Procurement Strategy with Backup Sourcing under Stochastic Supply Risk

Abstract

Supply risk can have a negative impact on a manufacturer's performance. Backup sourcing is one of the most commonly used strategies to mitigate the adverse consequences of supply risks. In this paper, we study a procurement strategy with backup sourcing when a manufacturer faces stochastic supply risk and demand. The optimal decisions of the players involved are investigated theoretically using the game theoretic framework, and the impacts of the key parameters, such as wholesale prices and the risk probability, are assessed numerically under supply information symmetry and asymmetry. The results illustrate that the reservation price provided by the backup supplier varies greatly under different information-sharing conditions. Reservation quantity is negatively correlated with the reservation price, which is affected by the risk probability, wholesale prices, and marginal cost of the backup supplier. We also show that given the same wholesale prices, the potential supply risk has a substantial impact on the manufacturer's expected profit, and the performance of the manufacturer under asymmetrical supply information is not always better than that under symmetrical information. In addition, we also discuss the impact of wholesale prices on reservation price and participants' profits based on numerical examples. The research enriches the understanding of a procurement strategy under stochastic supply risk, and the conclusions have certain management significance.