Independence of Capacity Ordering and Financial Subsidies to Risky Suppliers

Manufacturing & Service Operations Management, published online before print February 16, 2010, DOI:10.1287/msom.1090.0284

40 Pages Posted: 28 Nov 2007 Last revised: 22 Jun 2016

See all articles by Volodymyr Babich

Volodymyr Babich

Georgetown University - McDonough School of Business

Date Written: September 21, 2008

Abstract

The risk of supply disruptions due to suppliers' financial problems plays a prominent role in manufacturers' risk portfolios. Even large suppliers (e.g. Delphi) could file for bankruptcy, and manufacturer's actions, such as financial subsidies to the suppliers, affect profoundly suppliers' financial health. Using a dynamic, stochastic, periodic-review model of manufacturer's joint capacity reservation and financial subsidy decisions and a firm-value model of supplier's bankruptcy, we address the following questions: (1) How can one model the supplier's financial state and its relationship to the supplier's operational performance? (2) What are the operational benefits to the manufacturer from giving financial subsidies to the supplier, and what are the costs? (3) What is the optimal joint capacity ordering and financial subsidy policy for the manufacturer? (4) Should a powerful manufacturer share supply chain profits with a weaker supplier? We provide general conditions that allow the manufacturer to make ordering decisions independently from the subsidy decisions. In particular, to choose the optimal order quantities in the dynamic newsvendor setting, the manufacturer should use the newsvendor critical fractile expression. We provide conditions for the optimal subsidy policy to have a subsidize-up-to structure, perform comparative statics analysis, and describe conditions when the manufacturer may choose to share supply chain profits with the supplier.

Keywords: Supply Risk, Interface Between Operations and Finance, Random Capacity

JEL Classification: D24, G33, D92, L23

Suggested Citation

Babich, Volodymyr, Independence of Capacity Ordering and Financial Subsidies to Risky Suppliers (September 21, 2008). Manufacturing & Service Operations Management, published online before print February 16, 2010, DOI:10.1287/msom.1090.0284, Available at SSRN: https://ssrn.com/abstract=1033167

Volodymyr Babich (Contact Author)

Georgetown University - McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States

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