Supply chain coordination with put option contracts and customer returns

Abstract This article develops a newsvendor model to examine the optimal pricing and ordering decisions of a supply chain in which the supplier offers both wholesale price and option contracts to a retailer who faces customer returns and uncertain demand. The supplier is the Stackelberg leader who decides the option and exercise prices with a pre-determined wholesale price, and the retailer decides the product order quantity and option order quantity through the supplier’s two contracts. We discuss the impact of customer returns and the option contract on the optimal pricing and ordering decisions, and on the profits of the supplier and the retailer. We show that the retailer’s product order quantity, option order quantity, and expected profit decrease with customer returns rate; the supplier’s optimal option price and exercise price decrease as more customers return products. We also discuss the supply chain coordination mechanism and propose a contract that can achieve supply chain coordination and ensure that both the supplier and the retailer can be more profitable.