Inventory management with three suppliers under yield uncertainty and loss-aversion

In this paper, we consider a single-product, single-period inventory model where the retailer can order from three different suppliers. Supplier 1 is the cheapest but the most unreliable as the retailer may not get as many as he ordered. Supplier 2 is more expensive than supplier 1 by offering a supply option. supplier 3 is the most expensive but most reliable and will serve as an emergency supplier. Employing a loss-aversion utility function, we study the procurement problem for the retailer. In this model, the loss-averse retailer has to decide the order quantity from supplier 1 and reserve the order quantity from the supplier 2. We find that there exists an optimal solution no matter whether the retailer is loss-averse or not. We show by numerical experiments how the optimal decisions are affected by cost parameters, and find that the optimal order quantity from supplier 1 increases by the degree of loss-aversion while the reserve quantity from supplier 2 changes in a reverse way. Furthermore, the expected utility of the retailer decreases by the degree of loss-aversion.