Safety Stock, Excess Capacity or Diversification: Trade-Offs under Supply and Demand Uncertainty

Aadhaar Chaturvedi, Victor Martínez-De-Albéniz

Research output: Contribution to journalArticle

Abstract

Firms mitigate uncertainty in demand and supply by carrying safety stock, planning for excess capacity and diversifying supply sources. In this study, we provide a framework to jointly optimize these three levers in a periodic review infinite horizon setting, and in particular we examine how one can reduce inventory and capacity investments through proper diversification strategies. Observing that a modified base-stock inventory policy is optimal, we find that the capacity-diversification problem is well behaved and characterize the optimal mix of safety stock, excess capacity and extra number of supply sources. We find that higher supply uncertainty results in higher safety stock, more excess capacity, and higher diversification. But safety stock and diversification are non-monotonic in demand uncertainty. Our results can be extended to situations in which suppliers are heterogeneous, and can be used to develop effective heuristics.

Original languageEnglish
Pages (from-to)77-95
Number of pages19
JournalProduction and Operations Management
Volume25
Issue number1
DOIs
Publication statusPublished - 1 Jan 2016

Fingerprint

Planning
Trade-offs
Excess capacity
Supply uncertainty
Diversification
Safety stock
Demand uncertainty
Uncertainty
Base stock
Periodic review
Suppliers
Heuristics
Capacity investment
Inventory investment
Inventory policy
Diversification strategy
Demand and supply
Infinite horizon

Keywords

  • capacity
  • diversification
  • inventory
  • supply risk

Cite this

@article{f1511b8937a54b598bbed38b2b82a631,
title = "Safety Stock, Excess Capacity or Diversification: Trade-Offs under Supply and Demand Uncertainty",
abstract = "Firms mitigate uncertainty in demand and supply by carrying safety stock, planning for excess capacity and diversifying supply sources. In this study, we provide a framework to jointly optimize these three levers in a periodic review infinite horizon setting, and in particular we examine how one can reduce inventory and capacity investments through proper diversification strategies. Observing that a modified base-stock inventory policy is optimal, we find that the capacity-diversification problem is well behaved and characterize the optimal mix of safety stock, excess capacity and extra number of supply sources. We find that higher supply uncertainty results in higher safety stock, more excess capacity, and higher diversification. But safety stock and diversification are non-monotonic in demand uncertainty. Our results can be extended to situations in which suppliers are heterogeneous, and can be used to develop effective heuristics.",
keywords = "capacity, diversification, inventory, supply risk",
author = "Aadhaar Chaturvedi and Victor Mart{\'i}nez-De-Alb{\'e}niz",
year = "2016",
month = "1",
day = "1",
doi = "10.1111/poms.12406",
language = "English",
volume = "25",
pages = "77--95",
journal = "Production and Operations Management",
issn = "1059-1478",
publisher = "Wiley-Blackwell",
number = "1",

}

Safety Stock, Excess Capacity or Diversification : Trade-Offs under Supply and Demand Uncertainty. / Chaturvedi, Aadhaar; Martínez-De-Albéniz, Victor.

In: Production and Operations Management, Vol. 25, No. 1, 01.01.2016, p. 77-95.

Research output: Contribution to journalArticle

TY - JOUR

T1 - Safety Stock, Excess Capacity or Diversification

T2 - Trade-Offs under Supply and Demand Uncertainty

AU - Chaturvedi, Aadhaar

AU - Martínez-De-Albéniz, Victor

PY - 2016/1/1

Y1 - 2016/1/1

N2 - Firms mitigate uncertainty in demand and supply by carrying safety stock, planning for excess capacity and diversifying supply sources. In this study, we provide a framework to jointly optimize these three levers in a periodic review infinite horizon setting, and in particular we examine how one can reduce inventory and capacity investments through proper diversification strategies. Observing that a modified base-stock inventory policy is optimal, we find that the capacity-diversification problem is well behaved and characterize the optimal mix of safety stock, excess capacity and extra number of supply sources. We find that higher supply uncertainty results in higher safety stock, more excess capacity, and higher diversification. But safety stock and diversification are non-monotonic in demand uncertainty. Our results can be extended to situations in which suppliers are heterogeneous, and can be used to develop effective heuristics.

AB - Firms mitigate uncertainty in demand and supply by carrying safety stock, planning for excess capacity and diversifying supply sources. In this study, we provide a framework to jointly optimize these three levers in a periodic review infinite horizon setting, and in particular we examine how one can reduce inventory and capacity investments through proper diversification strategies. Observing that a modified base-stock inventory policy is optimal, we find that the capacity-diversification problem is well behaved and characterize the optimal mix of safety stock, excess capacity and extra number of supply sources. We find that higher supply uncertainty results in higher safety stock, more excess capacity, and higher diversification. But safety stock and diversification are non-monotonic in demand uncertainty. Our results can be extended to situations in which suppliers are heterogeneous, and can be used to develop effective heuristics.

KW - capacity

KW - diversification

KW - inventory

KW - supply risk

UR - http://www.scopus.com/inward/record.url?scp=84954076835&partnerID=8YFLogxK

U2 - 10.1111/poms.12406

DO - 10.1111/poms.12406

M3 - Article

AN - SCOPUS:84954076835

VL - 25

SP - 77

EP - 95

JO - Production and Operations Management

JF - Production and Operations Management

SN - 1059-1478

IS - 1

ER -