An analysis of a supply chain with options contracts and service requirements

This article studies a one-period two-party supply chain with a service requirement. At the beginning of a single retail season, the retailer can obtain goods by either ordering from a firm or by purchasing and exercising call options. The retailer’s optimal ordering policy and the supplier’s optimal production policy are derived in the presence of options contracts and a service requirement. In addition, it is shown that options contracts benefit both the retailer and supplier. Furthermore, it is shown that the retailer’s optimal expected profit is non-increasing in the service requirement and the supplier’s optimal expected profit is non-decreasing in the service requirement, either with or without options contracts. A special class of distribution-free contracts that can coordinate the supply chain with options contracts and the service requirement are derived. Furthermore, as opposed to the case of non-coordinating contracts, it is shown that there is always a Pareto contract. Finally, the retailer’s and supply chain’s optimal service level are derived.