Managing Disruption Risk When Supply Drives Future Demand

Abstract

In many industries, future demand is driven by past sales, and the inability to sell today can decrease future market size. While the dependence of demand on sales has been addressed in several streams of Operations literature, such a setting has not been studied in the disruptions literature. Yet, we find that when supply disruption can decrease future demand, risk mitigation strategies become quite different from those presented in the existing disruptions literature, where demand is largely independent of sales. For example, there may exist distinct values of probability of disruption at which the order quantity from an unreliable supplier increases in probability of disruption, when the OEM either single or even dual sources from the unreliable and reliable suppliers. We consider a multi-period setting with demand in each period a multiple of sales in the previous period. The OEM can obtain supply from a reliable (not subject to disruption) and unreliable supplier (subject to disruption). We characterize optimal policies analytically and visualize them with numerical simulations. Our study is particularly relevant nowadays as many industries where future demand is driven by sales (i.e. consumer electronics) frequently experience supply disruptions.