Impact of Disruption Risk at Different Supplier Tiers

Abstract

We consider a three-tier supply chain, where a tier-0 firm (OEM) can source from two potential tier-1 suppliers, and each tier-1 supplier can source from two potential tier-2 suppliers. Either a tier-1 or a tier-2 supplier is susceptible to disruption risk. We study the impacts of disruption risk at different supplier tiers on the performance of both centralized and decentralized supply chains, and further characterize supplier selection strategies of the OEM and tier-1 suppliers in the presence of fixed sourcing costs. We formulate the two stage decision problems (i.e., supplier selection and production stages), then solve the optimal/equilibrium sourcing strategy and production quantities. Our results show that without fixed sourcing costs, the central ized supply chain yields a lower profit under an unreliable tier-1 supplier than an unreliable tier-2 supplier. This result is reversed in the decentralized supply chain if the disruption probability is high. Such insight continues to hold when (1) each tier has multiple firms and more than one unreliable firm in the unreliable supplier tier, and (2) considering more than two supplier tiers of the OEM. With fixed sourcing costs, the centralized system is less inclined to source from an unreliable tier-1 firm than an unreliable tier-2 firm. In the decentralized supply chain, with the increase of fixed sourcing cost, the OEM’s sourcing strategy changes from dual sourcing to single sourcing when a tier-1 supplier is unreliable, but surprisingly, it can switch from single sourcing back to dual sourcing when a tier-2 supplier is unreliable and has very low or high disruption probability. Our results suggest that competition and double marginalization in the decentralized supply chain can alter the relative impact of disruption risk at different supplier tiers on the supply chain’s sourcing strategy and profitability; in addition, these results underscore the importance of supply chain visibility into sub-tier suppliers’ risk profiles

Keywords: supply disruption, sourcing strategy, supply chain network structure