Vulnerable options in supply chains: Effects of supplier competition

Abstract

Abstract:Concerned with the risk of supplier default, a firm may choose to diversify its orders among multiple suppliers. Furthermore, the discrepancy in production lead-times among suppliers furnishes a firm with a valuable option to defer ordering decisions until uncertainty has been partially resolved. The suppliers also have an option: to defer their pricing decisions. Using a single-period, multi-stage model of a two-echelon supply chain with competing risky suppliers and a single manufacturer, this paper investigates how the supplier default risk and default co-dependence affect manufacturer procurement and production decisions, supplier pricing decisions, firms profits, and the deferment option value and how the introduction of the deferment option alters supplier competition.

Decentralized Supply Risk Management

“…Instead of competing on price while keeping the supply risk parameters constant (as in Babich et al 2007 andBabich 2006), suppliers can compete on "quality" by making investments in their production capabilities that affect their yield uncertainty. Federgruen and Yang (2009) study examples of quality competition, in which the supplier selects the mean and/or standard deviation of their production yield distribution.…”

“…A popular sub-class of yield/capacity models (e.g., Baiman et al, 2000;Babich, 2006;Babich et al, 2007;Chaturvedi and Martínez-de-Albéniz, 2010;Gurnani and Shi, 2006;Swinney and Netessine, 2009;Yang et al, 2009a,b) is that with all-or-nothing yields, which corresponds to random number y following a Bernoulli distribution: the buyer receives either the full order quantity or nothing at all. This type of yield model offers a fine compromise between tractability and fidelity, and is especially appropriate when modeling, for example, the loss of finished goods inventory due to recalls, or accidents or closures that put a supplier out of commission.…”

“…Creating external or internal backup sources of supply: Babich (2006) and Yang et al (2009a) allow the possibility that either the buyer or the supplier or both have access to a source of backup production in the event of a disruption.…”

“…More specifically, in the latter paper, the buyer has a deferment option, which is "vulnerable," because the supplier with shorter lead time may experience a default before the buyer has a chance to order from it. Babich (2006) considers a multistage game, where the "slow" supplier submits a bid, then the buyer makes an ordering decision, then the "fast" supplier submits a bid, then the buyer makes another ordering decision. Thus, supplier competition is separated in time, which leads to interesting observations, as will be discussed below.…”

“…Babich et al (2007) and Babich (2006) use a Bertrand competition model (Bertrand, 1883), where risky suppliers submit bids for the per-unit wholesale price of the product and the buyer selects which suppliers to work with and how much to order from each supplier, based on these bids and the joint distribution of supplier defaults. Babich et al (2007) consider a one-period model, whereas Babich (2006) uses a multi-period model and recognizes that disparities in production lead times across suppliers allows the buyer to delay its ordering decision. More specifically, in the latter paper, the buyer has a deferment option, which is "vulnerable," because the supplier with shorter lead time may experience a default before the buyer has a chance to order from it.…”