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20,3
222
Competitiveness Review: An
International Business Journal
Vol. 20 No. 3, 2010
pp. 222-234
q Emerald Group Publishing Limited
1059-5422
DOI 10.1108/10595421011047415
An agile and diversified supply
chain: reducing operational risks
Shuguang Liu and Jun Lin
School of Business, State University of New York, New Paltz,
New York, USA, and
Karen A. Hayes
Ulster Savings Bank, AA/EOE, Kingston, New York, USA
Abstract
Purpose – Recent trends of outsourcing in global competition make the firms vulnerable to operational
risks. The purpose of this paper is to illustrate how firms implement supply chain strategies to reduce
operational risks, especially risk exposure involving catastrophic events.
Design/methodology/approach – Drawn on risk management and supply chain research, the
concepts of operational risk and the underlying demand and supply uncertainties are delineated. Then,
based on literature review and numerical demonstrations, the authors evaluate the effectiveness of
supply chain strategies in reducing operational risks. The paper examines the benefit of these
strategies and illustrate how to setup risk pooling and dual sourcing programs.
Findings – Employing the strategies of risk pooling and dual sourcing, an agile and diversified supply
chain can be built to cope with the demand or supply uncertainties and in turn reduce the operational risks.
Practical implications – Leaders in any organization should consider operational and supply risk
critically when planning their competitive strategy. They could foster creative solutions in supply
chain strategies and essentially enhance competitiveness.
Originality/value – The paper highlights the tension between outsourcing trend in pursuit of
competitive advantage and risk exposure to catastrophic events. This paper fulfils a practical need for
better understanding of how supply chain strategies could be implemented to reduce operational risks.
Keywords Supply chain management, Natural disasters, Risk management, Outsourcing
Paper type Research paper
I. Introduction
Recent trends in global competition have put supply chain risk at the forefront of business
minds. Global markets are increasingly interconnected, outsourcing is a more common
business practice, and companies are restructuring to enhance their core competencies
(Bremmer, 2005). A widely dispersed supply chain could enhance operational effectiveness,
which essentially improve firm performance and competitiveness. However, risk exposure
could erode the benefits, or even harm firm competitiveness. Managing supply chain risk
while maintaining competitiveness builds up tensions for firms in the global economy
(Manuj and Mentzer, 2008). In addition, the impact of natural or man-made disasters
magnifies the impact of operational risks (Waart, 2006). Under these challenges, according to
a recent McKinsey survey, firms are falling behind in their actions to mitigate supply chain
risks (Krishnan and Shulman, 2007).
Events like 911, Hurricanes Katrina and Rita, and the Tsunami of 2004 leave
organizations waiting at the edge, not only to feel the impact personally, but also for the
economic effects to trickle down (Juttner et al., 2003). In this rapidly changing and
uncertain environment, companies need to be able to mitigate potential shocks, react to
changes swiftly, and remain relatively stable in these “choppy waters.” Supply chain An agile and
risk management strategies provide a multitude of ways to navigate these shifting tides diversified
(Tang, 2006).
When a catastrophic event occurs, extreme changes in demand, supply, and supply chain
lead-times become of primary concern. Natural disasters create an immediate need for
items such as bottled water, sanitary food, first aid and construction materials. In the
aftermath of such tragedies, demand for these products can eventually be fulfilled. 223
However, the crucial question becomes: can this demand be filled in the appropriate and
necessary amount of time? In addition to the fluctuation in demand comes a wave
of disruption in supply. Adverse events that have impacted the supply chain, in recent
years, vary widely from natural disasters to man-made catastrophes. Some examples
are: various labor strikes, the Taiwan earthquake, an Ericsson supplier fire, multiple
corporate failings, a tire recall, the 911 terrorist attacks, the Iraq war, the severe acute
respiratory syndrome outbreak, blackouts, and Hurricanes Katrina and Rita (Deleris
and Pate-Cornell, 2004). Each of these can be traced to have some rippling effects on our
economy, not only on demand, but also supply.
Balancing demand and supply is one of the most commonly expressed tenets
of business. Without dependable supply, an organization cannot guarantee that it will
be able to fulfill demand, and consequently provide revenues for the company to sustain
operations. Managers take precautionary steps to avoid disrupting supply. When we
speak of supply chain risk management, there are typically two types of uncertainty:
demand and supply. We will discuss operational risks in general first, then examine each
of the two types of uncertainty and focus on how to reduce risk, especially when faced
with a catastrophic event. We present two major strategies to reduce the likelihood that
this type of event cripples a company’s supply chain: risk pooling and dual sourcing. In
addition, we will discuss the possible cost benefits of employing these two risk-reducing
strategies. As such, we try to shed additional light on approaches to managing supply
chain risk, a direction pointed out by Khan and Burnes (2007).

