Option contracts: a solution for overloading problems in the delivery service supply chain

Owing to the limited service capacity of express delivery providers, most online retailers have to reject many orders during hot selling seasons. In this paper, we consider an express delivery service supply chain consisting of an express delivery provider and an online retailer whereby the selling season includes both regular periods and online sales periods. Utilizing a modified newsvendor model, we derive the express delivery provider’s optimal capacity decision and find that the overloading problem cannot be avoided because delivery service cannot be inventoried. To solve such a problem, we introduce an option contract to coordinate the supply chain. By allowing the online retailer to book the capacity, the express delivery provider can rent capacity from a third party in advance. Results show this approach can mitigate the problem significantly. We also extend our model to a supply chain consisting of a delivery provider and two retailers.