Abstract
This study considers a supply chain, including one manufacturer and one retailer, in which stochastic demand and return policy is focused upon. When each site aims to maximize its individual profitability, decentralized control may arise in the system. From the overall system's point of view, the decentralized supply chain will not be as efficient as the centralized one. Various studies have attempted to resolve the inefficiency of supply chains. However, such studies have focused on the optimization from retailer's perspective only and thus ignored manufacturer's interest. This study emphasizes manufacture's self-interested situation and determines optimal production quantity. Furthermore, it will contribute to decentralized control with the retailer offering option premium. It is also demonstrated that the Pareto efficiency can be attained in the supply chain by employing the option premium incentive.