Backup sourcing with capacity reservation under uncertain disruption risk and minimum order quantity

Abstract

Ample evidence has confirmed the importance of backup sourcing when disruption of the major supply source is inevitable. The decisions associated with how to work with the backup supplier to ensure backup or emergency supply when the primary source experiences shortfall have received a great deal of attention. We study a capacity reservation contract between a buyer and a backup supplier when there is uncertainty about the major supplier’s disruption risks. Additionally, we consider the constraint that requires the buyer to order either none or at least a minimum order quantity in the case of contingent sourcing. By committing to such backup contracts, the buyer seeks to lower its contingent purchasing cost and to ensure the availability of merchandise in the presence of risks. The involving players’ optimal decisions are investigated theoretically and the impacts of the key parameters and special scenarios are assessed numerically. The study contributes to the literature by providing a better understanding of how to use a capacity reservation contract as a vehicle to build long-term relationship in backup sourcing and of the impacts of disruption uncertainty and contingent supply availability.