II. Operational risk

Beth, the operations manager of one of the largest pet accessory retailers, is making her
morning commute to work. On the radio she hears about civil unrest overseas. Normally,
this would be a story that Beth would take in as information about the world and
continue on with her day, but this strike is adversely affecting the city of its main
supplier. Unfortunately, they are the sole manufacturer of the fall dog sweater line, the
hottest new craze of the season that is slated to hit the stores in exactly two weeks. This is
the biggest run they have done and the success of the company depends on it. What was
once a leisurely ride is now a race to save the corporation.
Jeffrey, the chief executive officer (CEO) of a medical supply distributor in New
England, is reviewing the most recent sales reports. This morning his sales manager made
an urgent request for a meeting. As he shakes a chill and sneezes, Jeffrey is aware that
there has been an unusual amount of people absent from work recently. This has left him
shorthanded, especially in light of an abnormal increase in sales. As the sales manager
enters the CEO’s office, he does not say a word. Instead, he slaps down a report from the
World Health Organization titled “Flu season in New England – this is the worst year yet.”
The above vignettes are not actual accounts, but do represent what could be a
genuine nightmare for any executive. Catastrophes like these can lead an organization
CR into pandemonium or collapse if there is not a risk management strategy in place. Risk
20,3 management could have saved these executives from a large amount of stress and
scrambling. For example, if Beth had two suppliers producing this very important line,
her job would not be to miraculously pull another supplier from a hat, but rather to go to
plan B of maximizing the second supplier’s capacity. If Jeffrey had an inventory sharing
plan in place with his southeast partner, he would not have to bear the brunt of an
224 overwhelming demand alone.
Risk in an organization can generally be described as any exposure that creates a
potential threat to the life of the business. These threats can be categorized into four main
areas: financial, operational, compliance, and strategic. All of these risks are important for
an organization to assess and mitigate. Financial risk relates to how the organization
funds its operations, i.e. does the company have enough money to do what it needs and
wants to do? This area also concerns any investments that the company makes and the
fluctuations in exchange rates. Compliance risk has to do with the ever-changing body of
laws that govern businesses. More than ever before, businesses are required to track and
report statistics, send notices to customers, and comply with strict security requirements
(Pundmann and Kobel, 2003). Strategic risk covers a wide array of external events that
threaten a company’s ability to sustain operations. It can be separated into seven major
areas: industry, technology, brand, competitor, customer, project, and stagnation (Drzik
and Slywotzky, 2005). This paper will focus on operational risk for general businesses and
describing its components in detail. More specifically, we will focus on operational risk
associated with external stakeholders – supply chain risk. We will discuss three forms of
uncertainty that executives are faced with: supply, demand, and lead-time. The two
vignettes given above are a preview of risk solutions that will be discussed in specific.

