Dual sourcing under supply uncertainty : impact of tariff and shipping cost

Abstract

Supplier diversification is often adopted to mitigate the negative impact of supply uncertainty and increased tariffs in the global supply chain. In this study, we consider a globalized supply chain in which a domestic buyer sources from both a reliable supplier with a high tariff rate (e.g., a supplier located outside a free trade area) and an unreliable supplier with a low tariff rate (e.g., a supplier located in a free trade area) and transport products through the logistics service providers (LSPs) to the domestic market. First, depending on who shall bear the tariff and shipping cost, the buyer and the supplier can undertake one of the following three trading term scenarios: Ex Works (EXW), Delivered at Place (DAP), or Delivered Duty Paid (DDP). Second, based on distinct tariff bases for dutiable value, CIF (Cost Insurance Freight) and FOB (Free on Board) are studied, respectively. We find that, as the tariff rate increases, counter to our intuition, the buyer is more willing to bear the tariff and shipping cost. Interestingly, we also show that dual sourcing remains the equilibrium for the buyer under FOB, whereas single sourcing from the unreliable supplier located in a free trade area can emerge when CIF is adopted and the tariff rate is relatively high. Based on these findings, our paper proposes a short-term strategy associated with tariff adjustment and a long-term strategy with respect to trading term adjustment to help an import market keep business in its own free trade areas.