period capacity reservation contract with fixed purchase price and reservation level. A reservation cost, proportional with the reservation level, has to be paid for the option of receiving any amount per period up to the reservation level. A long-term decision has to be made regarding the reserved capacity level, and then it has to be decided – period by period – which quantities to procure from the two sources. Considering the multi-period problem with stochastic demand and spot price, the structure of the optimal combined purchasing policy is derived using stochastic dynamic programming. Exploiting these structural properties, an advanced heuristic is developed to determine the respective policy parameters. This heuristic is compared with two rolling-horizon approaches which use the one-period and two-period optimal solution. A comprehensive numerical study reveals that the approaches based on one-period and two-period solutions have considerable drawbacks, while the advanced heuristic performs very well compared to the optimal solution. Finally, by exploiting our numerical results we give some insights into the system’s behavior under problem parameter variations.

► We consider a dual sourcing problem with a spot market and capacity reservation (option) contract.
► We model the interdependence between decisions and risk both in demand and spot price.
► The optimal structure of a dual sourcing policy is derived using stochastic dynamic programming.
► An advanced heuristic is proposed to obtain near-optimal policy parameters.
► A numerical study reveals good performance of the heuristic for a wide range of parameter settings.