Reserve Stock and the Effect of Supplier Diversification

Abstract

Reserve stocks are used to protect supply chain operations from interruption effects caused by suppliers’ interludes, delays, quality snags and many other reasons. A deliberate strategy proposed in this thesis is to diversify suppliers in order to smooth out the shortage risk induced from supply interruptions. The model formulated is based on the work of Hansmann (1962) [7] who consider a reserve stock to meet demand in case one source of supply becomes unavailable. Hansmann’s model is expanded to include two suppliers. Subsequently, sensitivity analysis is performed on parameters and variables such as demand rate, percentage distribution of stock between suppliers, expected interruption time, shortage cost and other elements in order to compare the results of a dual-sourcing strategy with that of a single-sourcing strategy. Results indicated that diversification help mitigate shortage risk even when the additional supplier is not superior in terms of cost or reliability. In addition, results show that when having identical suppliers, minimum total cost is incurred when equal amounts are procured from each supplier. In particular, this research indicates that the scenario for the inclusion of a “dominated supplier” to the portfolio of suppliers may be worth taking into consideration. The dominated supplier is characterized by having higher interruption rate, higher mean of interruption time, and higher ordering costs Finally, in this research, the model is extended to include three or more suppliers available for procurement having different characteristics. Results show that for a more diversified system, more benefits in reducing shortage and overall costs are expected.