International Journal of Production Research, 2021

Vol. 59, No. 1, 286–300, https://doi.org/10.1080/00207543.2020.1722861

Facing market disruptions: values of elastic logistics in service supply chains

Tsan-Ming Choi ∗

Business Division, Institute of Textiles and Clothing, The Hong Kong Polytechnic University, Hung Hom, Kowloon, Hong Kong
(Received 25 November 2019; accepted 22 January 2020)

Market disruptions are commonly seen nowadays which directly affect demand. However, in logistics service supply chains,
service capacity suppliers and service providers usually have to prepare logistics-service-capacity before demand is known.
In this paper, we explore a logistics service supply chain with which the logistics-service provider (LP) has to decide
the quantity of capacity to reserve to satisfy future demand in the upcoming season, which depends on whether market
disruption occurs or not. The optimal capacity planning policy is determined and the impacts brought by the chance of
market disruption are uncovered. Then, we consider the scenario with ‘elastic logistics’ in which capacity can be adjusted
after the market state is known. We analytically establish the corresponding optimal dynamic policy and prove that it helps
to stop the ripple effect from appearing. We explore the value of elastic logistics and propose conditions and measures to
achieve Pareto improvement in the supply chain upon the adoption of elastic logistics. We extend the analysis to the case
with the risk-averse LP and uncover that our qualitative findings remain robust, irrespective of the LP’s risk attitude.
Keywords: market disruptions; elastic logistics; ripple effect; service supply chain systems; service capacity; supply chain
management; risk aversion

1. Introduction
1.1. Background
It is well-known that markets are full of uncertainties. Nowadays, in the world full of turbulence, demand disruptions appear
from time to time. For instance, wars and political conflicts would create demand disruptions in the market. In November
2019, Chile’s political and societal unrest had created huge market disruptions.1 Extreme weather and the associated dis-
asters, which also include storms, typhoons, earthquakes and floods, would bring huge troubles to the market. In October
2019, Typhoon Hagibis created huge damages to Japan2 and required over 100,000 people to help as rescuers. The market
in Japan was severely affected which also created disruptions.
In the presence of these market turbulence and disruptions, the logistics industry faces one big challenge, which is on
the reservation of logistics-service-capacity. For example, for many large scale logistics service providers, before the start
of a major season (e.g. Christmas), they have to reserve logistics-service-capacity in advance (e.g. prepare capacity by
signing an agreement with the logistics service suppliers such as airlines) in order to satisfy future market demand. If the
market demand is stable, these logistics service providers (LPs) can easily plan and prepare the logistics-service-capacity
(Choi et al. 2019; Ren et al. 2020) by ‘ordering’ from the logistics-service suppliers (LSs). However, if market demand may
suffer a major disruption which is unpredictable and uncontrollable, logistics-service-capacity planning becomes difficult,
if not impossible to be prepared. Moreover, the market disruption not only affects the LP, but also the whole logistics
service supply chain system, which includes the upstream logistics service supplier. In other words, the ripple effect (Ivanov,
Dolgui, and Sokolov 2019), which describes how the impact of a disruption propagates along the supply chain and affects
its performance, is also present.
In the logistics industry, a relatively new terminology called ‘elastic logistics’ recently emerges. Here, elastic logistics
commonly refers to the ‘flexibility to expand or reduce (logistics) capabilities to accommodate changing demands within
the supply chain’.3 In the market with flexibility, elastic logistics becomes achievable and how it affects the logistics service
supply chain and its members under market disruption is largely unknown.
Motivated by the frequent occurrence of market disruptions nowadays and the emergence of elastic logistics, we conduct
an analytical study in this paper which aims to address the research questions as specified in Section 1.2.

*Email: jason.choi@polyu.edu.hk

© 2020 Informa UK Limited, trading as Taylor & Francis Group

 International Journal of Production Research 287

1.2. Research questions (RQs) and major findings

This paper aims to derive answers to the following research questions via a theoretical modelling approach:
Research Question 1 (Optimal policies): When demand uncertainty is induced by market disruptions, in the absence of elastic
logistics, what is the optimal logistics-service-capacity planning policy (i.e. the optimal amount of capacity to acquire) in the logistics
service supply chain? In the presence of elastic logistics, by dynamic programming, what is the optimal logistics-service-capacity
dynamic planning policy (i.e. the optimal amount of capacity to acquire dynamically at two different time points) in the logistics
service supply chain?

Research Question 2 (Critical factors and the ‘ripple effect’): What are the factors which affect the optimal logistics-service-
capacity policies with and without elastic logistics?

Research Question 3 (Value of elastic logistics): What is the value of elastic logistics? When will elastic logistics benefit the whole
logistics service supply chain and its members?

Research Question 4 (Risk-averse LP): Extending the analyses to the case with a risk-averse LP, are the findings derived in the
main model (which assumes the LP is risk neutral) still valid?

Addressing the above research questions yields several important insights and findings. For example, in the absence of
elastic logistics, the optimal logistics-service-capacity planning policy is a static policy. In the presence of elastic logistics,
the optimal policy is a dynamic one. We also show that the unit cost for acquiring logistics-service-capacity (at Time 0), and
the setup cost coefficient (for the case when the setup cost is quadratic) are important factors affecting the optimal policies.
We further find that the presence of elastic logistics grants the LP the needed flexibility to fight against market disruption
and stop the ripple effect from appearing in the logistics service supply chain. We also explore the values of elastic logistics
of both LP and LS. We uncover that when the optimal logistics-service-capacity reserved at Time 0 is not reduced and the
fee of joining the elastic logistics alliance platform is sufficiently low, implementing elastic logistics is a Pareto improving
measure to both the LP and LS. However, when these conditions are not satisfied, we propose the use of a two-part tariff
contract (Dong, Ng, and Cheng 2017; Shen, Xu, and Choi 2019) with a credit transfer to help and prove that it can always
guarantee the achievability of Pareto improvement in the supply chain upon the implementation of elastic logistics (if the
use of elastic logistics benefits the whole supply chain system). Finally, we extend our analyses to the case with a risk-
averse LP using the mean-risk approach. We analytically prove that the qualitative conclusion and insights derived in the
main model (i.e. the case with a risk-neutral LP) remain robust when the LP becomes risk averse. Based on these results,
the corresponding managerial implications are further discussed.

1.3. Paper’s structure

The rest of this study is arranged as follows. We review the related literature, mainly in operations management, in Section
2. We build the analytical benchmark model (without elastic logistics) and derive the optimal logistics-service-capacity
planning policy in Section 3. We explore and establish the optimal logistics-service-capacity dynamic planning policy in
Section 4 using dynamic programming. We investigate the value of elastic logistics in Section 5. To show robustness of
results, we extend the analysis in Section 6. We present the summary of findings, managerial implications, and future
research directions one by one in Section 7. To make the paper easier to read, we put all technical proofs in Appendix 1.

