Buyer-supplier currency exchange rate flexibility contracts in global supply chains

Abstract

This paper analyzes a decentralized global supply chain under a newsvendor setting, where a supplier delivers a certain quantity of a single product to a buyer in accordance with the terms of a mutually agreed upon contract. This contract is signed prior to the delivery of the product and subsequent payment, thus, exposing the supply chain to the risk of currency exchange rate fluctuations. We propose two types of currency exchange rate flexibility contracts to explore the characteristics of exchange rate risk mitigation policies for the buyer and the supplier. Furthermore, we investigate the effects of the contract structures on the optimal order quantity, as well as the expected profits of both supply chain members. Our results show that the optimal order quantity of the buyer decreases when the wholesale price is uncertain due to exchange rate volatility. Also, both our proposed contracts tend to improve the expected profits of both the buyer and the supplier, when the payment is made in the supplier’s currency, indicating the desirability of adopting such contractual agreements from the perspective of both parties. On the other hand, when the payment is made in the buyer’s currency, our suggested contracts do not yield such win-win scenarios. Finally, we examine the effectiveness of availing the services of a local vendor, which is capable of satisfying any demand in excess of the quantity ordered from the foreign source with short notice, in order to mitigate the risks associated with an overseas order.