Contracts choice for supply chain under inflation

• Date: 01 November 2018
• Published date: 01 November 2018
• DOI: http://doi.org/10.1111/itor.12263

Intl. Trans. in Op. Res. 25 (2018) 1907–1925

DOI: 10.1111/itor.12263

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Contracts choice for supply chain under inflation

Nana Wan and Xu Chen

School of Management and Economics, University of ElectronicScience and Technology of China, Chengdu, China

E-mail: wannana850417@163.com [Wan]; xchenxchen@263.net [Chen]

Received 4 August2015; received in revised form 29 October 2015; accepted 28 December 2015

Abstract

Inflation causes an increase in the retail price and a decrease in the market demand, both arise from the

problem of seasonal product management and occur during the long production lead time. As an effective

tool for hedging against the risks, option contracts, including call, put, and bidirectional option contracts,

have been proved to benefit two members in a one-supplier and one-retailer supply chain under inflation.

The aim of this paper is to examine the effect of different option contacts on the decisions and performances

for both the supplier and the retailer under inflation. Our results suggest that the retailer prefers adopting

portfolio contracts with bidirectional options under inflation, whereas the supplier is inclined to provide call

option contracts under inflation. Our study also revealsthat call option contracts are implemented ultimately

by the supply chain under inflation because of the supplier’s market dominant position.

Keywords: supply chain risk management; inflation; call option contracts; put option contracts; bidirectional option

contracts; portfolio contracts

1. Introduction

Since the global financial crisis in 2008, the inflationary pressure around the world has been further

increasing over the past few years. As a result of the negative influence of inflation, the performance

of the global market is poor and real economic growth is slow. During the inflationary period, the

price level of most commodities runs faster than the average wages, which leads to a decrease in

the consumption demand. At the same time, the selling price of raw materials and energy also goes

up dramatically, which leads to an increase in the costs of production. Due to the sluggish demand

caused by inflation, the pricing power of companies is weakened. It means that it is too hard for

companies to shift the rising costs into the sale price of products. Thus, we can observe that a large

number of small- and medium-sized firms are trapped in a battle for survival under inflation. Many

large-scale companies have to take a series of steps to tackle the troublesome problem caused by

inflation. It is pretty obvious that inflation exerts an important influence on the daily operation of

the companies and even the supply chain. Thereby, there exist practical and theoretical values in

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International Transactionsin Operational Research C

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1908 N. Wan and X. Chen / Intl. Trans. in Op. Res. 25 (2018) 1907–1925

the related research on the effect of inflation on the decisions and performances of the companies

within the supply chain.

Option contracts are always considered as a flexible mechanism that provide the retailer with

the order flexibility without burdening the supplier. In order to accommodate the rapidly changing

marketplace, option contracts have been extensively used recently in many industries, such as

food processing, electronics, and so on. For example, Hewlett Packard adopts option contracts to

purchase electronic components and saves more than $15 million in operational costs (Nagali et al.,

2008). Facing various risks from supply, demand and price, option contracts are always regarded

as a viable alternative. In addition, option contracts are classified into three different categories:

call option contracts, put option contracts, and bidirectional option contracts (Zhao et al., 2013).

With call option contracts, the retailer has a right to reorder a certain number of products from

the supplier during the selling season. With put option contracts, the retailer has a right to return

a certain number of products to the supplier at the end of the selling season. With bidirectional

option contracts, two types of rights mentioned above are provided with the retailer because both

call and put options are contained in bidirectional options. It is pretty obvious that the effect of

different option contracts on an identical companyis not the same. Thereby,there exist practical and

theoretical values in the related research on the effect of different option contracts on the decisions

and performances of the companies within the supply chain.

As a consequence, quite a number of studies relating to the effect of inflation on the inventory

control strategy have been reported in the past few years. However, almost all of the published

papers do not consider the effect of inflation on the supply chain. In addition, a wide range of

studies investigate the efficiency enhancement for the supply chain members derived from the

utilization of option contracts under different settings. However, most of the published papers only

consider the demand uncertainty and neglect the risks of demand and price caused by inflation.

Given such conditions, Wan and Chen (2015a, 2015b, 2015c) incorporate the effect of inflation

and option games into a modeling framework, and investigate the role of option contracts on the

supply chain decisions and performance under inflation. They prove that the utilization of option

contracts is beneficial for the members to improve their economic efficiency and for the channel

to achieve the coordination under inflation. However, they only concentrate on one certain type of

option contracts in each article and do not discuss the effect of different option contracts on the

supply chain under inflation. Our research aims to fill the gap in the literature. In this paper, we

plan to address several following key questions:

rWhat is the effect of different option contracts on the ordering and production decisions under

inflation?

rWhat is the effectof different option contracts on the optimal expected profits of both the supplier

and the retailer under inflation?

To answer the above questions, we limit ourselves to the same problem setting as Wan and Chen

(2015a, 2015b, 2015c). To some extent, our work can be considered as an extension of the above

papers. In this paper, we consider a one-period two-echelon supply chain consisting of one supplier

who manufactures one type of seasonal products and one retailer who purchases from the supplier

and sells to the end customers. We investigate the relationships among the optimal decision policies

for both the supplier and the retailer in the presence of different option contracts under inflation.

C

2016 The Authors.

International Transactionsin Operational Research C

2016 International Federation of OperationalResearch Societies