Sourcing Decisions with Capacity Reservations under Supply Disruptions

Abstract

Firms employing both offshore outsourcing and nearshore sourcing strategies may face supply disruption, demand uncertainty, and quality risks simultaneously. Sourcing decisions become inevitably important and complicated when both profit and the customer-service level are taken into consideration. In this paper, we model a scenario where a manufacturer who faces stochastic demand procures major modules from an overseas supplier and two local suppliers. The overseas supplier offers quality products while being susceptible to disruption risks; if the local suppliers, who are completely reliable and serve as a backup, offer products that are of inferior quality, it may result in lower market acceptance and a bad experience for the final customers. The manufacturer has to reserve capacity with backup suppliers before urgent orders are placed, when the primary source experiences a shortfall. We explicitly derive the manufacturer's optimal order quantities and reservation quantities, which are functions of the heterogeneous suppliers’ wholesale prices, reservation prices, and other parameters. The impacts of the fill-rate constraint and customer-experience quality constraint on the manufacturer's purchasing decisions are investigated. Interesting managerial insights on the merits of backup sourcing with capacity reservations for managing demand uncertainties and supply disruption risks are also discussed.