Offshore Outsourcing, Yield Uncertainty, and Contingency Responses

Abstract

In this article, we study an offshore outsourcing arrangement for a buyer of a produced good in the presence of supply yield uncertainty. We analyze the performance of contingency responses to the realized yield information at the end of production and prior to its delivery to the destination market. The contingency responses considered are: (i) Emergency Production via which an emergency order is placed with another fast and perfectly reliable offshore supplier; (ii) Emergency Production and Delivery via which an expedited shipping of (partial or total) good units is used on top of Emergency Production. Within a periodic review inventory system with uncertain demand setting, we theoretically characterize the optimal decisions on the cycle order size, the emergency order size, and the way to split the available good units between the fast and slow shipping modes. We provide comparative statics on how the choices of these quantities are affected by each other and by the demand and yield uncertainties. We use numerical examples to illustrate the values of such contingency responses and the impact of other factors on the cost of meeting demand.