Designing a supply contract to coordinate supplier’s production, considering customer oriented production

•A manufacturer tries to achieve customer oriented production, e.g. ATO system.•The manufacturer coordinates its supplier’s production, by an option contract.•The manufacturer’s optimal order and supplier’s optimal production are obtained.•The necessary conditions for coordination between them are obtained.•Risk and profit sharing analysis between the contract partners is provided.

This paper investigates how a manufacturer, who is trying to develop a customer-oriented production system, should design a supply contract with its component supplier. The manufacturer sells its products during a selling season, with stochastic demand and tries to coordinate supplier’s production quantity, with long lead-time, in order to provide sufficient stock. Along this line, a coordinating contract based on an option mechanism is used as the supply contract. The manufacturer’s optimal order, the supplier’s optimal production and the necessary conditions for coordination between them in the mentioned environment are obtained. Also, risk and profit sharing analysis between the contract partners is provided. A numerical example is conducted to illustrate the analysis.