Coordinating Supply Chains with Fairness Concerns using Option Contracts

In this chapter, we investigate whether the option contract can coordinate a supply chain when supply chain members have fairness concerns. Specifically, we consider a supply chain consisting of a manufacturer and a retailer where the two members can be either rational or fair-minded, and explore the condition under which the supply chain can be coordinated using an option contract. We follow the traditional newsvendor model by assuming that the market demand is stochastic with a cumulative distribution function and the retail price is exogenous. Under the option contract, the manufacturer’s decision variables include its option price and its exercise price, and the retailer is to decide its order quantity. We derive the equilibrium results for four different scenarios, that is, (i) both the two members are rational, (ii) the supplier is rational but the retailer is fair-minded, (iii) the supplier is fair-minded but the retailer is rational, and (iv) both are fair-minded. While the option contract can coordinate the supply chain when either of the two members is rational, we also find that when both the two members are rational, the option contract can coordinate the supply chain only under some specific conditions. Furthermore, we investigate whether the two members will suffer the disadvantageous or the advantageous inequality in the equilibrium and find some interesting findings.