2. Literature review and contribution statement

This paper relates to logistics service supply chains, market disruptions and the ripple effect. We carefully review some
representative publications in production research and operations management on them.
For logistics services, there are several recent empirical studies. For example, Chu, Feng, and Lai (2018) empirically
explore how relationships (called ‘guanxi’) and organisation structure (i.e. OS) affect ‘logistics service innovation’ (LSI).
The authors focus their attention on the ‘third-party logistics providers in China’ and conduct a survey-based study. They
prove that ‘political and business’ relationships all have a significantly ‘positive effect’ on LSI. The authors further show
that the ‘political relationship’ is especially prominent for the case when the ‘third-party logistics providers’ possess a
centralised OS. Konig, Caldwell, and Ghadge (2019) report an empirical study on how LPs could migrate to the higher-end
‘market segment’. The authors conduct ‘semi-structured interviews’ with many logistics service companies. They provide
scientifically sound evidence on why many logistics companies have to stick to the lower end market and cannot move
to the higher-end segment. In analytical studies, Liu et al. (2018) study how the ‘distributional and peer-induced fairness
concerns’ affect the optimal ‘order allocation’ in logistics. In their model, the authors consider the presence of one ‘logistics
service (LS) integrator’ who works with two ‘LPs’ under competition. They develop an implementable ‘incentive alignment’
288 T.-M. Choi

scheme to improve the benefit of the LS integrator. Wang (2018) studies the ‘meal delivery’ operations with logistics network
considerations. The author explores a vehicle routing problem with ‘multiple suppliers’ and ‘multiple customers’. The author
examines various types of logistics configurations and argues that the ‘sharing logistics services’ scenarios would outperform
the ‘exclusive logistics service’ scenario. Wang et al. (2019) explore how an e-platform can facilitate ‘manufacturing service
collaboration’. The authors construct an optimisation model to help and verify the performance of the proposed algorithms
with the use of simulation experiments. Ren et al. (2020) study the optimal logistics capacity decision by using the deep
learning approach by integrating demand forecasting and inventory decisions together. Note that the above studies in the
literature have examined logistics service capacity decisions analytically. However, the concept of ‘elastic logistics’ has not
been explored. In addition, different from the prior studies, this paper examines the case with different market states (which
also relate to the probable occurrence of market disruption) and aims to derive optimal policies and identify the value of
elastic logistics.
For disruptions in supply chains, the prior studies focus mainly on physical product supply chain operations with demand
disruptions. For instance, Asian and Nie (2014) propose effective measures to optimise supply chains which face disrup-
tion risks. The authors highlight the role played by demand uncertainty. Xu et al. (2016) highlight how demand disruption
affects optimal manufacturing and stocking decisions. The authors build analytical models to study ‘different disruption
scenarios’. They conduct computational analyses to uncover how ‘disruption time and magnitude’ would affect the optimal
decisions on manufacturing and stocking. Yang and Fan (2016) study demand disruption with the consideration of ‘infor-
mation management strategies’. The authors build models with optimal control setup and explore the optimisation problem
using simulation experiments. They highlight the super performance achieved by the ‘collaborative planning, forecasting
and replenishment’ scheme in the supply chain. Behzadi et al. (2018) investigate demand disruption for a supply chain
with agricultural products. The authors establish a multiple-period multiple-product system. They focus on revealing how
‘allocation flexibility’ can become an effective strategy to deal with disruption risk. The authors also consider the impacts
brought by risk-aversion of the decision-makers. Kumar, Basu, and Avittathur (2018) study optimal ‘sourcing and pricing
strategies’ with disruption risk. The authors consider the presence of multiple ‘competing retailers’. They uncover how the
retailers can utilise ‘pricing’ as the tool to deal with disruption risk. This paper is similar to the above studies in which
‘market demand disruption’ is considered. However, there are many differences. First, this paper focuses on logistics ser-
vice supply chains but the reviewed studies focus on physical product supply chains. Second, this paper considers elastic
logistics as a way to deal with market disruption which has not been examined in the prior literature. This paper bridges
these important research gaps.
Finally, this paper also relates to the important concept on ‘ripple effect’ (RE) which depicts the propagation effect
brought by disruption. We concisely review a few critical papers in the area. First, Ivanov, Sokolov, and Dolgui (2014)
examine the RE in three-dimensions, namely ‘efficiency-flexibility-resilience’ in the presence of disruptions. The authors
provide a classification of the literature and propose a future research agenda. One interesting proposal is the mapping
between RE and the renowned Bullwhip Effect in supply chain management. Ivanov (2017) conducts a study on RE using
the ‘simulation’ approach. The author discovers new research areas which can be explored by using the optimisation mod-
elling with simulation analysis. To illustrate the argument, a technical ‘simulation model’ is built for a multiple-echelon
system and the respective RE is investigated. Dolgui, Ivanov, and Sokolov (2018) update the literature review on RE and
classify the existing analytical RE research into different major streams, such as ‘mathematical optimisation, simulation,
control theoretic and complexity and reliability’ studies. Most recently, Ivanov, Dolgui, and Sokolov (2019) examine the
impacts brought by ‘digital technologies’ on RE. The authors focus on uncovering how RE plays a role in the ‘Industry 4.0’
era. In this paper, we examine the impacts brought by market disruptions and the corresponding RE in the logistics service
supply chain. This is an area under-explored in the current literature.
This paper contributes to the literature on logistics operations and service supply chain management (Wang et al. 2015;
Choi 2016) in several ways. First, in the presence of probable market disruption, it derives the analytically proven optimal
policies for logistics-service-capacity planning with and without elastic logistics. Second, it uncovers the factors which
affect the optimal policies. Third, it highlights the value of elastic logistics and discusses the situation in which the whole
logistics service supply chain system and its members will all be benefited by the presence of elastic logistics.

3. Benchmark model: preliminaries

We construct the ‘benchmark’ analytical model in this section in which there is no ‘elastic logistics’. In the market, there
is a seasonal demand for a logistics service (e.g. ocean cargo). Before demand is known (at Time 1), a logistics service
provider (LP) has to determine the capacity to reserve (at Time 0) q0 to satisfy the demand by placing an order to the
upstream logistics service supplier (LS). In terms of profit and cost parameters, the LP earns a unit revenue of p and pays
the LS a unit cost of c0 .4 The LS offers the logistics service at a unit cost of m. In the logistics service supply chain, for
 International Journal of Production Research 289

the LP, setting up the logistics-service-capacity itself requires an investment which is a service capacity setup cost K(q0 ),
which is paid by the LP. In this paper, we consider the case in which K(q0 ) is a convex and increasing function in q0 , which
is a common assumption in the literature (Choi et al. 2017). A quadratic cost function would satisfy this feature. Define
G(q0 ) = dK(q0 )/dq0 and the inverse function of G(·) is denoted by G−1 (·). We assume the LP is risk neutral in the main
model analyses (Sections 3 to 5) and we extend the analysis to the case with a risk-averse LP in Section 6.2.
Common to many widely observed cases nowadays, the market is not stable. The instability relates to political, economic
as well as environmental issues. For example, protests, trade-war, extreme weathers and storms, etc. all will create a sudden
demand drop which is not controllable by members of the logistics service supply chain. In our model, we assume that
demand can exhibit a high state or a low state. If market disruption occurs, demand will appear to be ‘low’ (L); otherwise,
demand will be in the ‘high state’ (H). We represent the demands at low state (i.e. disruption) and high state as xL and xH ,
respectively. The chance that demand is in the ‘high state’ is denoted by 0 ≤ ρ ≤ 1. As a result, the chance that demand
is in the ‘low state’, i.e. market disruption occurs, is 1 − ρ.5 The assessments of ρ and β are based on data collected and
observed in the market, e.g. via big data analytics (Choi, Wallace, and Wang 2018).
(0)
With the above description, we can easily derive the profit function of the LP (πLP (q0 )) and expected profit functions
(0) (0)
(LP (q0 )and LS ) for the LP and LS as follows:
(0)
πLP (q0 ) = ρ[(p − c0 )q0 − p max(q0 − xH , 0)] + (1 − ρ)[(p − c0 )q0 − p max(q0 − xL , 0)] − K(q0 ), (1)

  q0    q0 
(0)
LP (q0 ) = ρ (p − c0 )q0 − p (q0 −xH )fH (xH )dxH + (1 − ρ) (p − c0 )q0 − p (q0 −xL )fL (xL )dxL − K(q0 )
0 0
  q0    q0 
= ρ (p − c0 )q0 − p FH (xH )dxH + (1 − ρ) (p − c0 )q0 − p FL (xL )dxL − K(q0 ), (2)
0 0

