Flexible supply contracts for short life-cycle goods: The buyer's perspective

In this paper we analyze a two-period supply contract which allows for order adjustment by the buyer. The buyer is required to place orders for two periods. After observing initial demand, the buyer is then allowed to adjust the second order, paying a per unit order adjustment penalty. We describe the optimal behavior of the buyer under such a contract, both in determining the initial order quantities and in subsequently adjusting the order. We compare the solution to a contract where no adjustment is allowed and to the case where adjustment is allowed without penalty. We demonstrate that flexible contracts can reduce the potentially negative effect of correlation of demand between two periods. Further, we investigate how the duration of the first period vis-à-vis the second period affects the profitability of the buyer as a function of the degree of correlation.