Risk management as an executive responsibility

Typically, in most small to mid-size companies, risk is managed by all executives and
managers concurrently. The president of the organization might spearhead an initiative
to get the whole team on board, but there is not only one person responsible for managing
risk. In the last decade, large corporations began appointing the chief information officer
(CIO), as the main person responsible for managing risk. general motors, for example,
has appointed CIOs that work within each business unit to ensure the integration of
technology and help maintain its security. This not only improves reporting and
analysis, but also enables division managers to monitor for threats and make projections
on which to base risk decisions.
The most recent development in risk management is that many large companies have
appointed a chief risk officer (CRO). This is an executive position that is responsible for
managing risk company-wide by recognizing and prioritizing potential threats, coming
up with solutions to protect the organization, implementing systems that alleviate
disruptions, and creating systems to measure all of the above. Technology enables the
CRO to monitor and analyze the performance of current risk systems and look for trends
that might dictate that a new system needs to be put in place. Often, a CRO will work
closely with a CIO. The CRO function is to develop and implement solutions. The CIO
develops and implements the data control solutions that support the CRO’s initiatives.
Companies making the most of these executive positions have found them to be more
than just a patrol of the internal and external environment, but also a key set of skills
used as input in making strategic business decisions.
Operational and supply risks An agile and
Generally, operational risk has been defined as “the risk of loss resulting from inadequate diversified
or failed internal processes, people, and systems or from external events” (Banking
Supervision, 2004). Here, “external events” may include interactions with nature, the supply chain
community, government, and strategic partners. A company faces operational risk from
external organizations it has to align with. For example, when a purchaser depends on a
supplier, the purchaser absorbs a certain amount of the supplier’s risks. This is one reason 225
that many organizations have chosen to develop strategic partnerships with these
affiliates, as opposed to a deadpan buyer-supplier relationship. A supplier can invest
capital into reducing the suppliers risk and consequently its own.
Supply chain risk focuses more on operational risks associated with external
stakeholders – suppliers and buyers. It encompasses all functions of the business related
to supply and demand activities, internally and externally. When one follows a product’s
life cycle, supply chain risk would include all of the people, processes, systems and
physical property involved from beginning to end. This includes but is not limited to the
following areas: product design, marketing, suppliers, distribution, and customers.
Similar to operational risk, supply chain risk includes the risk absorbed from any outside
company that is utilized along the length of the supply chain. Supply chain risk can also
take other more unexpected forms. For example, a predominant political figure has an
environmental concern about your property; the exchange rate of your main suppliers
country is fluctuating rapidly; there is a strike in the port you utilize and no containers are
being unloaded; trade embargoes and sanctions restrict or make exchanges costly.
Traditionally, the main strategy to reduce risk was to be insured. Alas, insurance
companies are changing their policies to be more restrictive. After 911 and Hurricanes
Katrina and Rita, US insurers are realizing that in the face of major tragedies, they cannot
sustain operations as previously composed. After a catastrophe, insurance companies
must juggle requests for new policy coverage at the same time they are processing large
claims and requests for payouts. Catastrophic events have an impact on both supply and
demand for many industries. For example, the retail fashion industry after 911 was left
with fewer customers and too many dresses. Also, the airline industry was faced with
customers afraid to fly and therefore many empty seats (Stauffer, 2003). Organizations
must now get creative in coming up with solutions that create their own protection and
security, and try to disaster-proof their supply chains (Reese, 2007).
Another strategy of managing supply chain risk is through the positioning of
inventory. The idea is to carry less inventory and trim production utilizing just-in-time
methods. Companies are seeking economies of scope and going global to procure a low
cost per unit. Unfortunately, these cost reducing methods also produce increased risk.
It has been suggested that the supply chain can be improved by thinking strategically,
broadening cooperation, considering tradeoffs, and acknowledging even unquantifiable
risks (Stauffer, 2003). In addition, making the supply chain more flexible, as shown below,
will decrease risk and may achieve cost benefits as well.

