Analysis of supply contracts with commitments and flexibility

In this article we address an important class of supply contracts called the Rolling Horizon Flexibility (RHF) contracts. Under such a contract, at the beginning of the horizon a buyer has to commit requirements for components for each period into the future. Usually, a supplier provides limited flexibility to the buyer to adjust the current order and future commitments in a rolling horizon manner. We present a general model for a buyer's procurement decision under RHF contracts. We propose two heuristics and derive a lower bound. Numerically, we demonstrate the effectiveness of the heuristics for both stationary and non-stationary demands. We show that the heuristics are easy to compute, and hence, amenable to practical implementation. We also propose two measures for the order process that allow us to (a) evaluate the effectiveness of RHF contracts in restricting the variability in the orders, and (b) measure the accuracy of advance information vis-a-vis the actual orders. Numerically we demonstrate that the order process variability decreases significantly as flexibility decreases without a dramatic increase in expected costs. Our numerical studies provide several other managerial insights for the buyer; for example, we provide insights into how much flexibility is sufficient, the value of additional flexibility, the effect of flexibility on customer satisfaction (as measured by fill rate), etc. © 2008 Wiley Periodicals, Inc. Naval Research Logistics, 2008