Strategy analysis of newsvendor based trading options in supply chains

Abstract

Option is introduced into supply chain management to improve the ability of handling demand uncertainty and hence seek better performance of the participants. An option model based on classic newsvendor problem is developed to quantify and price a trading contract in a supply chain, by which buyers (or retailers) can both order products and purchase options, and decide whether to buy or sell their remaining options in the second period after demand is realized in the first period. We examine how trading options works in the market consisting of two retailers in both competing and cooperative scenarios. Using the concept of best response in game theory, the outcomes of trading with interdependent demands are analyzed. Depending on their current inventory, options in hand and demand information of the second period, the optimal trading quantity in the non-interdependent demand model could be found, where trading quantity is irrelevant to options price.