Quantity commitment, production and subcontracting with bargaining

This paper considers a firm that can make products in-house but also can purchase from a unique qualified supplier. The firm contracts to buy a guaranteed minimum quantity from the supplier and the supplier and the firm then establish their respective production quantities. Once the firm realizes its demand, it may contact the supplier for further units beyond the committed quantity, and a renegotiation ensues. Of particular interest is the role that in-house production capabilities and post-demand negotiation power plays in determining how firms set prices and make production decisions. It is shown that bargaining power may actually hurt the buyer beyond a certain point as it may lead the supplier to underproduce. The situation for which suppliers would be willing to speculate and produce beyond the contracted quantities is explored. A four-stage, game-theoretic model is proposed to explore these issues and characterize the structure of optimal production levels, prices and commitment levels. Managerial insights on the effects of bargaining power, in-house capacity and production costs in such relationships are provided. [Supplementary materials are available for this article. Go to the publisher's online edition of IIE Transactions for the following free supplemental resource: Appendix.].