Multiperiod Production and Ordering Policies for a Retailer-Led Supply Chain through Option Contracts

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This paper formulates two groups of multiperiod production and ordering models with call and bidirectional option contracts for a two-party supply chain consisting of one followed supplier and one dominant retailer, respectively. Based on dynamic programming theory, we characterize the optimal policy structures for two partners in each period. We also provide an approximation for the corresponding policy parameters evaluation in two cases. Then, we investigate the impacts of different option contracts and the demand risk on the decisions and performances of two members. Our results suggest that, whether concerning call or bidirectional option contracts, the optimal policies for two members always follow a base stock type. When the price parameters are the same for different option contracts, the service levels of both the system and the retailer are higher with call option contracts than with bidirectional ones, whereas the retailer’s inventory risk is lower with bidirectional option contracts than with call ones. Under the same conditions stated above, call option contracts can always benefit the supplier, but not the retailer. Owing to the retailer’s dominant position, call option contracts are better choice for the supply chain if the option (exercise) price is low (high), while bidirectional option contracts are more suitable choice for the supply chain if the option (exercise) price is high (low). In addition, an increase in the demand risk would prompt the supplier to increase his production quantity and the retailer to reduce the initial firm order quantity, either with call or bidirectional option contracts.