Bidirectional options in random yield supply chains with demand and spot price uncertainty

• Published in: Annals of operations research 2021-07, Vol.302 (1), p.211-230
• Main Authors: Luo, Jiarong, Chen, Xu, Wang, Chong, Zhang, Gaoxun
• Format: Article
• Language: English
• Subjects: Business and Management; Combinatorics; Contracts; Coordination; Game theory; Operations research; Operations Research/Decision Theory; Original Research; Put & call options; Spot market; Supply chains; Theory of Computation
• ISSN: 0254-5330; 1572-9338
• DOI: 10.1007/s10479-021-03986-5

This article develops a game-theoretic model to value the bidirectional option in a one-manufacturer and one-component-supplier system. The production process of the supplier is subject to random yield. The manufacturer contracts the supplier with bidirectional options to obtain components, and assembles them into end products to meet a stochastic demand. In addition, both firms can sell or/and buy the components on a spot market. First, the unique optimal order and production strategies of the decentralized system under bidirectional option contracts are derived. Second, resorting to numerical example and comparing the bidirectional option model with the call option model, we find that the manufacturer’s optimal firm and total order as well as expected profit under bidirectional options are larger than that of under call options, but the option quantity has the opposite tendency. The supplier’s optimal production quantity are larger under bidirectional options than that of under call options, but only when the option (exercise) price exceeds a certain value, the supplier’s expected profit under bidirectional options will be larger than that of under call options. Third, the coordination of the decentralized system under bidirectional option contracts is analyzed and a coordination mechanism with the contract is designed.