Supply Chain Coordination with Option Contracts in VMI System

This paper focuses on the optimal option contract coordinating of ordering quantity and option prices between retailer and supplier in a VMI system under market uncertainty. The option contract is characterized by a dominant supplier with two parameters which are ordering price c(o) and executive price c(e) paid by retailer. An option ordering price is paid by retailer for each additional ordering unit of product at the end of selling reason if realized demand is larger than retailer's committed minimum ordering. An executive price plays a role of purchasing price for each unit of product if retailer set a second ordering. A successful coordination has been shown and a numerical analysis demonstrates that such an option contract brings a Pareto improvement to each party, especially to the retailer. At last, the analysis of market uncertainty effects on the profits of both sides illustrates that, as the increasing of market demand uncertainty, the retailer's ordering quantity of options will increase but his profit will reduce, and supplier's profit will add.