Integrating Long-Term and Short-Term Contracting in Beef Supply Chains

Onur Boyabatlı · Paul R. Kleindorfer · Stephen R. Koontz

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Supply Chain and Inventory Management Livestock Farming and Management Economics of Agriculture and Food Markets

Abstract

This paper analyzes the optimal procurement, processing, and production decisions of a meat-processing company (hereafter, a “packer”) in a beef supply chain. The packer processes fed cattle to produce two beef products, program (premium) boxed beef and commodity boxed beef, in fixed proportions, but with downward substitution of the premium product for the commodity product. The packer can source input (fed cattle) from a contract market, where long-term contracts are signed in advance of the required delivery time, and from a spot market on the spot day. Contract prices are taken to be of a general window form, linear in the spot price but capped by upper and lower limits on realized contract price. Our analysis provides managerial insights on the interaction of window contract terms with processing options. We show that the packer benefits from a low correlation between the spot price and product market uncertainties, and this is independent of the form of the window contract. Although the expected revenues from processing increase in spot price variability, the overall impact on profitability depends on the parameters of the window contract. Using a calibration based on the report by the GIPSA (Grain Inspection, Packers and Stockyards Administration. 2007. GIPSA livestock and meat marketing study, vol. 3: Fed cattle and beef industries. Report, U.S. Department of Agriculture, Washington, DC), this paper elucidates for the first time the value of long-term contracting as a complement to spot sourcing in the beef supply chain. Our comparative statics results provide some rules of thumb for the packer for the strategic management of the procurement portfolio. In particular, we show that higher variability (higher spot price variability, product market variability, and correlation) increases the profits of the packer, but decreases the reliance on the contract market relative to the spot market. This paper was accepted by Yossi Aviv, operations management.

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References

2003Supply Chain Coordination with Contracts 1976The Valuation of Uncertain Income Streams and the Pricing of Options 1999Flexible and Risk-Sharing Supply Contracts Under Price Uncertainty 2003Integrating Long- and Short-Term Contracting via Business-to-Business Exchanges for Capital-Intensive Industries 2004Production Planning Under Yield and Demand Uncertainty with Yield-Dependent Cost and Price 2002Newsvendor Networks: Inventory Management and Capacity Investment with Discretionary Activities 2005Competitive Options, Supply Contracting, and Electronic Markets 1999Random Yield and Random Demand in a Production System with Downward Substitution

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