On the Value of Mitigation and Contingency Strategies for Managing Supply Chain Disruption Risks

Abstract

We study a single-product setting in which a firm can source from two suppliers, one that is unreliable and another that is reliable but more expensive. Suppliers are capacity constrained, but the reliable supplier may possess volume flexibility. We prove that in the special case in which the reliable supplier has no flexibility and the unreliable supplier has infinite capacity, a risk-neutral firm will pursue a single disruption-management strategy: mitigation by carrying inventory, mitigation by single-sourcing from the reliable supplier, or passive acceptance. We find that a supplier’s percentage uptime and the nature of the disruptions (frequent but short versus rare but long) are key determinants of the optimal strategy. For a given percentage uptime, sourcing mitigation is increasingly favored over inventory mitigation as disruptions become less frequent but longer. Further, we show that a mixed mitigation strategy (partial sourcing from the reliable supplier and carrying inventory) can be optimal if the unreliable supplier has finite capacity or if the firm is risk averse. Contingent rerouting is a possible tactic if the reliable supplier can ramp up its processing capacity, that is, if it has volume flexibility. We find that contingent rerouting is often a component of the optimal disruption-management strategy, and that it can significantly reduce the firm’s costs. For a given percentage uptime, mitigation rather than contingent rerouting tends to be optimal if disruptions are rare.