One of the many painful lessons of the COVID-19 pandemic is that the world’s supply chains are highly vulnerable to external shocks, especially when manufacturers rely on a single source for the parts that they need. This issue created a severe problem when governments and ventures were racing to ramp up COVID-19 vaccine production. Offering cutting-edge insights for researchers, practitioners and policy makers, Lijian Lu of HKUST and colleagues demonstrate the benefits of dual sourcing in the post-pandemic era and reveal the optimal procurement strategy for a manufacturer with two suppliers.

“Manufacturing companies and retail chains often have or can create access to two alternative supply sources for component parts, product modules, finished goods, or supply materials,” say the researchers. One of these sources is typically low cost but has long lead times, while the other responds more quickly but at a higher price. Although offshore sourcing—offering price savings at the expense of a lengthy turnaround—was the trend in recent decades, more and more companies are turning to onshore options to offset the increased inventory costs and stockout risks associated with long lead times. As the researchers note, “the COVID crisis has incentivized many companies to open up an onshoring or near-shoring option in parallel to their ‘regular’ source.”

Indeed, according to the authors, “many companies have come to realize that a hybrid approach employing two or more suppliers, simultaneously, is, frequently, considerably more effective than one that relies on a single supplier.” However, companies that utilize two or more suppliers face an important challenge: choosing the optimal timing and amount of their orders with each supplier, given suppliers’ differing prices and lead times. “The objective is to minimize expected total costs over the full planning horizon,” the researchers say.

To address this challenge, the authors first develop a general model involving the use of so-called “two-part capacity contracts,” in which manufacturers reserve a particular number of orders before the start of their operational planning horizon. “The practice of reserving or installing capacities with one or multiple suppliers has been particularly prevalent in industries with high demand volatility,” note Lu and colleagues, “or under global supply scarcity.” In the presence of two suppliers, the authors propose, “two part contracts are an ideal mechanism to share the risk within the supply chain.” This approach enables manufacturers to reserve capacity up front while controlling the predictability of costs.

To test their model, the authors conduct a numerical study to determine how the capacity levels (i.e., number of reserved units) selected by manufacturers vary with suppliers’ reservation and execution cost rates. They are then able to identify the optimal procurement policy “in the presence of two suppliers, differentiated by their lead time and per-unit cost price.”

These findings provide practical insights for supply managers. First, “the benefits of dual sourcing increase with the total capacity in the system, albeit with decreasing marginal returns to scale.” Second, dual sourcing is always beneficial when the onshore/expedited (and more expensive) supplier is used alongside (not instead of) the regular supplier. The authors’ general advice to managers is to use the expedited supplier as an infrequent backup to handle volatile demand and situations in which lead time is markedly shortened.