Exploring Contracts with Options in Loyalty Reward Programs Supply Chain

This paper explores analytically the issue of whether an option contract mechanism is a viable alternative to help hedge against demand uncertainties for rewards in a Loyalty Reward Programs (LRP) enterprise-led supply chain. We introduce an analysis framework based on the study of the problem of planning the supply of rewards (and points) given demand uncertainties and considering option contracts featuring two parameters namely the option price and the option exercise. A two-stage stochastic linear programming with simple recourse model is developed to formulate this problem and solved using a solution procedure based on the sampling average approximation scheme. We benchmark our analysis with a wholesale price contract, a commonly used mechanism in buyer-supplier supply chains. Our preliminary numerical experiments show that option contracts can be considered as an attractive means to mitigate higher level of redemption demand variability as they tend to yield a higher LRP enterprise profitability and lower increases in both the liability level and budget usages.