(0)
LS = (c0 − m)q0 . (3)
To enhance the presentation, we define the following function and a list of notation is shown in Table 1.

Proposition 1 (0)
LP (q0 ) is a concave function and the unique optimal logistics-service-capacity to prepare, denoted by
q∗0 , is:
q∗0 = arg[J(q0 ) = 0] where J(q0 ) = p − c0 − (ρ)pFH (q0 ) − (1 − ρ)pFL (q0 ) − G(q0 ).
q0

Proposition 1 reveals that the expected profit function of the LP under the benchmark model is concave and hence the
optimal logistics-service-capacity to prepare uniquely exists. In addition, when K(q0 ) is a quadratic function of the capacity,
i.e. K(q0 ) = kq0 2 /2, then we have: G(q0 ) = kq0 , which means J(q0 ) = p − c0 − (ρ)pFH (q0 ) − (1 − ρ)pFL (q0 ) − kq0 .

4. Elastic logistics market scenario

In the logistics industry, many LPs cooperate together to form alliances. This in fact is a common trend in the sharing
economy (Choi, Taleizadeh, and Yue 2020) For example, the company Global Alliance Logistics works with its partners all
around Asia in order to provide reliable logistics services to its clients.6 Now, we consider the case in which the LP joins
an ‘elastic logistics’ alliance platform in which the members (i.e. different LPs) operate together a ‘spot market’ in which
extra capacity is assumed to be always available at Time 1 at a higher unit cost of c1 > c0 . This cost c1 is a market-driven
parameter and we consider the situation when the LP can sell and buy a unit of capacity for sure at c1 at Time 1.7 We
consider the case that to join this elastic logistics alliance platform, the LP has to pay a fee . We represent qEL 0 as the
capacity reserved at Time 0 under the case with elastic logistics (EL). Note that there is no arbitrage opportunity for the LP
as reserving capacity and offering the logistics service incurs a cost K(qEL 0 ), which is increasing in capacity.
Under the elastic logistics alliance platform, there is flexibility for the LP to trade capacity in the ‘spot market’: Depend-
ing on the value of c1 , the LP may reserve more or less capacity at Time 0. Then, when the demand distribution is known at
Time 1 (i.e. whether there is market disruption or not is known), the LP can then buy or sell its ‘Time 0 reserved capacity’.
This is what we call the ‘elastic logistics’ market scenario in this paper.
In this case, we can develop the following dynamic program for a two-stage optimisation problem:
At Time 1:
290 T.-M. Choi

Table 1. Some notation employed in this paper.

Notation Meaning
H High-state (in market demand)
L Low-state (in market demand, i.e. with disruption)
LP Logistics-service provider
LS Logistics-service supplier
q0 Service capacity to reserve at Time 0 (decision variable)
qEL∗
0 Service capacity to reserve at Time 0 under the elastic logistics case (decision variable)
q1,i Service capacity to acquire from the spot market at Time 1 under the elastic logistics case
(decision variable) when the market state i ∈ (H, L) is known
p Unit revenue of selling logistics-service-capacity
ρ Chance of having the high-state
β Chance of having the low-state and market disruption, where β = 1 − ρ
c0 Unit cost of acquiring the logistics-service-capacity from LS at Time 0
c1 Unit cost of acquiring the logistics-service-capacity from spot market at Time 1
m Unit service cost incurred by the LS
 The fixed fee for the LP to join the elastic logistics alliance platform
K(q0 ) LP’s setup cost for acquiring logistics-service-capacity from the LS
k If K(q0 ) is quadratic, the respective setup cost coefficient
G(q0 ) = dK(q0 )/dq0 G(q0 ) = dK(q0 )/dq0
G−1 (·) The inverse function of G(·)
Fi (·) The cumulative distribution function of xi (i.e. demand at market state i ∈ (H, L))
fi (·) The probability density function of demand at market state i ∈ (H, L)
 The risk tolerance level of the LP
xL ‘Low state’ demand (under market disruption)
xH ‘High state’ demand
(0)
LP (q0 ) The LP’s expected profit function (without EL)
(0)
LS The LS’ expected profit function (without EL)
(EL,0)
LP (qEL0 ) The LP’s expected profit function (with EL)
(EL,0) EL
LS (q0 ) The LS’ expected profit function (with EL)
VEL∗LP Expected value of EL for LP
VEL∗LS Expected value of EL for LS
VEL∗ Expected value of EL for the supply chain

If the market state is i ∈ (H, L), the expected profit function8 is:

 q0 +q1,i
(1,i)
LP (q1,i ) = (p − c0 )q0 + (p − c1 )q1,i − p (q0 + q1,i −xi )fi (xi )dxi − . (4)
0

The optimal q1,i which maximises (1,i)

LP (q1,i ) is:

q∗1,i = ξi − qEL
0 , (5)

where
 
p − c1
ξi = Fi−1 . (6)
p

At Time 0:
 International Journal of Production Research 291

Table 2. Effects of parameter changes on q∗0 and qEL∗

0 .

Parameter changes q∗0 qEL∗

0

β↑ ↑ No change
k↑ ↓ ↓
c0 ↑ ↓ ↓

Table 3. The optimal dynamic elastic logistics capacity planning policy.

Time Optimal Decision
Time 0 Acquire a logistics service capacity of qEL∗
0 G−1 (c
= 1 − c0 ).
Time 1 Define: Q∗1,i = |q∗1,i | = |ξi − qEL∗
0 |, for i ∈ (L, H).
If the market state is H, then: Acquire Q∗1,H units of logistics service capacity when ξH − qEL∗ 0 > 0; do nothing when
ξH − qEL∗ = 0; sell Q ∗ units of logistics service capacity when ξ − qEL∗ < 0.
0 1,H H 0
If the market state is L (i.e. market disruption occurs), then: Acquire Q∗1,L units of logistics service capacity when
ξL − qEL∗
0 > 0; do nothing when ξL − qEL∗ 0 = 0; sell Q∗1,L units of logistics service capacity when ξL − qEL∗
0 < 0.

