Coordination by Option Contracts in a Retailer-Led Supply Chain with

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WANG Xiaolong (王小龙) et al:Coordination by Option Contracts in a Retailer-Led … Table 1 illustrates the profit allocation issues in detail. For these calculations, the new contract is feasible only when 34.8o2 43.8. For low o 2 in this range, each party becomes strictly better off. In particular, consider the best profit allocation situations for which each side gets a double-digit share of the extra profit. When o 2 is around 40, the supplier will get more than 60% of the extra system profit which is double what he earned before coordination. Such a rosy profit improvement surely offers a strong incentive for the supplier to accept the new contract. Most interestingly, such profit allocations correspond to o2 39.6 which N N implies e+ o1 w1 and d = d1= 0. Thus, order postponement (until the demand uncertainty is resolved) can be beneficial to each party. This is contrast to the traditional thought that suppliers always welcome as-early-as-possible orders. Our opinion is that suppliers hate late orders mostly because they make the work of arranging production schedules more difficult. However, a properly designed incentive mechanism, which both clarifies the quantity that the supplier should produce and brings extra profit, eliminates these negative concerns. Such a result, however, needs further proof from theory and practice. Table 1 Profit allocations between the two parties Extra profit allocation on supplier Second-period option price (% of improvement scope) 0 100 34.8 1 … … 39.6 67 39.9 63 40.2 58 40.5 53 40.8 48 41.1 44 41.4 39 41.7 35 42.0 30 42.3 26 … … 43.8 3 Note: For simplicity, we state here only the allocation status for the supplier. Its counterpart for the retailer can be calculated since the sum is equal to 1. 4 Conclusions 579 This analysis considers the coordination of option contracts in a retailer-led supply chain where the retailer designs the contract and the supplier’s production needs to be coordinated with the contract. Consider the case where the supplier operates two modes of production and the retailer has the ability to update the demand forecast as the selling season approaches. Within this contract class, a set of pricing conditions are defined that align the supplier and retailer to act in the best interests of the channel. The analysis leads to some interesting results. First, option prices should be negatively correlated to the price and should be in a relevant range. This gives a trade-off between the higher unit compensation the supplier requires and the lower repurchasing price he will get. To assure that the option mechanism is an effective incentive, the option prices should be within a relevant range. The second-period option price should be no greater than the difference between the second- period unit production costs and the salvage value. Otherwise, the supplier will earn little due to the rapidly decreasing exercise price and the coordination will fail. Second, the first-period option price should be no greater than the second-period price and should be linearly correlated to the second-period option price when the latter is beyond some threshold. This result is true regardless of the specific functional form of the market demand or market signal. Third, the retailer’s ordering behavior is influenced by the dual effect of the predictive power of the new market information and option prices. Some extreme pricing cases may result in the ordering behavior being independent of the new market information. The influence pattern is so complex that there is no closed form solution to the retailer’s first-period optimal order quantity. Fortunately, this does not prevent exploring the optimal pricing conditions which are stated in Proposition 3. A numerical example is given for the profit allocation issues. An interesting result is that order postponement may be beneficial to both parties, though this needs further theoretical proof.
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