III. Managing two types of uncertainty

Demand uncertainty
The most common form of mitigating demand uncertainty is to make extensive
forecasts. However, these extrapolations are usually wrong, especially for long-term
planning. Rather, a forecast of a collection of demands for a single product in a short
CR period of time will be more accurate (Simchi-Levi et al., 2003). Capitalizing on this fact,
20,3 risk pooling allows an organization to combine demands and variability for multiple
locations and forecast the total demand, thus making it more accurate. Risk pooling
across locations refers to the strategy that multiple locations hold their inventory at one
central warehouse. There are two important advantages of this risk mitigating strategy:
(1) Accuracy. Any unpredictable changes in demand seen by one location will be
226 offset by the lack of unpredictability in another location.
(2) Cost. When inventory is held at one location for one retailer, it is necessary to hold
safety stock to satisfy the variable shifts in demand. In contrast, risk pooling
combines the safety stocks; thus less safety stock is necessary to support the
swinging demand patterns for multiple locations, which in turn reducing total
inventory costs (Simchi-Levi et al., 2003).

Supply uncertainty
Supply uncertainty is the likelihood that an event prevents inbound supply from making
its way to the purchasing firm, therefore crippling its ability to meet demand and
consequently harming the organization (Zsidisin, 2003). In choosing a supply strategy,
most companies put a high priority on increasing expected return. They may find a
supplier that can offer a very low cost per unit, but at the expense of being far away and
unreliable. Although this sole source offers an increase in expected return, it also
presents increased risk. If something were to happen with this sole source, the supply
chain is disrupted. A prime example of this is when Ericsson lost an estimated $2 billion
in 10 minutes. A fire that happened at its chipmaking source left Ericsson with no
alternative. Since this disaster, Ericsson has developed and implemented a supply chain
risk management strategy that includes identifying, analyzing, and managing internal
and external risks for both the company and its suppliers and sub-suppliers (Norrman
and Jansson, 2004). This results in lowered risk for all parties as well as lower insurance
premiums. Such a strategy is both proactive and reactive, relating risk consequences to
time (business recovery time) and money (business interruption value).
Supply uncertainty as a whole can be reduced using a dual sourcing strategy. Dual
sourcing resolves the increased risk of a single supplier by supplementing with another
more reliable supplier. Adding another supplier decreases the expected return, but in turn
lowers the risk variance and deviation from the mean. As in the Ericsson case, the
marginal short-term increase in cost is offset by the relief of costly business interruptions
in the long-term. This is not a short-term plan for those looking to fill their pockets today,
but rather long-term stability that will provide a more consistent expected return.
Additionally, the purchaser is provided with a contingency plan, making the supply chain
more flexible.

IV. Sharing burdens with risk pooling

As mentioned before, risk pooling is the aggregation of similar risks that will reduce the
total risk any one party bears. It capitalizes on the mathematical fact that the demand for
any one product can be more accurately predicted for a collection of retailers, as opposed
to just one. The risk pooling analysis below will show that there is a cost benefit as well.
One form of risk pooling is when multiple locations combine inventories at a
centralized warehouse, sharing inventory and safety stock costs with other members of
the same organization. In a decentralized (unpooled) system, each location holds
an on-hand inventory plus a safety stock, in order to cover any unexpected increases in An agile and
demand. In a pooled scenario, each location holds the bulk of inventory and safety stock diversified
in the centralized warehouse, thereby sharing the costs for both physical space and
safety stock. Example 1 illustrates this situation. supply chain
Example 1: risk pooling across locations to reduce demand risk
Suppose there are two retailers of a product. The table provides historical data of weekly 227
demand for the last eight weeks at each retailer. Assume the product is replenished from
a supplier with the same lead time of two weeks for both retailers. And the ordering cost
is $50 per order and inventory holding costs $0.30 per unit per week. To deal with the
demand uncertainty, safety stock is held to reach a 95 percent service level. Table I
shows the related information.
Without pooling, using economic order quantity model the retailers order 102 and 107
units, respectively. Safety stocks at each retailer are 20.56 and 24.46 units. The total
safety stocks from these two retailers are 45.02 units. On average, the inventory held is
safety stock plus half of the order quantity. Thus, the average inventories are about
72 and 78 units, respectively. These numbers are shown in Table II.
With pooling, the demands from two retailers are combined together. The average
demand faced by the pooled system is the sum of the average demand faced by each
of the Retailer 1 and 2. However, the demand variability (measured by standard
deviation) faced by the pooled system is much smaller than the combined variability
faced by each retailer, 12.37 vs 19.35 to be exact. In the pooled system, the safety stocks
and average inventory are 28.78 and 102 units, respectively, resulting a net saving of
16 units in safety stocks and 45 units in average inventory. Furthermore, as the
correlation between the demands at two locations decreases (moving towards 2 1), the
savings in safety stocks and average inventory increase. In other words, if the demand
patterns at the two locations are much different, there will be more savings in safety
stock and average inventory resulted from pooling.
Cadillac is using this form of risk pooling to its advantage. There is a central
distribution center in Florida. Each dealer has models in its showroom that are available
for test driving, but no cars that will be sold off the lot. Instead, when customers place
an order, their vehicle is customized at the distribution center according to the package
they ordered. It was reported that the ability to combine forecasts for all the Florida