We move backward, putting (5) into the expected profit function at Time 0 yields the following:
  ξH 
(EL,0)
LP (qEL
0 ) = ρ (p − c0 )qEL
0 + (p − c1 )(ξH − 0 )
qEL −p (ξH −xH )fH (xH )dxH
0
  ξL 
+ (1 − ρ) (p − c0 )qEL
0 + (p − c1 )(ξL − 0 )
qEL −p (ξL −xL )fL (xL )dxL − K(qEL
0 )−
0
  ξH 
= ρ (p − c0 )qEL
0 + (p − c1 )(ξ H − qEL
0 ) − p FH (xH )dxH
0
  ξL 
+ (1 − ρ) (p − c0 )qEL
0 + (p − c1 )(ξL − q0 ) − p
EL
FL (xL )dxL − K(qEL
0 ) − , (7)
0

(EL,0)
LS (qEL
0 ) = (c0 − m)q0 .
EL
(8)
(EL,0) EL
0 which maximises LP
The optimal qEL (q0 ) uniquely exists and we summarise the results in Proposition 2.

Proposition 2 (The optimal dynamic elastic logistics capacity planning policy) (EL,0) LP (qEL
0 ) is a concave function and
the unique optimal logistics-service-capacity to prepare at Time 0, denoted by q0 , is: q0 = G−1 (c1 − c0 ). At Time 1,
EL∗ EL∗

when the market state i ∈ (H, L)is known, the optimal logistics-service-capacity to acquire from the spot market or sell out
is ξi − qEL∗
0 .

Proposition 2 shows the existence of a unique optimal logistics-service-capacity decision at Time 0 under the elas-
0 ) = k(q0 ) /2, then q0
tic logistics case. If K(·)is a quadratic cost function, i.e. K(qEL = (c1 − c0 )/k. Table 3 (in the
EL 2 EL∗

conclusion section) shows the full details of the optimal dynamic elastic logistics capacity planning policy.
Focusing on the case when the cost function K(·)is quadratic, we can construct Table 2 and summarise the results in
Proposition 3.

Proposition 3 (a) When the unit cost for acquiring logistics-service-capacity (at Time 0) or the setup cost coefficient
(for a quadratic K(·)) increases, both q∗0 and qEL∗
0 decrease. (b) When the chance of having market disruption increases, q∗0
EL∗
increases whereas q0 remains unchanged.

Regarding the impacts brought by different parameters on the optimal Time 0 logistics-service-capacity decisions,
Proposition 3 indicates that: (a) Intuitively, the cost related parameters increase (the unit cost for acquiring logistics-service-
capacity (at Time 0), and the setup cost coefficient increases), both q∗0 and qEL∗
0 decrease. (b) Counter-intuitively, when the
chance of having market disruption increases, q∗0 increases whereas qEL∗ 0 remains unchanged. The findings imply that elastic
292 T.-M. Choi

logistics is a correct measure to deal with market disruptions because its presence will make the effect of market disruption
vanish. We have Proposition 4.

Proposition 4 The presence of elastic logistics grants the LP the needed flexibility to fight against market disruption
and stop the ripple effect. It is optimal to reserve a logistics-service-capacity which is independent of the chance of market
disruption.

Proposition 4 is an interesting result which highlights the strength of elastic logistics with respect to market disruptions.
It also partially explains why nowadays, for volatile markets in which more and more disruptions appear, a lot of LPs are
proposing elastic logistics-related services to their customers.

5. Values of elastic logistics

In the above sections, we have examined the optimal policies. We examine the values of elastic logistics to the LP and LS
in the following. Before that, we define the following:
 q∗0
∗ ∗
AH,0 = (p − c0 )q0 − p FH (xH )dxH , (9)
0

 q∗0
A∗L,0 = (p − c0 )q∗0 −p FL (xL )dxL , (10)
0

 ξH
H,0 = (p − c0 )q0
AEL∗ + (p − c1 )(ξH − qEL∗
0 )−p FH (xH )dxH ,
EL∗
(11)
0

 ξL
L,0 = (p − c0 )q0
AEL∗ + (p − c1 )(ξL − qEL∗
0 )−p FL (xL )dxL ,
EL∗
(12)
0

∗EL = ρ[(AEL∗ ∗ ∗ ∗ ∗
H,0 + AH,0 ) − (AL,0 + AH,0 )] + (AL,0 − AL,0 ) − (K(q0 ) − K(q0 )).
EL∗ EL∗ EL∗
(13)
Putting the optimal logistics-service-capacity decisions into the corresponding expected profit functions, we have the
following:

(0)∗ (0) ∗
LP = LP (q0 )
  q∗0    q∗0 
∗
= ρ (p − c0 )q0 − p FH (xH )dxH + (1 − ρ) (p − c0 )q∗0 −p FL (xL )dxL − K(q∗0 )
0 0

= ρ(A∗H,0 − A∗L,0 ) + A∗L,0 − K(q∗0 ), (14)

(0)∗ (0) ∗ ∗
LS = LS (q0 ) = (c0 − m)q0 , (15)

(EL,0)∗
LP = (EL,0)
LP (qEL∗
0 )
  ξH 
= ρ (p − c0 )q0 + (p − c1 )(ξH − q0 ) − p
EL∗ EL∗
FH (xH )dxH
0
  ξL 
+ (1 − ρ) (p − c0 )qEL∗
0 + (p − c1 )(ξ L − qEL∗
0 ) − p FL (xL )dxL − K(qEL∗
0 )−
0

= ρ(AEL∗
H,0 − L,0 )
AEL∗ + AEL∗
L,0 − 0 )
K(qEL∗ − , (16)

(EL,0)∗
LS = (EL,0)
LS (qEL∗
0 ) = (c0 − m)q0 .
EL∗
(17)
Define the following, which represent the expected values of EL for the LP, LS and service supply chain, respectively:

VEL∗LP = (EL,0)∗
LP − (0)∗
LP , (18)
 International Journal of Production Research 293

VEL∗LS = (EL,0)∗
LS − (0)∗
LS , (19)

VEL∗ = VEL∗LP + VEL∗LS . (20)

Investigating (18) and (19), we can clearly see that if the logistics-service-capacity reserved at Time 0 is larger under the
case with elastic logistics, then the LS will be benefited. If the fixed fee for joining the elastic logistics alliance platform is
sufficiently low, then the LP will get a higher profit after having elastic logistics in place. As a result, we have Proposition 5.

Proposition 5 The presence of elastic logistics is a Pareto improvement measure to both the LP and LS if and only if:
∗
0 ) ≤ 0, and  ≤ EL , with at least one inequality being strict.
J(qEL∗

Proposition 5 shows the necessary and sufficient conditions under which the presence of elastic logistics would benefit
both LP and LS by achieving Pareto improvement. Here, Pareto improvement (Heydari, Choi, and Radkhah 2017) means
that for the two members (i.e. LP and LS), either they are both strictly better off (i.e. win-win) or at least one of them is
strictly better off and the other achieves the same profit level as before (i.e. before having ‘elastic logistics’).

6. Extended analyses
6.1. Achieving Pareto improvement
In Section 5, we present the necessary and sufficient conditions for Pareto improvement to appear upon the adoption of
elastic logistics. However, one situation may arise, what if the whole logistics service supply chain is benefited by the
implementation of elastic logistics but one member suffers a profit loss? In this situation, we have the win-lose situation in
the supply chain, which is not good for the sustainable long term implementation of any supply chain strategy (because the
member who loses will not faithfully serve). In this section, we examine what can be done in this case.

