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“While we have sold out of our initial supply, stores continue to receive iPhone 5 shipments regularly and customers can continue to order online and receive an estimated delivery date. We appreciate everyone’s patience and are working hard to build enough iPhone 5 for everyone.” Apple said on September 24, 2012, after iPhone 5 was sold out. However, among Apple’s two? Two display suppliers, Japan Display Inc. and South Korea’s LG Display Co. both had trouble producing to meet the demand due to the sharp increase in Apple’s order.
The same thing happened with Xiaomi, a large mobile phone manufacturer in China. Lei Jun, who is the CEO of Xiaomi, promised the customers that Mi9 would satisfy the customers’ demand without delay. However, the fact was not in line with the announcement of Mr. Jun, and Mi9 sold out quickly. After Lei Jun announced that the goods would be replenished soon, Xiaomi’s component suppliers were under huge production pressure for the replenishment of some components that were required 3 months ago.
Along with the growth of E-commerce and express logistics, especially in China, where there are the largest Business-to-Business(B2B) platform and the largest logistics network in the world, the efficiency of trade is becoming higher, and the process from order to delivery becomes more time-saving. It also makes zero-stock transactions possible and necessary. Consider the following scenario: A firm acting as a distributor in the traditional supply chain used to buy products from upstream suppliers with wholesale prices at the beginning of the quarter. And during the sales quarter, they will store these products, try to handle these “dead stock,” and find a way to import more if these products are sold out. Therefore, in order to make more profits, the distributor hopes to change the order quantity at any time to cope with the constantly changing market demand.
As for suppliers in the upstream of the supply chain, in the “wholesale price model,” the suppliers make products according to the forecast of the market, then sell to distributors with the wholesale prices. The extra orders from retailers caused by the change in the market will create additional production pressure for the suppliers. Nowadays, one supplier may face many distributors, which makes the pressure caused by the changed orders even more serious in a B2B model. Being different from distributors who hope to have the chance to make real-time changes in the order, the suppliers, on the other hand, hope to confirm orders early and sell more products to the downstream of the supply chain. The conflict of interests between suppliers and distributors is difficult to solve by the “wholesale price model.”
By making new option contracts with suppliers, distributors will pay option prices to purchase the right—the right to buy a range of goods from suppliers with exercise prices sometime later and enforce parts of the right at different periods of the sales quarter. Suppliers sell the right and charge option prices. When an option is exercised, the supplier is obligated to sell the goods to the distributor with the contractual price (exercise price). Therefore, when the option contract is made, the future trading volume is fully considered by the two parties to prevent any of them from deciding the sales volume or production volume arbitrarily.
At the same time, option prices can reflect the share of the risks and benefits. It not only prevents one party from bearing the loss alone caused by market risks but also shares extra profits from market speculation. For suppliers, option prices can be used as a portion of the commercial profits before the transaction is done; even if distributors break option contracts or buy fewer products relatively, they can also get option prices which can reduce their risk of loss. For distributors, options can be waived if the market outlook is not good, and the maximum loss is just the price of buying the options. When the market prospect is good, distributors will buy more products to earn more profits; then there will be a part of profits which can be transferred to suppliers.
However, in the process of making options, it is impossible to fully predict the market demand. That is, the quantity of options and the final amount of sales are not the same. For retailers, when the quantity of options is less than the market demand, they still need to purchase at wholesale prices even after the execution of the options to maximize their profits. Therefore, the “option model” is not completely opposed to the “wholesale price model,” but they complement each other.