Strategic Spot Trading Benefits Supply Chains

Aug. 31, 2007
Supply chain participants can create greater efficiencies.

By strategically using both fixed-price contracts and open market trading, supply chain participants can create greater efficiencies according to a recent study by Haim Mendelson and Tunay Tunca, of Stanford's Graduate School of Business. The study shows that by strategically using both fixed-price contracts and open market trading, supply chain participants can create greater efficiencies.

Information technology has reduced the costs of putting together spot markets, which resemble a stock exchange where suppliers and even manufacturers with surpluses trade goods all over the world in a freewheeling, frequently electronic, environment.

"The use of electronic markets for business-to-business trading allows market participants to learn what's going on in the marketplace in terms of supply and demand, even if they don't have that information firsthand," says Mendelson, the Kleiner Perkins Caufield and Byers Professor of Electronic Business and Commerce, and Management at the Graduate School of Business.

Business-to-business spot markets can provide up-to-date information about the availability of raw materials, the cost of production, and consumer demand for the end product. Because all of this happens much closer to the time that the end product ships to the consumer, supply chain participants can update their plans to take into account real-time information. But Mendelson warned that business must "carefully assess the liquidity of the market before you jump on the spot-trading bandwagon."

In industries with liquid markets, the researchers advise, manufacturers and suppliers should leave more of the purchasing for the open market. In industries with illiquid markets, they should do more of their purchases through fixed-price contracts early on. But in all cases, both are needed: No matter how efficient electronic spot markets can be, there will likely be a role for long-term contracting. A good spot market, their study reveals, creates efficiencies not only in the spot market itself, but also reaching back to the long-term contract stage.

"Suppliers will anticipate that a well-functioning spot market is coming up -- where information about supply and demand is current -- and so will price more competitively early on," Mendelson says. This makes the supply chain more efficient and increases the total profit of the businesses that constitute the supply chain. At the same time, consumers also benefit, because a more efficient supply chain translates into lower retail prices.

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