Proposition 6 If VEL∗ > 0 and either (i) VEL∗LP < 0 or (ii) VEL∗LS < 0 holds, a simple two-part tariff contract with a
credit transfer Tl→j (from supply chain member l to j) can always guarantee the achievability of Pareto improvement upon
the implementation of elastic logistics. (a) If VEL∗LP < 0, then a credit transfer from the LS to LP which is equal to |VEL∗LP |
will suffice, i.e. TLS→LP = |VEL∗LP |. (b) If VEL∗LS < 0, then a credit transfer from the LP to LS which is equal to |VEL∗LS | will
do, i.e. TLP→LS = |VEL∗LS |.

Proposition 6 is a simple yet very practical and meaningful result. It indicates that when the whole logistics service
supply chain is benefited by the adoption of elastic logistics, just like the LP is required to pay a fixed fee  in order to join
the elastic logistics alliance platform, another ‘fixed fee’ in the form of credit transfer can be arranged so that the supply
chain member who suffers a loss will be compensated. This directly yields Pareto improvement in the logistics service
supply chain. Of course, the two-part tariff contract is just one example. To achieve Pareto improvement, other contracts
(Chan and Chan 2010; Chiu, Choi, and Tang 2011; Shen, Choi, and Minner 2019) such as revenue sharing will also be
helpful. Refer to Appendix 2 for the case with the use of revenue sharing contract.

6.2. Risk-averse LP
In the supply chain system, since market demand disruption is closely related to supply chain risk, it is natural to consider the
risk-averse behaviour of supply chain members (Zhang et al. 2020). In this paper, as the LS operates in a ‘make-to-order’
(MTO) style, it faces no profit uncertainty and hence risk. Thus, we focus our attention on examining the risk aversion
attitude of the LP.
In this paper, we consider the mean-risk approach for formulating a risk-averse decision-making model. Note that the
mean-risk approach is widely applied in production research and operations management (see, e.g. Chiu et al. 2018).
For the case with elastic logistics, at Time 1, when the market state i ∈ (H, L) is realised, the profit risk associated with
the logistics-service-capacity planning decision is measured by the variance of profit (see Appendix for the derivation) given
as follows:
R(1,i)
LP (q1,i ) = p
i (q0 + q1,i ),
2
(21)
where

i (·) = V [p max(q0 − xi , 0)]. (22)
We define the risk tolerance level of the LP to be  > 0, where a larger  means the LP is less risk averse. We represent
the inverse function of
i (·) by
i−1 (·). At Time 1, when the market state i ∈ (H, L) is realised, the risk-averse optimisation
294 T.-M. Choi

model is given by the following:

max (1,i)
LP (q1,i )
q1,i

subject to R(1,i)
LP (q1,i ) ≤ . (23)
As we focus on the case when the LP is risk averse, we consider the situation when the constraint in (23) is active. Define:
 
−1 
ξi,MR =
i . (24)
p2
We have Proposition 7.

Proposition 7 For the case with a risk-averse LP in the presence of elastic logistics: (a) At Time 0, the optimal logistics-
−1
service-capacity to prepare, denoted by qEL∗ 0,MR , is: q0,MR = G (c1 − c0 ). At Time 1, when the market state i ∈ (H, L) is
EL∗

known, the optimal logistics-service-capacity to acquire from the spot market is ξi,MR − qEL∗ 0 . (b) Similar to the risk-neutral
case, the presence of elastic logistics grants the LP the needed flexibility to fight against market disruption and stop the
ripple effect in the logistics service supply chain.

When we compare the result of Proposition 7(a) (risk-averse case) with Proposition 2 (risk-neutral case), we can easily
see that the optimal logistics-service-capacity to reserve at Time 0 remains the same under the risk-averse and risk-neutral
LP cases in the presence of the elastic logistics. The key reason explaining this point is that the Time 0 logistics-service-
capacity to reserve depends on the setup cost K(·). As it is deterministic and depends only on Time 0 capacity, it is not
affected by the LP’s risk attitude. For the optimal logistics-service-capacity to acquire at Time 1, it is different between the
risk-averse and risk-neutral cases. For the ripple effect, we can see from Proposition 7(b) and Proposition 4 that the presence
of elastic logistics effectively helps fight against market disruption and stop the ripple effect to appear in the logistics service
supply chain for both the risk-averse and risk-neutral cases.
For the case without elastic logistics, we can build a simpler mean-risk optimisation problem as the case with elastic
logistics a Time 0. Then, we can conduct similar analyses and find the optimal logistics-service-capacity decision. Define:

L(q0 ) = p2 [ρ
H (q0 ) + (1 − ρ)
L (q0 )]. (25)

We have Proposition 8.

Proposition 8 For the case with a risk-averse LP in the absence of elastic logistics: The optimal logistics-service-
capacity to prepare at Time 0, denoted by q∗0,MR , is: qEL∗ −1
0,MR = L (/p ).
2

Proposition 8 shows that a unique optimal logistics-service-capacity exists for the risk-averse LP. The specific value
depends on the chance of market disruption. Comparing with the risk-neutral case, the optimal decision rule is similar,
except the exact solution is different.

7. Conclusion
7.1. Summary of findings and insights
Motivated by the frequent occurrence of market demand disruptions nowadays and the emergence of elastic logistics, we
have conducted a theoretical study in this paper. To be specific, we have explored a logistics service supply chain with
two members, namely the downstream logistics service provider (LP) and the upstream logistics service supplier (LS).
In our model, the logistics service provider has to decide the quantity of capacity to reserve (by placing ‘order’ to the
LS) in order to satisfy future demand in the upcoming season. However, demand is not only seasonal, but also depends on
whether market disruption occurs or not. In the first model without considering elastic logistics, we have derived the optimal
capacity planning policy and uncovered the impacts brought by the chance of market disruption. Then, we have considered
the scenario with ‘elastic logistics’ in which capacity can be adjusted after the market state is known. We have analytically
established the optimal dynamic policy for the case with elastic logistics and shown that it helps to stop the ripple effect from
appearing. We have further explored the value of elastic logistics and proposed conditions and implementable measures to
achieve Pareto improvement in the supply chain upon the adoption of elastic logistics. Finally, we have extended the analysis
to the case with the risk-averse LP and uncovered that our qualitative conclusion from the main model with a risk-neutral
LP remains robust.
 International Journal of Production Research 295

