Trading reserved capacity independently among supply chains Yick-Hin Hung n , Leon Y.O. Li, T.C.E. Cheng Department of Logistics and Maritime Studies, The Hong Kong Polytechnic University, Hong Kong Special Administrative Region, China article info Available online 29 December 2010 Keywords: Super capacity Alternative inventory Co-opetition game abstract We propose a novel mechanism for pooling the reserved capacity (super capacity) of different supply chains, so that they can more effectively match their single-period inventory supplies with their demands. Through this mechanism, retailers can buy or sell unutilized super capacity independently as a commodity in a sub-industry before and during the selling season, which helps improve supply flexibility and increase the utilization of suppliers’ reserved capacity. Our findings provide a new channel coordination strategy for a group of supply chains to hedge against capacity and inventory risks by trading super capacity with their competitors, which yields individual and aggregate benefits. & 2010 Elsevier B.V. All rights reserved. 1. Introduction The purpose of this paper is to develop a strategy and a mechanism for alleviating the cost of mismatching between supply and demand in supply chains characterized by the provision of short life-cycle products with the stochastic demand. We propose a novel mechanism for pooling the reserved capacity of a group of supply chains to mitigate their single-period inventory and capa- city risks. In the two-stage newsvendor problem, order replenish- ment is usually provided by a supplier’s reserved capacity via a prior exclusive commitment. If any reserved capacity is not used, it is wasted. This capacity is seldom decoupled from its product and treated as a commodity, which can be traded independently in the market. We argue that the capacity is a product in itself, which has its own market value if its special characteristics are able to satisfy the customer needs (Kotler et al., 2007). Thus, it may be possible to reduce the demand variability inherent in different supply chains by pooling the reserved capacity of chains concerned. To this end, we study the issue of ‘‘co-opetition’’ among retailers, whereby the reserved capacity is traded as futures with a view to making Pareto- improvement gains. Van Mieghem (2003) defines capacity as a measure of proces- sing abilities and limitations that stem from the scarcity of various processing resources, which is represented as a vector of stocks of various processing resources. From a business perspective, a type of capacity, that needs a shorter lead-time, has a higher value than another type of capacity that requires a much longer lead-time, if both types of capacity produce similar products of the same quality. This is particularly true for short life-cycle products with the stochastic demand, provided that the lead-time is short enough to allow the replenishment of goods in the post-early season, after the early sales information has been obtained. Fashion products are typical examples of short life-cycle products with the stochastic demand. Hunter and Valentino (1995) comment that the demand for fashion products is almost, by definition, impossible to forecast. However, an early season observation of as little as 20% of sales can provide a much better forecast of the demand distribution over the whole season (Fisher and Raman, 1996). Hence early season replenishment is an important means for adjusting an inventory level to match the stochastic demand. However, the supplier faces several issues in offering short lead- time capacity to retailers. First, the supplier may need stronger management skills, in general, to overcome lead-time problems. Second, retailers may inflate their demand forecasts. Third, the supplier bears the risk that production capacity may not be fully utilized in the selling season, since the impact of demand uncertainty is shifted from retailers to the supplier. If these issues are to be addressed, an incentive scheme needs to be devised to compensate the supplier for its investment and a mechanism needs to be put in place to help the supplier to manage its risks. Motivated by the need to address these issues, we propose a new strategy based on the concepts of risk pooling and postponement to tackle the one-period inventory problem. It is a common practice that one manufacturer supplies different products to various retailers and retailers buy goods from different suppliers. Under such circumstances, production capacity becomes a commodity in itself among a group of retailers and, accordingly, a sub-industry of those using the same capacity is formed. If a supplier has a group of customers, it can reduce its overall risk by pooling the capacity for all its customers (Jin and Wu, 2007). The retailer then uses short lead-time capacity as an alternative inventory instead of the physical product. Therefore, we propose that capacity with a short lead-time in different periods can be sold independently as futures before it expires. Whenever this capacity Contents lists available at ScienceDirect journal homepage: www.elsevier.com/locate/ijpe Int. J. Production Economics 0925-5273/$ - see front matter & 2010 Elsevier B.V. All rights reserved. doi:10.1016/j.ijpe.2010.12.018 n Corresponding author. E-mail address: yh@yhhung.com (Y.-H. Hung). Int. J. Production Economics 133 (2011) 105–112