Dual sourcing under heavy-tailed demand: an extreme value theory approach

Abstract

We consider a single-period dual-sourcing problem in which a buyer purchases its products from two different suppliers and sells them to a market with uncertain demand. One supplier is cheaper but less responsive, whereas the other supplier is more responsive but more expensive. The buyer determines the order quantity from the low-cost supplier and the capacity level from the responsive supplier in such a way that maximises its profit. We apply extreme value theory to analyse the impact of tail heaviness of demand distribution on optimal dual-sourcing strategy. We numerically find that tail heaviness moderates the effect of increasing demand uncertainty on optimal order levels. We also show that dual sourcing allows companies to increase their fill rates cost effectively under heavy-tailed demand if the capacity reservation cost of the responsive supplier is relatively low.

Keywords:

• dual sourcing
• heavy-tailed distribution
• extreme value theory

Acknowledgements

This paper is an outcome of the author’s doctoral studies carried out at HEC Lausanne. The author is grateful to Suzanne de Treville, Valerie Chavez-Demoulin, Özalp Özer and Stefan Minner for their helpful comments on the earlier versions of the paper. The author is also grateful to anonymous referees, whose comments substantially improved the paper.