Option ordering and coordination strategies for a two-periodsupply chain

Abstract

PurposeDue to rapid product obsolescence, there is a significant decline in the market prices, which causes that the sale season is often divided into two periods. This paper aims to consider a class of two-period supply contracts that offer the retailer the ordering flexibility in response to the market changes. This paper analyzes the two-period ordering and coordination problem with option contracts.Design/methodology/approachThe authors incorporate call, put and bidirectional option contracts into the two-period ordering model. By applying stochastic dynamic programming, the authors derive the retailer’s optimal ordering policies for two periods. By benchmarking the case without option contracts, they highlight the advantage of option contracts. Through the mutual comparisons, the authors also explore the impacts of different option contracts. On this basis, the authors explore the conditions on which two-period supply contracts containing options can coordinate the supply chain.FindingsThis study shows that the retailer is always better off with option contracts. In addition, the effectiveness of different option contracts depends on the option contract parameters. When the parameters are the same for different option contracts, bidirectional option contracts are superior to call and put ones; otherwise, bidirectional option contracts might be superior or inferior to call and put ones. If designed properly, two-period supply contracts containing options can coordinate the two-period supply chain.Originality/valueThis paper is the first to highlight the value of option contracts as well as explore the role of different option contracts on the two-period procurement problem. The insights derived from our analysis can provide a good way on how to help the retailer work more efficiently in a two-period setting.