Directorate of distance education

Option Contracts
In addition to demand uncertainty, large problem size, and 
outsourcing contracts, manufacturers can also benefit from models 
and tools that can incorporate option contracts into capacity planning. 
A manufacturer might establish a fixed-price capacity contract with its 
suppliers to rent a fixed amount of capacity.
The manufacturer needs to pay for the capacity whether or not it 
uses the capacity. In practice, the supplier’s cost of capacity might have 
two components: a fixed cost and a variable cost. For example, equipment 
costs and the monthly salaries of workers are fixed costs, while power 
consumption and employee overtime payments are variable costs.
An option contract separates these two types of costs. With option 
contracts, the manufacturer buys the rights to use a fixed amount of 
capacity with an upfront fixed payment. If it decides to execute its rights 
and use these capacities, it needs to pay an exercise price for each unit of 
capacity that it actually uses. 

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Notes
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Lesson 4.5 - Inventory Optimisation
Learning Objectives
After reading this lesson you should be able to:
➢ Explain the processes of classical optimisation
➢ Explain the tenets of optimisation
➢ Describe the optimization of simple lot size formula
➢ Describe the rationalization of the optimized lot.
Introduction
In this supplement we briefly present several optimization concepts 
from calculus and relate them to inventory control. If you have never 
studied calculus, you may not thoroughly understand these concepts; they 
are stated to provide a brief review for those who understand the basics of 
classical optimization.
The only inventory case derived here is the simple lot size formula, 
the first inventory model presented in the chapter. The derivation is 
started where the chapter stopped; development of the model terms are 
not repeated.