Week 1 2 3 4 5 6 7 8

Retailer 1 30 43 18 29 41 23 27 38
Retailer 2 42 29 37 31 24 44 16 46
Total 72 72 55 60 65 67 43 84 Table I.

Average demand SD Order quantity Safety stock Average inventory

Retailer1 31.13 8.84 102 20.56 72

Retailer 2 33.63 10.51 106 24.46 77
Pooling 64.75 12.37 147 28.78 102 Table II.
CR dealers have increased the level of customer service and made predictions more accurate
20,3 (Sheffi, 2005).
Another form of risk pooling is postponement. Retailers can standardize the basic
form of multiple models or brands, leaving customization until closer to the end of
the product life cycle. By doing this, the demand for multiple products at the basic level
can be aggregated, and thus more accurate. If demand for one product goes down, the
228 leftovers do not have to be scrapped, but rather can be utilized by another product line.
For example, HP has done this with its printers to more accurately forecast and respond
to demand. The basic form of the printer sold globally is manufactured and then shipped
to the area that it will eventually be sold in. Once it arrives, it is customized to the local
needs, i.e. plugs that match that of the country in which it will be sold and instructions
and manuals in the native language (Sheffi, 2005).

Setup risk pooling

Risk pooling attempts to hold in balance the delicate combination of localized service
and keeping down inventory costs. The company that coordinates for customers is
concerned with the amount of time it takes to get a part or product. The closer the central
location is, the less time it should take to receive the inventory. Risk pooling can be used
to lower inventory costs while maintaining the ability to get the products in a timely
fashion. For example, consider an auto parts store located in a large city. If the central
depot is located within the city limits, it may take no more than a few hours to get the
product needed in hand. With the multitude of auto-shops and cars located within the
city limits, it is likely there would be cost effective to locate a central warehouse close by.
On the other hand, consider a tractor service center. The end-users are mostly farmers,
spread out in the countryside. The nearest service location is likely to be quite a distance,
and even further would be the parts provider if not on site. It would be costly for a tractor
repair service to keep a plentiful amount of all tractor parts on hand. Risk pooling allows
them to procure the parts needed, as long as they arrive in time to provide the service.
This is when transshipment policy becomes an issue. Some questions to resolve before
setting up risk pooling are: where will the central warehouse be? How many locations
will participate? How quickly will we need to get the products and how will that happen?
Using our own transportation or utilizing an outside organization? What will be our
transshipment policy?

