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Centralization versus decentralization: Risk pooling, risk diversification, and supply chain disruptions

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  • Schmitt, Amanda J.
  • Sun, Siyuan Anthony
  • Snyder, Lawrence V.
  • Shen, Zuo-Jun Max

Abstract

We investigate optimal system design in a multi-location system in which supply is subject to disruptions. We examine the expected costs and cost variances of the system in both a centralized and a decentralized inventory system. We show that, when demand is deterministic and supply may be disrupted, using a decentralized inventory design reduces cost variance through the risk diversification effect, and therefore a decentralized inventory system is optimal. This is in contrast to the classical result that when supply is deterministic and demand is stochastic, centralization is optimal due to the risk-pooling effect. When both supply may be disrupted and demand is stochastic, we demonstrate that a risk-averse firm should typically choose a decentralized inventory system design.

Suggested Citation

  • Schmitt, Amanda J. & Sun, Siyuan Anthony & Snyder, Lawrence V. & Shen, Zuo-Jun Max, 2015. "Centralization versus decentralization: Risk pooling, risk diversification, and supply chain disruptions," Omega, Elsevier, vol. 52(C), pages 201-212.
    • Handle: RePEc:eee:jomega:v:52:y:2015:i:c:p:201-212
    DOI: 10.1016/j.omega.2014.06.002
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    References listed on IDEAS

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