7.2. Practical implications

In Section 1.2, we have proposed various research questions. We now discuss the managerial insights and practical
implications, with respect to them one by one.
Optimal policies: We have analytically derived the optimal logistics-service-capacity planning policies. In the absence
of elastic logistics, the optimal logistics-service-capacity planning policy is a static one (Proposition 1). In the presence of
elastic logistics, the optimal policy is dynamic (Proposition 2) and the optimal logistics-service-capacity planning at Time
1 depends on which market state turns out to be true (and hence whether market disruption occurs). Table 3 shows the
mechanism of the optimal dynamic elastic logistics capacity planning policy. Both optimal policies can be implemented
easily in practice and LPs can make reference to them in making their optimal capacity planning decisions in the real
world.
Critical factors and the ‘ripple effect’: From Proposition 3, we have analytically shown that when the unit cost for
acquiring logistics-service-capacity (at Time 0), or the setup cost coefficient (for the case when the setup cost is quadratic)
increases, both the Time 0 optimal logistics-service-capacity (i.e. q∗0 and qEL∗
0 ) decrease. This result is intuitive as it implies
that the profitability of offering logistics service drops and hence it is logical to reduce the amount of commitment (in
the form of reserved logistics-service-capacity). Interestingly, when the chance of having market disruption increases, the
optimal logistics-service-capacity for the case without elastic logistics (i.e. q∗0 ) increases whereas the optimal logistics-
service-capacity at Time 0 for the case with elastic logistics (i.e. qEL∗ 0 ) remains unchanged. The findings directly imply
that the presence of elastic logistics grants the LP the needed flexibility to fight against market disruption and stop the
ripple effect. It is optimal to reserve a logistics-service-capacity which is independent of the chance of market disruption
(Proposition 4). The above findings imply that, facing market disruption, LPs who wish to dampen the ripple effect should
consider implementing elastic logistics in their logistics service supply chain.
Value of elastic logistics: We have analytically derived the expressions for values of elastic logistics of both LP and
LS. We highlight the fact that when the optimal logistics-service-capacity reserved at Time 0 is not reduced and the fee of
joining the elastic logistics alliance platform is sufficiently low, implementing elastic logistics is a Pareto improving measure
to both the LP and LS (Proposition 5). However, this need not always be the case. There are cases in which one supply chain
member (i.e. either LP or LS) suffers a loss even though the whole supply chain system is benefited by the adoption of
elastic logistics. In this situation, we have proposed the use of a two-part tariff contract with a credit transfer to help and
proven that it can always guarantee the achievability of Pareto improvement in the supply chain upon the implementation of
elastic logistics (Proposition 6). All these results show the situations and propose implementable measures to achieve Pareto
improvement in the logistics service supply chain. LPs can hence make reference to these findings in deciding whether to
join the elastic logistics alliance platform or not.
Risk-averse LPs: Finally, we have extended our analyses to the case with a risk-averse LP using the mean-risk approach.
When we take a look at the analytical results of Proposition 7(a) (risk-averse case) with Proposition 2 (risk-neutral case), it
is crystal clear to note that the optimal logistics-service-capacity to reserve at Time 0 remains the same under the risk-averse
and risk-neutral LP cases in the presence of the elastic logistics. For the optimal logistics-service-capacity to acquire at
Time 1, it is different between the risk-averse and risk-neutral cases. For the ripple effect, which refers to the propagation of
impacts brought by market disruption along the supply chain, the findings from Proposition 7(b) and Proposition 4 directly
imply that the presence of elastic logistics effectively helps cope with market disruption and stop the ripple effect to appear
in the logistics service supply chain for both the risk-averse and risk-neutral cases. Overall speaking, the findings show that
our qualitative conclusion and insights derived in the main model (i.e. the case with a risk-neutral LP) remain valid when
the LP becomes risk-averse. For LPs, no matter they exhibit the risk-averse or risk-neutral attitude, our proposed findings
and managerial implications in this paper remain robust.

7.3. Future research

In this paper, we examine the situation when there is just one LP and one LS in a serial logistics service supply chain.
Future research can be conducted to examine a more complex supply chain system. For example, we can study the case
with two LPs and a common LS. Then, the competition effect between the two LPs can be explored. Future research can
also be done towards environmentally sustainable operations (Li et al. 2019; Guo, Choi, and Shen 2020) and measures
such as quick response (Chan, Shen, and Cai 2018) can be examined. In this paper, we assume the existence of an elastic
logistics alliance platform. This type of platform operations is especially prominent in the sharing economy (Yuan and Shen
2019) and deserves deeper and further investigation. Last but not least, it will also be promising to study market disruption
problems using the multi-methodological approach (Choi, Cheng, and Zhao 2016; Li et al. 2019). For example, combining
empirical data and analytical modelling can provide many solid and scientifically sound insights.
296 T.-M. Choi

Acknowledgements
The author sincerely expresses his hearty thanks to the editors and reviewers for their helpful comments. He also thanks Professor Dmitry
Ivanov for his kind invitation to develop this paper and contribute to the special issue.

Disclosure statement
No potential conflict of interest was reported by the author(s).

Notes
1. https://www.bbc.com/news/world-latin-america-50315106 (accessed 20 November 2019).
2. https://www.bbc.com/news/world-asia-50037907# (accessed 20 November 2019).
3. https://logisticsofthings.dhl/story/elastic-logistics/ (accessed 20 November 2019).
4. In this paper, we take this ‘wholesale price’ c0 as a given parameter which is decided by the bargaining (Shi, Chan, and Dong 2018)
between the LP and LS. To be specific, following Taylor and Plambeck (2007), if the LP and LS bargain non-cooperatively, the
‘subgame perfect equilibrium’ wholesale price c0 = λp, where 0 < λ < 1 reflects the relative bargaining power between the LP and
LS.
5. Note that in this paper, we simply consider the case when there is a discrete chance for market disruption to occur, and the cor-
responding market state will become low. Otherwise, it is normal (and the market state is high). This model well-captures market
disruptions for our problem.
6. http://www.igalogistics.com.hk/home.html (accessed 21 November 2019).
7. Note that we consider the selling price and buying price of the per unit logistics-service-capacity in the spot market under the elastic
logistics alliance platform are equal because: (i) Since our purpose of this study is to highlight how elastic logistics can help dampen
the ripple effect and deal with market disruptions, including different selling and buying prices will create another revenue source
from this elastic logistics alliance platform which dilutes the focus of this study. (ii) This arrangement is ‘fair’ in the sense that the
elastic logistics alliance platform has to pay a fee to join and can enjoy the benefit of acquiring or trading extra logistics-service-
capacity at Time 1. (iii) For analytical tractability, including more variety of cases will complicate the analysis and yield findings
which are not analytically tractable.
8. In the logistics service supply chain, for the LP, setting up the logistics-service-capacity itself requires an investment which is
a service capacity setup cost K(·). In this case, the per unit logistics-service-capacity cost is lower. However, if the LP gets the
logistics-service-capacity from the ‘spot market’ in the elastic logistics alliance, the setup cost is paid by other members of the
alliance while the per unit logistics-service-capacity cost is higher. This is the tradeoff between getting the logistics-service-capacity
from the two sources considered in this paper.

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Appendix 1. All Proofs

Proof of Proposition 1.: By definition, we have:

  q0    q0 
(0)
LP (q0 ) = ρ (p − c0 )q0 − p (q0 −xH )fH (xH )dxH + (1 − ρ) (p − c0 )q0 − p (q0 −xL )fL (xL )dxL − K(q0 ).
0 0

q q (0)
Note that 0 0 (q0 −xi )fi (xi )dxi = p 0 0 Fi (xi )dxi (using the ‘integration by parts’ rule). Thus, we have (2): LP (q0 ) =
 q0
 q0

ρ (p − c0 )q0 − p 0 FH (xH )dxH + (1 − ρ) (p − c0 )q0 − p 0 FL (xL )dxL − K(q0 ).