Further findings about risk pooling

The typical newsboy vendor scenario shows how a company can approach economies
of scale by pooling their inventory in a central warehouse. Consolidated demand for each
location reduces total holding and penalty costs (Eppen, 1979). One of the building
blocks of risk pooling was the concept that service levels could be increased through the
use of lateral transshipment between two locations (Tagaras, 1989). Further exploration
of a group of three retailers and one central warehouse revealed that risk pooling
has advantages in reducing total system costs and improving customer service.
The advantages increased exponentially with the number of locations. Risk pooling
concept can be used to solve the supply chain network design problem. Snyder et al.
(2007) introduced a stochastic location model with risk pooling, which simultaneously
optimizes location, assignment, and inventory in a supply. For example, ALKO Inc.
has over 100 parts which are stored in five different DCs in five different regions.
The company needs to determine whether it should consolidate all or some of its parts in An agile and
a central warehouse. diversified
Careful consideration of the mathematics of risk pooling reveals that the benefit of
risk pooling is greater for two locations that have different variations in demand. If there supply chain
are two locations that see a drastic increase in demand at the same time, they will both
require the same magnitude of inventory from the central warehouse and possibly safety
stock. This may strain the limits of supply. Thus, risk pooling is not a substitute for 229
planning ahead, but rather a strategy for cutting costs and satisfying unexpected shifts
in demand (Simchi-Levi et al., 2003).
Although the risk pooling system produces a cost savings in most cases, this may not
be so for items that are used infrequently and are costly to hold in inventory. A scrutiny
of this situation reveals that the ability to move the product quickly through the levels in
the supply chain will reduce the overall cost of providing the service (Grahovac and
Chakravarty, 2001). The use of risk pooling will not always reduce the total inventory
necessary for these low-demand expensive items.

V. Diversify portfolio using dual sourcing

To achieve economies of scope, many firms are choosing to produce their goods in
developing countries. Emerging markets usually offer a surplus of labor and materials,
improving a manufacturer’s ability to lower their cost per unit, especially in comparison
to developed countries (Khanna et al., 2005). However, with this cost advantage comes
risk. The region may become hostile, or transportation between countries may become
restricted or very expensive. The economies of scope could easily become distorted.
If a company only has one supplier, a portion of its risk is specifically associated
with that supplier and its supply chain. In addition to choosing a supplier, the buyer also
chooses the national environment where the source is located. This environment includes
variances in the political and social systems, economic openness, labor and capital
markets, and finally product markets (Khanna et al., 2005). These attributes implicate
possible risks and ultimately disturbances in the supply chain from transportation
logistics, trade restrictions, political corruption, and even civilian hostility. With only a
single source as the supplier, the buyer is bound by these risks.
One specific strategy to mitigate supply risk is dual sourcing. With this strategy, a
company obtains goods from two separate suppliers simultaneously. The two companies
are opposite in many respects: domestic/costly/reliable vs foreign/unreliable/cheap. In this
case the main supplier offers a low price per unit, but also the aforementioned national
risks. The buyer maintains a relationship with a second source: a domestic supplier not
offering as low a price per unit, but a more reliable and stable supply, i.e. lower risk.
The local supplier’s proximity offers the peace of mind that in an emergency state, the
buyer would be more likely to get product to their customers when they need them.
By diversifying the portfolio of suppliers, risk is dispersed across multiple players,
therefore decreasing the impact any single player can have on the supply stream
(Kamrad and Siddique, 2004). In the case of a catastrophic event, the foreign supplier
might not be able to transport or even produce goods. The buyer has the alternative to
maximize its domestic supplier relationship in an effort to supplement and maintain a
steady supply.
In short, dual sourcing gives the buyer the advantage of lowered risk by balancing two
coveted forces: a cheaper cost per unit and the security of a reliable supply. Large successful
CR companies are using this strategy to their benefit. For example, Geberit, a large Swiss
20,3 sanitary fixture manufacturer, either retains an existing supplier as a second source, or
develops a second source in Asia. Companies can choose to meet ten to 20 percent of their
needs from a second supplier, which generally will work hard in hopes of displacing the
primary supplier. Service-level agreements can call for rapid ramp-up if required (Bovet,
2005). Another example is Griffin Manufacturing of Bedford, Massachusetts, one of the
230 largest players in manufacturing athletic apparel (Sheffi, 2005). Griffin Manufacturing uses
a multi-sourcing approach by utilizing a plant in Honduras that manufactures a portion of its
products at a high volume and low cost. There is also another plant in Massachusetts that is
closer, offering a more flexible option when short-term demands vary.

