Disruption risk management in service-level agreements

Abstract

This paper studies the impact of capacity/inventory disruption on a supplier's cost, where the supplier has heterogeneous service level agreements (SLAs) in place with multiple customers (retailers). We compare three capacity allocation policies in the presence of supply disruption, with both full and partial disruption cases investigated. The results show that the two-stage policy outperforms other capacity allocation policies when a disruption is anticipated and that partial disruption is more manageable than full disruption in terms of meeting the SLAs. Furthermore, the supplier is better off to negotiate a longer performance review period assuming the penalty per time unit is fixed. This result is contrary to findings in the literature for SLAs when there is no consideration of disruption. The insights from this study can assist suppliers in determining their capacity level, making capacity-related decisions such as locations of warehouses or production sites, in allocating capacity to customers and in negotiating SLA terms such as the performance review period length and penalty rates.