Integration of long- and short-term contracts in a market for capacity

Motivated by the potential growth of capacity markets due to 3-D manufacturing, we examine the integration of long- and short-term contracts for a capacity marketplace. In the marketplace, manufacturers and suppliers first participate in long-term contracts in which manufacturers reserve capacity at one or more suppliers. Subsequently, manufacturers and suppliers trade in a spot market to fulfill residual demand and sell residual capacity, respectively; in the spot market, the equilibrium price is determined dynamically and endogenously by the balance of supply and demand for capacity. We build a model to derive insights on the decisions taken by the manufacturers and suppliers and on the equilibrium characteristics of the market. We show existence of equilibria in both long- and short-term contract markets and establish a relationship between the equilibrium prices for the two types of contracts. We also find that when short-term-only contracts are available, the expected backlog is lower compared to when integrated contracts are used for much of the planning horizon. Further, we find that the presence of long-term contracts increases the volatility of spot prices. Our results will make practicing managers aware that contractual arrangement can influence spot price volatility.