Newsvendor models with random supply capacity and backup sourcing

Abstract

We consider newsvendor models with a primary supplier whose production is subject to random capacity. In order to hedge against this supply risk the retailer contracts with a reliable backup supplier to reserve capacity in advance, acquiring the option to use it after the delivery from the primary supplier and either before or after the demand realization. For both cases we identify the conditions under which the use of the backup supplier is beneficial and characterize the optimal order and reservation quantities. Furthermore, we examine how these optimal procurement quantities are affected by various model parameters.