How does it work?

When setting up a supplier network, managers must choose between entrusting
their orders to one supplier alone, or using multiple suppliers. Choosing a dual sourcing
strategy is like investing in insurance. It offers protection against the threat of a
disruption in supply and a platform for mitigating the uncertainty of lead-times. The
dual sourcing approach includes a variety of situations that attempt to resolve both of
these issues. These solutions do not eliminate risk completely, but certainly diminish the
likelihood of a catastrophe crippling the supply chain.
One example of a dual sourcing situation is when one source is reliable and the other
is unreliable. An “unreliable” supplier is defined as having a lengthy and unpredictable
lead time, while offering a discount to counteract this disparity. The “reliable” supplier is
exactly opposite, offering predictable lead-times but a more expensive cost per unit.
Example 2 shows a numerical illustration of this situation.

Example 2: dual sourcing to deal with supply risk

A US company considers sourcing a product from a local supplier and/or an oversea
supplier. The oversea supplier offers a lower price. However, the oversea supplier may
not be able to deliver with some small probability while the supply from the local is
guaranteed. Assume that the sales of the product in the coming selling season are
forecasted to be 10,000 units and the product is sold at $200 each. The oversea supplier
delivers the products at $50 a piece and the local at $75 per product. Further assume that
the fixed costs related to the product are $10,00,000. The company estimates that the
supply risk of the oversea supplier not being able to deliver for the season is 1 percent.
Under a dual supply arrangement the local supplier may be given a portion, say
20 percent of the business if it guarantees to supply all of the company’s requirements
should the need arise. Table III lists all these information.
We have three arrangements of sourcing: oversea supplier only, local supplier only,
and dual sourcing:

Dual arrangement (%)

Risk of disruption (%) Purchase price ($) No disruption Disruption

Local supplier 0 75 20 100

Table III. Oversea supplier 1 50 80 0
 (1) Using only local supplier, the profit for this product is calculated as: An agile and
P1 ¼ (200 2 75) *10,000 2 10,00,000 ¼ $0.25 m. diversified
(2) Using only oversea supplier and without disruption, the company expects a profit supply chain
of $0.5 m, calculated as (200 2 50) *10,000 2 10,00,000 ¼ $0.5 m, while with
disruption $1 m loss. Considering the 1 percent disruption rate, this arrangement
has half a million profit 99 percent of the time, and risks a loss of one million 1 percent
of the time. The expected profit is: P2 ¼ 99% *0.5 m þ 1% *(21 m) ¼ $0.485 m. 231
(3) Under dual sourcing, if there is no disruption, the profit when using dual
manufacturing will be: 80% *0.5 m þ 20% *0.25 m ¼ $0.45 m.

