Dual sourcing under heavy-tailed demand: an extreme value theory approach

Abstract

We consider a single-period dual-sourcing problem in which a buyer purchases its products from two different suppliers and sells them to a market with uncertain demand. One supplier is cheaper but less responsive, whereas the other supplier is more responsive but more expensive. The buyer determines the order quantity from the low-cost supplier and the capacity level from the responsive supplier in such a way that maximises its profit. We apply extreme value theory to analyse the impact of tail heaviness of demand distribution on optimal dual-sourcing strategy. We numerically find that tail heaviness moderates the effect of increasing demand uncertainty on optimal order levels. We also show that dual sourcing allows companies to increase their fill rates cost effectively under heavy-tailed demand if the capacity reservation cost of the responsive supplier is relatively low.

Supply chain resilience: definition, review and theoretical foundations for further study

“…Flexibility may apply both to a firm and to the supply chain (Stevenson & Spring 2007). Recent work has examined how Extreme Value theory can be used to price the value of flexibility when threatened with disruption, including the value of dual sourcing (Bicer 2015); and this may be a promising line of further study.…”

Why Do Companies Need Operational Flexibility to Reduce Waste at Source?

“…Our research is also related to a second stream of literature that prices the value of operational flexibility. Companies establish operational flexibility in different ways, such as lead-time reduction [2,8], quantity-flexibility contracts [10], and multiple sourcing [9,23]. These operational-flexibility strategies make it possible for buyers to determine order quantities after the partial or full resolution of demand uncertainty, helping them to better match supply with uncertain demand.…”

“…Ref. [9] extends [23] by using the extreme-value theory, so the tailored capacity model can be applied to a wider selection of product categories.…”

“…It is therefore important to conduct a comprehensive study of operational and environmental trade-offs arising from the interaction between different supply chain processes such as procurement and inventory management [7]. In the extant literature, the merits of operational flexibility are quantified from the perspective of its impact on profits [2,[8][9][10][11]. However, its benefits for environmental sustainability have not been addressed yet.…”

“…Compared with lead-time reduction, quantity flexibility does not require the localization of production near the market bases. Finally, we consider multiple sourcing, in which a buyer employs a domestic supplier and an offshore supplier to exploit the market responsiveness of the domestic supplier and the cost efficiency of the offshore supplier at the same time [9]. Although it has been well established in the extant literature that these three strategies are highly effective in reducing supply-demand mismatches, their impact on reducing waste is not well known.…”