Contingency Inventory Reservation for Low-Probability High-Impact Events

Contingency Inventory Reservation for Low-Probability High-Impact Events

Sercan Demir (University of Miami, Coral Gables, USA) and Murat Erkoc (University of Miami, Coral Gables, USA)
Copyright: © 2019 |Pages: 20
DOI: 10.4018/IJKBO.2019040101

Abstract

This article investigates reservation contracts for contingency inventory management between two buyers and a single supplier under a game theoretic framework. Two channel structures are considered in this context. In the first setting, the buyers simultaneously move to offer reservation fees to the supplier, who in turn, decides on the inventory amount she wants to carry for each buyer. In the second setting, the supplier moves first and offers nonrefundable-deductible reservation fees for the buyers, who respond with their respective reservation quantities. By reserving through a shared supplier, the buyers enable a contingency inventory pool which alleviates overage risk for the supplier and enables availability of products after low-probability high-impact events. Conditions for successful implementation of contingency reservation contracts are investigated. The results obtained for both channel structures were contrasted. It is shown that in a market where the buyers have more negotiation power, reservation contracts are more likely to achieve inventory buildup under relatively lower event probabilities.
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1. Introduction

Firms must take low-probability big-impact events such as natural disasters and supply disruptions into consideration in their supply planning since they might cause crippling and irreversible effects on businesses. The negative effects of such disasters on global companies might be quite damaging for supply chain operations. For example, Toyota suffered from severe parts shortages when the magnitude-9.0 earthquake and tsunami destroyed many factories in northeastern Japan on March 11, 2011. The company’s global production in March 2011 dropped by 29.9% from a year ago, while its sales in Japan tumbled 45% for the month (usatoday.com 2011). During Hurricane Isaac about 1.3 million barrels per day of crude oil production were shut down and about 3 billion cubic feet per day of Gulf natural gas production were stopped according to the Bureau of Safety and Environmental Enforcement. This resulted with about 564,000 customers left without power in Alabama, Florida, Louisiana, and Mississippi (www.nytimes.com).

The disruptions in supply chains due to the catastrophic events create opportunities for smaller agile firms to capture market share from larger flexible firms. For instance, when the banana plantations in Central America were destroyed by the Hurricane Mitch, Dole lost 4% of its market share to its much smaller rival Chiquita. While Dole had no alternative supply source, Chiquita was able to source banana just-in-time from as far as Australia turning this disruption into an opportunity (Monllor and Altay, 2016).

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