If there is a disruption, the local manufacturer will supply the products and the company’s
profit will be $0.25 m. Taking into account that in case of a disruption the company will be
able to use the local supplier, the expected profit when operating with dual suppliers is
calculated as: P3 ¼ 1% *0.25 m þ 99% *0.45 m ¼ $0.448 m. These numbers are shown in
Table IV.
Considering both the expected returns and the risk associated with those returns,
dual sourcing may be a better arrangement than use only one single supplier.
Another variation of dual sourcing involves multiple suppliers competing for a
contract. This rivalry provokes the players not only to extract from negotiations the
best price and service combination (Klotz and Chatterjee, 1995); but also to create an
accelerated phase of learning. One dual sourcing model describes the scenario of
potential suppliers guaranteed a portion of the total order while bidding on a competitive
portion. The buyer invests its possible gain in the first period to subsidize and secure
supplier entry. The supplier strategically forfeits gain in this period to secure its portion
of the competitive order. In the second period, both buyer and suppliers see a return
on their investment; realizing the gain of dual sourcing. Another advantage to this model
is that “dual sourcing early-on controls the rate at which suppliers move down their
learning curves, thus mitigating problems associated with future cost asymmetries”
(Klotz and Chatterjee, 1995). By strategically staging this rivalry, the suppliers and
buyer take advantage of dual sourcing to induce a cost saving competition.
Some dual sourcing strategies highlight lead-time as a main factor to consider. When
working with a sole source, a buyer is bound by the timeframe of the one supplier, with
little if any flexibility. On the other hand, choosing to use many suppliers with different
lead times allows the buyer to coordinate and maximize the strengths of each. In addition
to added agility, lead-time can also be a negotiating tool. When a supplier cannot comply
with an agreed upon lead-time, the longer-than-expected lead-time could be exchanged as
a rebate, lowering the cost per unit. Some organizations choose to help their suppliers work
efficiently by investing capital in improving the facility. This is a strategic investment as it

Profit when no disruption Profit when disruption Expected profit

(99%) ($) (1%) ($) ($)

Local supplier (m) 0.25 0.25 0.25

Oversea supplier (m) 0.50 21 0.485
Dual arrangement (m) 0.45 0.25 0.448 Table IV.
CR improves relations, efficiency and cost for both companies, creates a strong bond, and
20,3 positions the two organizations more as partners.

Further findings about dual sourcing

Researchers have analyzed the scenario presented in Example 2, exploring the different
levels of discount and percentage of the order to split that would maximize the total cost
232 of the full order, also considering the cost of transportation and logistics. They showed
that dual sourcing can provide savings on “annual inventory-logistics” when the right
split and combination of terms are negotiated (Ganeshan et al., 1999). When examining
the cost benefit of dual sourcing as compared to a single source, the mathematical
evaluations clearly show that there are significant saving opportunities when utilizing
dual sourcing (Ramasesh et al., 1991). Dual sourcing has been cited as advantageous
for not only buyers, but also suppliers. A competition inducing game of bidding and
reservations can be employed to feature a mutually beneficial relationship (Klotz and
Chatterjee, 1995). The producer-supplier relationship, when maintained as flexible
and aware of risk, will produce a competitive environment that is beneficial to all parties
(Kamrad and Siddique, 2004). Ryu and Lee (2003) propose lead-time reductions as an
investment that can be strategically implemented while utilizing dual sourcing. They
consider the dual sourcing scenario of lead time reduction as an investment to reduce
inventory operating costs. The results of their analysis show that investing in lead time
reduction can produce a significant savings in the expected total cost. More recently,
Yu et al. (2009) identified two critical values of the disruption probabilities, which
provide a guideline for choosing the most profitable sourcing method for the buying
firm. They argue that either single or dual sourcing can be effective depending on the
magnitude of the disruption probability.

VI. Conclusions
Catastrophes happen, whether they are manifested by man or nature. Leaders in any
organization should consider operational and supply risk critically when planning their
competitive strategy. Taking these precautionary steps forces a company to become
aware of the options and possible advantages of a solution. The strategies discussed
previously show that risk management strategies can provide additional benefits. Risk
pooling improves a company’s ability to react to sudden shifts in demand, while
simultaneously cutting total inventory costs. Dual sourcing reduces risk, generates a
more consistent expected return, and encourages a competitive environment that will
lead to lower costs. Exceptional leaders consider risk less of a threat and more of an
opportunity to foster creative solutions and enhance competitiveness.

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Corresponding author
Jun Lin can be contacted at: linj@newpaltz.edu

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