Modeling of Capacity Reservation and Supplier Selection Based on Option Contract

A key issue for manufacturing firms is planning for outsourcedcomponents. In this research, we have considered a manufacturer in aMake-to-Order production environment who has to outsource aspecial component from a set of suppliers. One selling season isconsidered and the manufacturer faces uncertain demand during theselling season. A good strategy for the manufacturer to balance bothholding and lost sale costs is to initiate capacity reservation contractswith his suppliers. Thus, unlike the previous researches we havepresented a mathematical model based on option mechanism that willhelp the manufacturer to select appropriate suppliers and orderallocation, simultaneously. The considered option mechanism has atwo part contract fee structure (option price and exercise price) and itis at the foundation of practical contracts used by different industries.A numerical example is used to illustrate the model and to investigatehow option mechanism improves manufacturer's expected profit incomparison with the situation without applying the option mechanism