Innovative upstream investments and input supply contracts

We explore how a cost-minimizing buyer innovates through the use of both a mix of transaction modes — contracts and spot markets — to secure a single input, given endogenous choice of upstream investments. We broadly define innovation as the internal structuring of how a firm purchases its inputs given it has the option of making innovative upstream investments that affect both the contract vendor's costs and the buyer's reservation spot market price within a risky external environment. The model examines the use of transaction-specific upstream investments that reduces the input vendor's costs, truncates the distribution of spot market prices and allows the buyer to take advantage of the synergy between the two modes.