Backup agreements in fashion buying - The value of upstream flexibility

We focus on backup agreements between a catalog company and manufacturers - a scheme to provide upstream sourcing flexibility for fashion merchandise. A backup agreement states that if the catalog company commits to a number of units for the season, the manufacturer holds back a constant fraction of the commitment and delivers the remaining units before the start of the fashion season. After observing early demand, the catalog company can order up to this backup quantity for the original purchase cost and receive quick delivery but will pay a penalty cost for any of the backup units it does not buy. In representative contracts with five companies, the fraction held as backup varies from 20% to 33% and the penalty ranges from 0 to 20% of cost. We model this inventory problem and derive the optimal solution. We provide results from a retrospective parallel test of the model against buyer decisions in 1993 based on a data set from the women's fashion department at a catalog company (Catco). The results indicate that backup arrangements can have a substantial impact on expected profits and may result in an increase in the committed quantity. Also, these arrangements may maintain the manufacturer's expected profit for a wide range of parameters.