Supply contracts for critical and strategic materials of high volatility and their ramifications for supply chains

Abstract

For critical and strategic materials such as a rare earth element or crude oil, we study a supply chain consisting of an intermediary/producer facing a highly volatile market to its customers and a local supplier at a different region subject to a fixed term supply contract. By viewing the opportunity to sign this contract as a real option, we construct a supply contract model and analytically derive the optimal contract-signing threshold price from the intermediary/producer perspective. Based on this threshold, we show how the relationship among the threshold price, lead time, and contract duration results in a classification of the supply chain’s preferences for lead time length, and to concrete guidelines for using the lead time and contract duration as tradable negotiation tools for supply chain contracts.

Acknowledgments

The authors would like to thank the Editor in Chief, Area Editor, and two anonymous referees for all the constructive and developmental comments throughout the long review process. The authors also would like to note that this material is based upon work supported by the National Science Foundation under Grant Numbers’ CNS 1238335, DUE 1504912, and EEC 1460984. Any opinions, findings, and conclusions or recommendations expressed in this material are those of the author and do not necessarily reflect the views of the National Science Foundation.

Additional information

Notes on contributors

K. Jo Min

K. Jo Min received a B.S. degree in mathematics systems science from the University of California, Los Angeles, and an M.S. and Ph.D. in industrial engineering and operations research from the University of California, Berkeley. He is currently John B. Slater Fellow of Sustainable Design and Manufacturing, Director of Undergraduate Education, and Associate Professor in the Department of Industrial and Manufacturing Systems Engineering, Iowa State University. His research interest focuses on economic modeling and analysis of energy and material systems such as generation planning for renewable energy and closed-loop supply chains.

Laura Lilienkamp

Laura Lilienkamp is a student at Smith College with a major interest in sustainability. She served as an undergraduate research assistant under an NSF REU program at Iowa State University. Her interests focus on Critical and Strategic Materials, Market Volatility, and Supply Chain Contracts.

John Jackman

John Jackman is Associate Professor in the Department of Industrial and Manufacturing Systems Engineering, Iowa State University. His current research interests are: Uncertainty in systems, incomplete information, computational models, system behavior prediction.

Chung-Hsiao Wang

Chung-Hsiao Wang received a B.S. degree in industrial engineering from Tunghai University, Taiwan, R.O.C., and an M.S. and a Ph.D. in industrial and manufacturing systems engineering from Iowa State University. He has worked as a research assistant for the Electric Power Research Center, Iowa State University, and for the Electric Power Research Institute (EPRI). Currently, he is a financial engineer and model analyst at Louisville Gas and Electric Company and Kentucky Utilities Company. His research interests include electric power utilities operations and power system economics, real options, and financial engineering.