Accidents, natural disasters, labor strikes, quality issues, machine breakdowns… such supply disruptions are the stuff of nightmares for senior managers. Two strategies widely used to mitigate these problems are source diversification and demand/pricing management.

Researchers Xiting Gong, Xiuli Chao and Shaohui Zheng studied more efficient strategies of dealing the issues above through joint pricing and inventory control. They investigated a firm that encounter price-sensitive random demands and has a quick-response supplier and a regular supplier that may suffer random disruptions. Their aim was to characterize the optimal sourcing and pricing policies over a planning horizon, and identify the impacts of sourcing diversification and supply reliability on the firm, on its customers, and on its suppliers.

The model they used for this study captured several features, namely unreliable supplier, multiple sourcing, different lead times and shipping modes, and coordination of pricing and inventory decisions.

Their work showed that the optimal inventory policy is a simple reorder point policy, and the optimal price in each period is a decreasing function of the starting inventory level in that period; and for the special case where the quick-response supplier is perfectly reliable, the optimal inventory policy is of a base-stock type and the optimal pricing policy is a list-price policy with markdowns. In addition, the study showed that both the firm and its customers benefit from sourcing diversification and higher supply reliability. It also illustrated the impact of sourcing diversification on the existing suppliers of the firm: if the selling price is exogenously fixed, then a supplier will be always worse off when an additional supplier is introduced; however, if the selling price is part of the decision, then a supplier could be better off when a competitor is introduced. They also find that a supplier does not always receive more orders when it has higher reliability.

This research was the first to consider the joint pricing and inventory control problem for a firm with dual unreliable suppliers of different lead times and disruption risks. It was also the first to analyze the impacts of source diversification and supply reliability on all three parties of the supply chain: the firm, the suppliers, and the customers, in a dynamic and stochastic setting.