Production Chain Disruptions: Inventory, Preparedness, and Insurance

51 Pages Posted: 28 Jan 2017 Last revised: 18 Feb 2018

See all articles by Lingxiu Dong

Lingxiu Dong

Washington University in St. Louis - John M. Olin Business School

Sammi Tang

University of Miami

Brian Tomlin

Tuck School of Business at Dartmouth

Date Written: February 4, 2018

Abstract

Disruptions that temporarily interrupt production pose a significant risk for manufacturing firms. To manage this risk firms can purchase interruption insurance and/or deploy operational measures such as storing inventory or taking preparedness actions that reduce the expected interruption length. In this paper we explore inventory, preparedness, and insurance in a two-stage production chain that can experience disruptions at either the upstream or downstream stage. We analytically characterize an inventory-only model and a preparedness-only model in which the firm uses either inventory or preparedness effort to manage disruption risk, and a joint model in which the firm deploys both operational measures. We identify the relationships between the two operational measures within a stage and across the two stages. We also examine how insurance affects a firm's optimal deployment of and preference between the two operational measures. In addition to providing insights into the interaction of these three risk management measures, our results provide insights into production-chain design. For example, the firm can reduce its disruption risk management cost by allocating more production activity downstream (when possible) and this risk management benefit can, at times, outweigh the possible production cost increase associated with allocating more production downstream.

Keywords: disruptions, risk, interruption insurance, production chain

JEL Classification: D24

Suggested Citation

Dong, Lingxiu and Tang, Sammi and Tomlin, Brian, Production Chain Disruptions: Inventory, Preparedness, and Insurance (February 4, 2018). Tuck School of Business Working Paper No. 2906431. Available at SSRN: https://ssrn.com/abstract=2906431 or http://dx.doi.org/10.2139/ssrn.2906431

Lingxiu Dong (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1156
St. Louis, MO 63130-4899
United States

Sammi Tang

University of Miami ( email )

5250 University Dr
Jenkins 414H
Coral Gables, FL 33146
United States
3052842810 (Phone)

Brian Tomlin

Tuck School of Business at Dartmouth ( email )

Hanover, NH 03755
United States

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