Sale-surety and quality warranty model based on options in supply chain

Options can be used to hedge risks caused by different types of uncertainty in supply chain management. The first part of this study examines how to use surety-options to coordinate a retailer-leader supply chain. It develops an option model in which the retailer guarantees sales and the supplier guarantees quality. The retailer and the supplier negotiate the options price and security regulations. The supplier can transfer part of the market risk to the retailer but in return has to bear the quality risk. By the theoretical analysis and the numerical examples, this study demonstrates that surety-options can coordinate the supply chain and achieve Pareto-improvement by encouraging the retailer to increase marketing efforts and the supplier to improve the quality.