Stockout risk and order splitting

Abstract

The importance of reliable supply is increasing with global sourcing and just-in-time (JIT) production. The transition to JIT purchasing implies single sourcing, which often involves problems with unreliable vendors. If a single, reliable supplier is not available, the order can be split among the vendors until a reliable supplier emerges. We address the problem under which circumstances is single or dual sourcing preferable if the objective of the decision is to minimize the stockout risk. Indifference curves show the delivery characteristics when single sourcing, dual sourcing with an even split, and dual sourcing with optimal split are best. The optimal split rate of dual sourcing is provided in the form of exact formulae and simple approximations. We show that dual sourcing is an appropriate alternative to single sourcing as long as the lead-time uncertainty cannot be decreased. Compared to single sourcing, the optimal split in dual sourcing frequently provides a lower stockout risk if the variability of the lead-time demand is considerable. This property holds even for a second supplier with much worse delivery characteristics, if the order quantity is substantially larger than the expected lead-time demand.