Supply Disruption with a Risk-Averse Buyer

Abstract

We consider a supply chain with two unreliable suppliers competing to supply one risk-averse buyer. We model the interaction among the supply chain participants as a Nash game among the suppliers, and Stackelberg games between the suppliers and the buyer. By introducing risk aversion, the buyer implements a spectrum of distinctive diversification and order inflation strategies, instead of the extreme ordering strategies of single sourcing, duplicate sourcing and various boundary ordering strategies in the risk-neutral case. In the case of exogenous wholesale price, we fully characterize the buyer's optimal order quantities. We find that the more reliable supplier can possibly increase his market share by increasing his wholesale price. In the case of endogenous wholesale prices, we find that cases of non-existence, uniqueness and multiplicity of equilibria can all possibly occur depending on the level of risk aversion, and we characterize the equilibrium in some cases. We also find that as the buyer becomes more risk averse he is less sensitive to the wholesale prices in terms of order quantities, giving more power to the suppliers to exploit the buyer's risk.