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

TLDR

We study a single‑product firm that can source from an unreliable, cheaper supplier and a reliable but more expensive one, with capacity constraints and potential volume flexibility at the reliable supplier. Contingent rerouting is feasible when the reliable supplier can increase its processing capacity, i.e., has volume flexibility. The authors show that optimal disruption‑management strategies depend on supplier uptime and disruption characteristics: risk‑neutral firms choose either inventory, single‑sourcing, or passive acceptance; higher uptime and longer, rarer disruptions favor sourcing mitigation over inventory, while mixed mitigation is optimal when the unreliable supplier is capacity‑limited or the firm is risk‑averse; contingent rerouting, enabled by reliable supplier volume flexibility, often appears in the optimal mix and can substantially lower costs.

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.