Supply Management in Multiproduct Firms with Fixed Proportions Technology

This paper studies the supply management of a primary input, where this input gives rise to multiple products in fixed proportions. My objective is twofold. First, I study fixed proportions technology under demand uncertainty in comparison with the flexible and dedicated technologies. I show that fixed proportions technology has a cost-pooling value over dedicated technology, which is larger than the capacity-pooling value of flexible technology over dedicated technology. I identify the critical role that demand correlation plays with the fixed proportions technology: in contrast to the capacity-pooling value, which decreases in demand correlation, the cost-pooling value increases in demand correlation. Second, focusing on the fixed proportions technology, I study supply management in the presence of contract and spot markets. I investigate how the optimal supply management strategy should respond to changing market uncertainties, and the differences in this response based on the contract type. I find that when the exercise price of the contract is high, a higher contract market dependence is the best response to the increasing demand correlation or spot price variability. However, a lower contract market dependence is the best response to the same when the exercise price is low. Managerially, these results are important because they imply that the supply management strategy adopted as a response to a change in the business environment should differ depending on the contract type. My results have implications about the new product strategy and the procurement contract choice of the processors in the agricultural industries. This paper was accepted by Yossi Aviv, operations management.