Abstract

This paper investigates a dynamic flexible compensation strategy to deal with supply disruptions. The manufacturer sources from a single supplier, and production could be completely interrupted by a supply disruption. Market demand is deterministic, but sensitive to the length of disruption duration and the level of compensation. By formulating a state-space framework to capture the demand dynamics during disruption, we present a deterministic optimal control approach that optimizes the dynamic flexible compensation strategy for supply disruption. Via Pontryagin's Maximum Principle, four types of optimal dynamic compensation strategies are proposed under the consideration of costs, disruption duration, and customer sensitivity. The results provide analytical guidance on how to dynamically adapt the price of compensation during the whole disruption period.

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