The impact of supply disruption risk on a retailer’s pricing and procurement strategies in the presence of a substitute product

Abstract

Retailers often experience stockouts when a supplier fails to deliver an order. In this paper, we identify the optimal procurement policy of a multi-product retailer in the presence of possible supply disruptions. Our analysis reveals that, in anticipation of potential supply disruptions, a retailer would typically benefit from ordering more units from a reliable supplier and fewer units from an unreliable one. Furthermore, the total number of units ordered may increase when there is supply disruption risk. As a result, the retailer may overstock some items. However, there are situations in which a retailer would optimally respond to supply uncertainty by consolidating its selling strategy around the unreliable supplier’s product. Under such a strategy, we find the surprising result that the retailer reduces the amount it orders from a reliable supplier as an unreliable seller becomes even less reliable. We also explore how supply disruptions can affect a retailer’s optimal pricing strategy. We find that under certain conditions, it is beneficial for a retailer to lower its price of a substitute product when one supplier fails to deliver its product. Finally, we find that, on net, consumers may benefit from supply uncertainty even though supply disruptions eliminate access to a desirable product.