Dual Sourcing: Creating and Utilizing Flexible Capacities with a Second Supply Source

45 Pages Posted: 11 Dec 2017 Last revised: 8 Apr 2022

See all articles by Awi Federgruen

Awi Federgruen

Columbia University - Columbia Business School, Decision Risk and Operations

Zhe Liu

Imperial College Business School

Lijian Lu

HKUST Business School - ISOM Department

Date Written: November 20, 2019

Abstract

We study a finite horizon, single product, periodic review inventory system with two supply sources and a salvage option. These supply sources are typically capacitated and capacity levels often need to be reserved or installed in advance of the operational planning horizon. The supply sources may thus be differentiated by their lead times, capacities and fixed and variable order costs. Salvage options allow for inventory reductions and incur fixed cost and variable revenues.

We first analyze the tactical problem of determining an optimal procurement strategy under given capacity profiles at the two suppliers. We then address the strategic model in which optimal capacity profiles, both static and dynamically adjusted, are obtained based on two-part capacity contracts.

We characterize the structure of optimal procurement strategies when the lead times of the two suppliers differ by a single period and the lead time for salvage opportunities matches that of one of the suppliers. For general lead time combinations, we show that the optimal procurement strategies satisfy monotonicity and limited sensitivity properties, and construct effective heuristics and upper and lower bounds based on our structural results.

Keywords: dual sourcing, capacity constraints, lead time, inventory management, convexity, dynamic programming

Suggested Citation

Federgruen, Awi and Liu, Zhe and Lu, Lijian, Dual Sourcing: Creating and Utilizing Flexible Capacities with a Second Supply Source (November 20, 2019). Columbia Business School Research Paper No. 18-3, HKUST Business School Research Paper No. Forthcoming, Available at SSRN: https://ssrn.com/abstract=3082943 or http://dx.doi.org/10.2139/ssrn.3082943

Awi Federgruen

Columbia University - Columbia Business School, Decision Risk and Operations ( email )

New York, NY
United States

Zhe Liu (Contact Author)

Imperial College Business School ( email )

Imperial College London
South Kensington Campus
London, SW7 2AZ
United Kingdom

Lijian Lu

HKUST Business School - ISOM Department ( email )

Clear Water Bay
Kowloon
Hong Kong

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