Dual sourcing in the age of near-shoring: Trading off stochastic capacity limitations and long lead times

Abstract

We model a periodic review inventory system with non-stationary stochastic demand, in which a manufacturer is procuring a component from two available supply sources. The faster supply source is modeled as stochastic capacitated with immediate delivery, while the slower supply source is modeled as uncapacitated with a longer fixed lead time. The manufacturer’s objective is to choose how the order should be split between the two supply sources in each period, where the slower supply source is used to compensate for the supply capacity unavailability of the faster supply source. This is different from the conventional dual-sourcing problem, and motivated by the new reality of near-shoring options. We derive the optimal dynamic programming formulation that minimizes the total expected inventory holding and backorder costs over a finite planning horizon and show that the optimal policy is relatively complex. We extend our study by developing an extended myopic two-level base-stock policy and we show numerically that it provides a very close estimate of the optimal costs. Numerical results reveal the benefits of dual-sourcing under near-shoring, where we point out that in most cases the manufacturer should develop a hybrid procurement strategy, taking advantage of both supply sources to minimize its expected total cost.