Coordination in Supply Chains With Uncertain Demand and Disruption Risks: Existence, Analysis, and Insights

Many companies with global supply networks suffer from market volatility and supply disruptions, which adversely affect both their short and long-term profits. Although using mechanisms, such as supply contracts, is useful to mitigate uncertainty, the inherent inefficiency of decentralization is a critical issue that needs to be considered at early design stages. This paper studies a supply chain problem where a buyer receives a product from a cheap but unreliable main supplier and signs an option contract with a perfectly reliable backup supplier to share supply and demand uncertainty. To build efficiency benchmark models, we first consider a centralized problem and then explore a decentralized problem where there is only a wholesale price contract between the buyer and the backup supplier. Considering the option contract, we reconstruct optimization problems and sequentially characterize the members´ reservation and production policies under a voluntary compliance regime. Subsequently, we establish a win-win coordination mechanism that maximizes system efficiency and meanwhile is desirable from both contract members´ perspectives. Results reveal that the proposed mechanism leads the backup supplier to choose a lower level of production capacity than the buyer´s reservation amount (i.e., an underproduction policy). We realize that the existing mismatch between the members´ optimal policies is caused by the buyer´s phantom ordering. This paper sheds light on the effectiveness of contract-based mitigation strategies that enable firms to ensure responsive backup capacity under demand uncertainty and supply disruptions.