The impact of multiple products and limited capacity on routine sourcing decisions

Abstract

We study the influence of limited capacity and multiple products on the optimal sourcing decisions for a manufacturer subject to supply and demand uncertainty. The manufacturer produces two products. The component of one product is sourced from two suppliers, one perfectly reliable and the other cheaper but unreliable, failing to deliver the order with some probability. We develop a mathematical model for a single-period setting and study the associated optimality conditions. Our results show that the supplier diversification strategy is significantly different when the buyer has limited capacity. Specifically, we find that single sourcing from an expensive and reliable supplier may be an optimal procurement strategy even when a cheaper option exists. In addition, when producing multiple products, the optimal sourcing strategy may hold inventory of one component to reduce the amount of capacity idling when the supply of a different component is disrupted. We use stochastic programming to validate our single-period findings in a multi-period setting. Although carrying inventory of finished products provides another tactic to mitigate supply uncertainty in a multi-period environment, we observe the key findings from single period, like single-sourcing from an expensive but reliable supplier, remain valid.