Supply diversification under random yield : the impact of price postponement

Abstract

Supply diversification and pricing are two common mechanisms for dealing with supply yield uncertainty. This paper characterizes a firm's pricing and sourcing decisions under supply yield uncertainty, and studies the interplay between the two mechanisms. We compare the optimal sourcing decisions under two distinct pricing schemes: (1) ex ante pricing—the firm simultaneously makes the sales price and sourcing decisions before production takes place; (2) responsive pricing—the pricing decision is postponed until after the production yield realization. Although the firm is better off with responsive pricing, the effect of price postponement on the optimal sourcing decision and the firm's need for supply diversification varies and is influenced by factors such as unit procurement cost, supply portfolio, and supply reliability. For the case of one unreliable supplier, we show that responsive pricing mitigates the overage and underage risks imposed by yield uncertainty, and results in a lower optimal order quantity than that under ex ante pricing when the procurement cost is low, and a higher quantity otherwise. For the case of two unreliable suppliers, we show that responsive pricing promotes supply diversification when the sole-sourced supplier's reliability is low, and discourages when it is high. By contrast, when the sole-sourced supplier's reliability is moderate, responsive pricing promotes supply diversification when its unit procurement cost is low and discourages otherwise. The composition of supply portfolio also has a fundamental impact on such strategic interplay: When the supply portfolio consists of one unreliable and one reliable supplier, diversified sourcing is never optimal under ex ante pricing, but may be optimal under responsive pricing. Thus, responsive pricing promotes dual sourcing in this setting. We also conduct comprehensive numerical experiments to both confirm the robustness of the main results and derive additional insights.