An emergency supplies procurement strategy based on a bidirectional option contract

Abstract

The occurrence of a disaster and its location, type, intensity, scope and duration are highly uncertain, making it hard to accurately estimate the emergency demand. As the main purchasers and managers of emergency supplies, governments face shortage and surplus risks when pre-purchasing and reserving emergency supplies before disasters occur. To address this dilemma, we design an emergency supplies procurement strategy based on a bidirectional option contract (BOC) by considering the system as a relief supply chain. Expected profit functions of the relief supply chain members include the procurement cost, inventory cost and production cost of emergency supplies, the cost and revenue of option trading, the salvage value and the value of demand satisfaction. We derive the purchaser’s optimal procurement portfolio and demonstrate that the BOC enables the coordination of the relief supply chain. We illustrate the superiority of the BOC procurement strategy over the benchmark procurement scenario without the use of the BOC. As an extension, we also compare the BOC with two unilateral option contracts in emergency supplies procurement and summarise the advantage of the BOC. The research extends the application context of the BOC and provides a feasible strategy for governments to procure emergency supplies.