Managing Procurement Through Option Contracts for a Firm Under Supply Disruption Risk

Abstract

Supply disruption is a common phenomenon in practice. In this study, we investigate the firm's optimal procurement strategy through two kinds of option contracts under supply disruption risk. Through theoretical analysis and numerical simulation, we obtain some important managerial implications. Under AOPC, the unreliable supplier is always utilized due to the economic advantage. When the option price is low, the firm will always reserve options from the reliable supplier. With the increase of the disruption risk, the firm will rely more on the reliable supplier to mitigate supply risk. Under COPC, when the option price and disruption information cost is relatively large, the order strategy in this scenario can be represented by two single-sourcing optimal order points. Otherwise, the firm will decrease the normal order and rely more on the contingency option reservation. When the disruption information cost is relatively low, it is beneficial for the firm to obtain more disruption information and postpone her option reservation decision in most situations. When the disruption information cost is moderate, the firm will choose AOPC and COPC alternately, as the disruption risk increases.