Risk-averse outsourcing strategy in the presence of demand and supply uncertainties

Abstract

This study investigates an outsourcing strategy for a risk-averse decision-maker facing two types of demand and supply uncertainties. The supply uncertainty includes both uncertainty in the rate of capacity allocation in the manufacturer and the uncertainty resulting from disruption risks. In order to capture the geographical characteristics of the suppliers, we assume that the suppliers belong to two different geographical regions: the manufacturer’s region (domestic supplier) and outside of the manufacturer’s region (foreign supplier). We also consider a realistic scenario in which the manufacturer and domestic suppliers might face two types of disruption:(i) local disruption which might occur inside the suppliers or manufacturer’s facility such as disruption in the production line, and (ii) regional disruption which might occur in the region of the domestic supplier and manufacture simultaneously, such as natural hazards. To provide a benchmark, at first, the risk-neutral model is analyzed and then the risk-averse model is developed to consider the risk attitude of the decision-maker. In the latter case, we apply two types of risk evaluation model to analyze the decision maker’s behavior: value-at-risk (VaR) and conditional value-at-risk (CVaR). In addition, we solve optimally both risk-neutral and risk-averse models by deriving Karuch–Kuhn–Tucker (K.K.T) optimality condition. Computational examples illustrate the impact of decision-maker attitude on the manufacture’s outsourcing strategy. In addition, the sensitivity of the optimal outsourcing decisions with regards to the important parameters of the model is analyzed.