On the Effectiveness of Option Contracts under Supply Disruption

Abstract

This paper studies the effectiveness of implementing option contracts for the procurement of seasonal products subject to short selling season, demand uncertainty, and supply-side disruption. The research intends to show how profitability and product availability can be enhanced both locally and globally by combining the long-term wholesale price contract and option contracts. Using the newsvendor model, the paper aims to identify business settings with respect to disruption parameters, demand uncertainty, and the option pricing under which the use of option contracts could improve supply chain performance. The main contribution of this research is that the effectiveness of option contracts is investigated under the impact of the supply-side disruption in addition to the demand uncertainty. The option contract-based portfolio procurement displays significant performance enhancement in terms of both the retailer profitability and the reduction in the lost sales quantity when supply-side disruptions prevail. The study of the procurement management subject to seasonal disruption can be readily applied to numerous business situations where the disruption can lead to devastating impacts such as the insufficient or untimely supply of COVID-19 vaccines with limited shelf life.