The value of flexible backup suppliers and disruption risk information: newsvendor analysis with recourse

Abstract

This article develops a model and analysis to provide insight into two effective remedies to increase supply chain resilience: (i) contracting with a secondary flexible backup supplier; and (ii) monitoring primary suppliers to obtain disruption risk information. To investigate the true value of these strategies, an analysis is performed under imperfect information concerning the disruption risks and considering a two-stage setting with recourse. In this setting, the firm first monitors its suppliers and then utilizes a recourse option subject to the limited quantity of a capacity reserved a priori via a contract with a flexible backup supplier. The firm’s jointly optimal behavior is analytically characterized (utilizing only the information available to the firm) regarding two interconnected decisions: (i) the advance capacity investment/reservation level with a flexible backup supplier; and (ii) the inventory ordering policy of the underlying products from both primary and backup suppliers. The presented results quantify effective disruption risk mitigation strategies for firms and provide managerial insights into the value of (i) a flexible backup supplier; (ii) disruption risk information; (iii) a contracted recourse option; and (iv) flexibility in the backup system.