Impact of supply risks on procurement decisions

Shanshan Guo, Lei Zhao, Xiaowei Xu

Research output: Contribution to journalArticlepeer-review

17 Scopus citations


We consider a firm that procures a product from a regular supplier whose production is subject to both supply disruption and random yield risks and a backup supplier whose production capacity requires reservation in advance. Under both deterministic and stochastic demand, we study the impact of the two types of supply risks on the firm’s optimal procurement decisions and the importance of correctly identifying the source of supply risks. We find that if the overall supply risk is unchanged but its main source shifts from random yield to supply disruption, the firm should order more from the regular supplier and reserve less capacity from the backup supplier. Ignoring the existence of supply disruption leads to under-utilization of the regular supplier and over-utilization of the backup supplier. Moreover, we examine the option value of the reserved capacity that is affected by the uncertainty of customer demand. We find that the option value increases/decreases in demand uncertainty if the reservation capacity is exercised after/before demand is realized.

Original languageEnglish (US)
Pages (from-to)411-430
Number of pages20
JournalAnnals of Operations Research
Issue number1-2
StatePublished - Jun 1 2016

All Science Journal Classification (ASJC) codes

  • Decision Sciences(all)
  • Management Science and Operations Research


  • Capacity reservation
  • Contingent sourcing
  • Random yield
  • Risk management
  • Stochastic programming
  • Supply disruption


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