Centralization versus Decentralization: Risk Pooling, Risk Diversification, and Supply Chain Disruptions

31 Pages Posted: 3 Apr 2008 Last revised: 19 Jun 2014

See all articles by Amanda J. Schmitt

Amanda J. Schmitt

MIT Center for Transportation & Logistics

Siyuan Sun

University of California, Berkeley - Department of Industrial Engineering and Operations Research

Lawrence V. Snyder

Lehigh University - Department of Industrial and Systems Engineering

Zuo-Jun Max Shen

University of California, Berkeley - Department of Industrial Engineering & Operations Research (IEOR)

Date Written: June 17, 2014

Abstract

We investigate optimal system design in a multi-location system in which supply is subject to disruptions. We examine the expected costs and cost variances of the system in both a centralized and a decentralized inventory system. We show that, when demand is deterministic and supply may be disrupted, using a decentralized inventory design reduces cost variance through the risk diversification effect, and therefore a decentralized inventory system is optimal. This is in contrast to the classical result that when supply is deterministic and demand is stochastic, centralization is optimal due to the risk-pooling effect. When both supply may be disrupted and demand is stochastic, we demonstrate that a risk-averse firm should typically choose a decentralized inventory system design.

Keywords: supply disruptions, inventory management, risk diversification

Suggested Citation

Schmitt, Amanda J. and Sun, Siyuan and Snyder, Lawrence V. and Shen, Zuo-Jun Max, Centralization versus Decentralization: Risk Pooling, Risk Diversification, and Supply Chain Disruptions (June 17, 2014). Available at SSRN: https://ssrn.com/abstract=1115392 or http://dx.doi.org/10.2139/ssrn.1115392

Amanda J. Schmitt (Contact Author)

MIT Center for Transportation & Logistics ( email )

77 Massachusetts Ave., E40
Cambridge, MA 02139
United States

Siyuan Sun

University of California, Berkeley - Department of Industrial Engineering and Operations Research ( email )

4141 Etcheverry Hall
Berkeley, CA 94720-1777
United States

Lawrence V. Snyder

Lehigh University - Department of Industrial and Systems Engineering ( email )

Harold S. Mohler Laboratory
200 West Packer Avenue
Bethlehem, PA 18015-1582
United States

Zuo-Jun Max Shen

University of California, Berkeley - Department of Industrial Engineering & Operations Research (IEOR) ( email )

IEOR Department
4135 Etcheverry Hall
Berkeley, CA 94720
United States

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