Disruption Risk Management in Two-Echelon Supply Chains: Early Commitment to Finished Goods

Abstract

This research focuses on managing supply chain disruption risk using inventory and reserve capacity in serial multi-stage supply chains. The research problem is to determine the optimal risk mitigation inventories (RMI) and reserve capacities when product transformation occurs at each stage. Disruptions at each stage are modeled as a random process. We find that under reasonable conditions it is better to hold more RMI downstream than upstream even when the holding costs upstream are lower. We also find that it is often optimal to hold more reserve capacity downstream than upstream even when reserve capacity costs are lower upstream. Our research also suggests that RMI is preferred to reserve capacity as a risk mitigation lever in long serial supply chains, i.e., in supply chains with a large number of stages. We further show that RMI and reserve capacity are not always substitutes as suggested by the literature, and we establish conditions when they are complements; that is an increase RMI can increase the marginal value of reserve capacity and vice versa.