Sourcing under Volatility: Offshoring, Onshoring or Both?

Abstract

We study a dual sourcing problem in an increasingly volatile world. We consider two types of volatilities. The first type models fluctuating economic conditions via an underlying Markov-modulated state-of-the-world which affects the two suppliers' cost structures, capacity limits and demands. The other type of volatility affects the actual outputs resulting from random supply processes. We develop two approaches to show how the optimal combined ordering strategy from the two suppliers, along with a salvaging policy, can be efficiently computed, and characterize the relatively simple structure of the optimal policies. We also present various comparison results of the expected total costs under different environments. We find that the firm can, by exploiting the dual sourcing options, benefit from environmental volatilities that affect the suppliers' cost structures or capacity limits; indeed, benefits increase as volatilities increase in specific ways. Numerical studies illustrate these results and reject other reasonable conjectures.

Keywords: dual sourcing, Markov modulated models, random supply mechanisms