298 T.-M. Choi
(0)
Checking the first-order derivative of LSP (q0 ) yields:
(0)
dLP (q0 ) dK(q0 )
= ρ[(p − c0 ) − pFH (q0 )] + (1 − ρ)[(p − c0 ) − pFL (q0 )] −
dq0 dq0
= (p − c0 ) − p[ρFH (q0 ) − (1 − ρ)FL (q0 )] − G(q0 ).
(0)
Differentiating dLP (q0 )/dq0 with respect to q0 gives the second order derivative below:
(0)
d 2 LP (q0 ) dG(q0 )
= −p[ρfH (q0 ) + (1 − ρ)fL (q0 )] − < 0. (A1)
dq0 2 dq0
In (A1), note that by definition, G(q0 ) = dK(q0 )/dq0 . Since K(q0 ) is a convex increasing function, we have: G(q0 ) = (dK(q0 )/dq0 ) > 0
and (dG(q0 )/dq0 ) > 0.
(0) (0)
Putting this result into (A1), we have: (d 2 LP (q0 )/dq0 2 ) < 0, which implies LP (q0 ) is a concave function.
To find the optimal logistics-service-capacity to prepare (i.e. q∗0 ), we can use the first-order-condition, i.e.
 (0)

∗ dLP (q0 )
q0 = arg = 0 = arg[J(q0 ) = 0].
q0 dq0 q0

Proof of Proposition 2.: At Time 1:

(1,i)  q +q
From (4), we have: LP (q1,i ) = (p − c0 )q0 + (p − c1 )q1,i − p 0 0 1,i (q0 + q1,i −xi )fi (xi )dxi − . Following the same approach as
(1,i)
in the proof of Proposition 1, we can rewrite LP (q1,i ) to be the following:
 q0 +q1,i
(1,i)
LP (q1,i ) = (p − c0 )q0 + (p − c1 )q1,i − p Fi (xi )dxi − .
0
(1,i)
Checking the derivatives of LP (q1,i ) yields:
(1,i)
dLP (q1,i )
= (p − c1 ) − Fi (q0 + q1,i ),
dq1,i
(1,i)
d 2 LP (q1,i )
= −fi (q0 + q1,i ) < 0. (A2)
dq1,i 2
(EL,0)
From (A2), we can see that LP (qEL 0 ) is a concave function and the unique optimal logistics-service-capacity to prepare at Time 1,
denoted by qEL∗
1,i , exists. To find qEL∗ , we solve the first-order-condition:
1,i
 (1,i)

EL∗ dLP (q1,i )
q1,i = arg = 0 = ξi − qEL∗
0 . (A3)
q1,i dq1,i

Time 0:
With (A3), moving backward to Time 0, we have (7):
  ξH 
(EL,0)
LP (qEL 0 ) = ρ (p − c )q
0 0
EL
+ (p − c1 )(ξH − qEL
0 ) − p FH (xH )dxH
0
  ξL 
+ (1 − ρ) (p − c0 )qEL EL
0 + (p − c1 )(ξL − q0 ) − p FL (xL )dxL − K(qEL
0 ) − . (A4)
0

It is straightforward to prove that the following results hold:

(EL,0)
dLP (qEL
0 )
= ρ[(p − c0 ) − (p − c1 )] + (1 − ρ)[(p − c0 ) − (p − c1 )]
dqEL
0

− G(qEL EL
0 ) = (c1 − c0 ) − G(q0 ), (A5)
(EL,0)
 
d 2 LP (qEL 0 ) 0 )
dG(qEL
=− < 0. (A6)
dqEL
0
2 dqEL
0
(EL,0) EL∗ = G−1 (c − c ).
From (A6), we can see that LP (qEL 0 ) is concave. From (A5), we can solve the first-order condition and find that: q0 1 0
Finally, for the complete optimal policy: At Time 1, when the market state i ∈ (H, L)is known, the optimal logistics-service-capacity to
acquire from the spot market is ξi − qEL∗ EL∗ = G−1 (c − c ). 
0 . At Time 0, q0 1 0
 International Journal of Production Research 299

Proof of Proposition 3.: The results are derived from Table 2, which shows that (i) q∗0 increases when β increases, and q∗0 decreases
when k increases or c0 increases; (ii) qEL∗
0 decreases when k increases or c0 increases, but it is independent of β. These results imply that
(a) When the unit cost for acquiring logistics-service-capacity (at Time 0) or the setup cost coefficient (for a quadratic K(·)) increases,
both q∗0 and qEL∗
0 decrease. (b) When the chance of having market disruption increases, q∗0 increases whereas qEL∗
0 remains unchanged. 

Proof of Proposition 4.: From Proposition 3, one important finding is that when the chance of having market disruption increases, qEL∗ 0
remains unchanged. This directly implies that the presence of elastic logistics grants the LP the needed flexibility to fight against market
disruption and stop the ripple effect. It is optimal to reserve a logistics-service-capacity which is independent of the chance of market
disruption. 

Proof of Proposition 5.:  For theLS:It is easy to check that J(q0 ) is a decreasing function. By definition, we have:
> < ∗
J(q∗0 ) = 0 and J(q̂) 0 if q̂ q . Thus, we have the following:
< > 0
∗
J(qEL∗
0 ) ≤ 0 ⇔ VELLS ≥ 0.
For the LP: From (18), we have:
(EL,0)∗ (0)∗
VEL∗LP = LP − LP
∗ ∗ ∗ ∗
= [ρ(AEL∗ EL∗ EL∗ EL∗
H,0 − AL,0 ) + AL,0 − K(q0 ) − ] − [ρ(AH,0 − AL,0 ) + AL,0 − K(q0 )]

= − + ∗EL .
It is also crystal clear to note that:
 ≤ ∗EL ⇔ VEL∗LP ≥ 0.
0 ) ≤ 0,
Thus, by definition, the presence of elastic logistics is a Pareto improvement measure to both the LP and LS if and only if: J(qEL∗
and  ≤ ∗EL , with at least one inequality being strict. 

Proof of Proposition 6.: If VEL∗ > 0 and either (i) VEL∗LP < 0 or (ii) VEL∗LS < 0 holds, then we have two cases.
Case 1.: ( VELLP < 0 and VEL∗LS > 0): In Case 1, the LP suffers a loss of |VEL∗LP |. As a result, if the LS is willing to grant the LP a
∗
credit transfer of |VEL∗LP |, i.e. TLS→LP = |VEL∗LP |, then we have: VEL∗LP = 0. Since VEL∗ > 0 and VEL∗ = VEL∗LS + VEL∗LP , we have
VEL∗LS > 0.
Case 2.: ( VEL∗LP > 0 and VEL∗LS < 0): In Case 2, the LS suffers a loss of |VEL∗LS |. As a consequence, if the LP is willing to grant
the LS a credit transfer of |VEL∗LS |, i.e. TLP→LS = |VEL∗LS |, then we have: VEL∗LS = 0. Since VEL∗ > 0 and VEL∗ = VEL∗LS + VEL∗LP ,
we have VEL∗LP > 0.
Combining the results from these two cases, the proof is completed. 

