Competition in the Supply Option Market 1

Abstract

This paper develops a multi-attribute competition model for procurement of commodities, such as electricity. We describe a purchasing process between a buyer and many suppliers for option contracts in a single period supply environment. The parameters of the negotiation are two-dimensional: the option reservation price, or premium, and the option execution price, also referred to as exercise price or strike. These two parameters illustrate the trade-off between total price and flexibility of the contract, and are both important to the buyer. We model the interaction between the suppliers and the buyer as a Stackelberg game in which the suppliers are the leaders and the buyer is the follower. Specifically, suppliers compete to provide supply capacity to the buyer and the buyer optimizes its expected profit by selecting one or more suppliers. We characterize the suppliers’ Nash equilibria in pure strategies for a class of customer demand distributions. In particular, we show that this type of interaction gives rise to cluster competition. That is, in equilibrium, suppliers tend to be clustered in small groups of two or three suppliers each, such that within the same group all suppliers use similar technologies and offer the same type of contract.

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@inproceedings{MartnezdeAlbniz2003CompetitionIT, title={Competition in the Supply Option Market 1}, author={Victor Mart́ınez-de-Alb{\'e}niz and David Simchi-Levi}, year={2003} }