Proof of Proposition 7.: For the case with elastic logistics, the profit function is at Time 1 at the market state i ∈ (H, L) is give as
follows:
(1,i)
πLP (q1,i ) = (p − c0 )q0 + (p − c1 )q1,i − p max(q0 + q1,i − xi , 0).
.
Taking variance yields,
(1,i)
RLP (q1,i ) = p2
i (q0 + q1,i ), where
i (·) = V [p max(q0 − xi , 0)].
Note that it is a standard result that
i (·) is a monotonic increasing function (see, e.g. Choi, Li, and Yan 2008). In the optimisation
problem, we have:
(1,i)
(Problem MR - EL) max LP (q1,i )
q1,i
(1,i)
subject to RLP (q1,i ) ≤ .
(1,i) (1,i) (1,i)
Since the constraint RLP (q1,i ) ≤  is binding, LP (q1,i ) is concave and RLP (q1,i ) is monotone, the optimal solution for Problem
MR-EL is:  
(1,i) −1 
qEL,MR∗
1,i = arg [R LP (q 1,i ) = ] = ξ i,MR =
i , for i ∈ (H, L). (A7)
q1,i p2
With (A7), moving backward to Time 0, we have the following:
  ξH,MR 
(EL,MR,0) EL,MR
LP (q0 ) = ρ (p − c0 )qEL,MR 0 + (p − c 1 )(ξH,MR − q EL,MR
0 ) − p F (x
H H )dxH
0
  ξL,MR 
+ (1 − ρ) (p − c0 )qEL,MR
0 + (p − c1 )(ξL,MR − qEL,MR
0 )−p FL (xL )dxL
0

− K(qEL,MR
0 ) − . (A8)
It is straightforward to prove that the following results hold:
(EL,MR,0)
dLP (qEL,MR )
0
= ρ[(p − c0 ) − (p − c1 )] + (1 − ρ)[(p − c0 ) − (p − c1 )] − G(qEL,MR
0 )
dqEL,MR
0

= (c1 − c0 ) − G(qEL,MR
0 ), (A9)
300 T.-M. Choi
(EL,MR,0)
d 2 LP (qEL,MR
0 )
< 0. (A10)
dqEL,MR2
0
(EL,MR,0) EL,MR
From (A10), we can see that LP (q0 ) is concave. Solving the first-order condition yields qEL,MR∗
0 = G−1 (c1 − c0 ).
Similar to the arguments we have made in the proof of Proposition 4, we find that the presence of elastic logistics effectively helps
fight against market disruption and stop the ripple effect to appear in the logistics service supply chain for the risk-averse LP case. 

Proof of Proposition 8.: For the case without elastic logistics, we can build a simpler mean-risk optimisation problem as the case with
elastic logistics a Time 0.
(0)
(Problem MR) max LP (q0 )
q0 (A11)
(0)
subject to RLP (q0 ) ≤ ,
(0)
where RLP (q0 ) = p2 [ρ
H (q0 ) + (1 − ρ)
L (q0 )] = L(q0 ). 

(0)
Similar to the proof of Proposition 7, note that we assume the constraint (A11) is binding, and LP (q0 ) is a concave function and
(0)
RLP (q0 ) is monotonic increasing. As a result, solving Problem MR is equivalent to finding the optimal logistics-service-capacity to reserve
(0) −1
(at Time 0) which solves the RLP (q0 ) = , which yields qEL∗0,MR = L (/p ).
2

Appendix 2. Revenue sharing contract

We now consider how the use of revenue sharing contract can achieve Pareto improvement, instead of using the two-part tariff contract.
In this analysis, for the case without EL, we just use the original results derived. Under the case when Pareto improvement fails to appear
when EL is implemented, we explore if a revenue sharing (RS) contract can help. To be specific, for the case with EL, under the RS
contract, the LP gets 0 ≤ α ≤ 1 proportion of the revenue p for each unit of logistics capacity demanded, and shares 0 ≤ 1 − α ≤ 1
proportion of the revenue p to the LS. We can hence revise the model as follows (we use ˆ to represent the decisions and important
functions for the case with RS contract under EL):
At Time 1:
If the market state is i ∈ (H, L), the expected profit function is:
 q0 +q1,i
ˆ (1,i) (q̂1,i ) = (p̂ − c0 )q0 + (p̂ − c1 )q̂1,i − p̂
 (q0 + q1,i −xi )fi (xi )dxi − , where p̂ = αp.
LP
0
ˆ (1,i) ∗ −1
The optimal q1,i which maximises  LP (q1,i ) is: q̂1,i = ξ̂i − q̂0 , where ξ̂i = Fi ((p̂ − c1 )/p̂).
EL

At Time 0:
We move backward, putting (5) into the expected profit function at Time 0 yields the following:
 ξ̂H 
ˆ (EL,0) (q̂EL
 0 ) = ρ (p̂ − c )q̂
0 0
EL
+ (p̂ − c1 )( ξ̂H − q̂EL
0 ) − p̂ ( ξ̂H −x )f (x
H H H )dxH
LP
0
 
ξ̂L
+ (1 − ρ) (p̂ − c0 )q̂EL
0 + (p̂ − c1 )(ξ̂L − q̂EL
0 ) − p̂ (ξ̂L −xL )fL (xL )dxL
0

− K(q̂EL
0 ) − .
   
 ξ̂H  ξ̂
ˆ (EL,0) (q̂EL ) = (c0 − m)q̂EL + ρ p̄ξ̂H − p̄
 (ξ̂H −xH )fH (xH )dxH + (1 − ρ) p̄ξ̂L − p̄ 0 L (ξ̂L −xL )fL (xL )dxL , where p̄ = (1 − α)p.
LS 0 0 0

The optimal q̂EL

which maximises ˆ (EL,0) (q̂EL )
 uniquely exists which is equal to q̂EL∗ = G−1 (c1 − c0 ). At Time 1, when the market
0 LP 0 0
state i ∈ (H, L)is known, the optimal logistics-service-capacity to acquire from the spot market is ξ̂i − q̂EL∗
0 . We define the following:
 ξ̂H
ÂEL∗ EL∗
H,0 = (p̂ − c0 )q̂0 + (p̂ − c1 )(ξ̂H − q̂EL∗
0 ) − p̂ FH (xH )dxH ,
0
 ξ̂L
ÂEL∗ EL∗
L,0 = (p̂ − c0 )q̂0 + (p̂ − c1 )(ξ̂L − q̂EL∗
0 ) − p̂ FL (xL )dxL .
0
Putting the optimal logistics-service-capacity decisions into the corresponding expected profit function under EL, we have the following:
ˆ (EL,0)∗ = 
 ˆ (EL,0) (q̂EL∗ EL∗ EL∗ EL∗ EL∗
0 ) = ρ(ÂH,0 − ÂL,0 ) + ÂL,0 − K(q̂0 ) − ,
LP LP
ˆ (EL,0)∗ = 
 ˆ (EL,0) (q̂EL∗
0 ).
LS LS
Define the following: V̂ EL∗LP = ˆ (EL,0)∗

(0)∗
− LP , ∗
V̂ EL =  ˆ (EL,0)∗
− .
(0)∗
LP LS LS LS

Proposition 9 The revenue sharing contract can achieve Pareto improvement for the implementation of elastic logistics if and only if
V̂ EL∗LP ≥ 0 and V̂ EL∗LS ≥ 0, with at least one inequality being strict.
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