Supplier Diversification Strategies in the Presence of Yield Uncertainty and Buyer Competition

The benefits of supplier diversification are well established for price-taking firms. In this paper, we investigate the benefits from supplier diversification for dual-sourcing duopolists. We consider a two-echelon supply chain in which suppliers sell components to buyers who produce and sell substitutable products. The suppliers' output processes are uncertain and modeled as having a proportional random yield. Buyers engage in a quantity-based Cournot competition. We find that an increase in supplier correlation leads to more correlated buyers' outputs and a decrease in their profits. In the presence of end-market competition, dual sourcing still brings value by reducing the inefficiency caused by random yield: Namely, when the suppliers' yield processes are strongly negatively correlated, dual sourcing increases the expected market output and improves the firms' profits over sole sourcing. However, unlike a monopolist firm, a duopolist does not necessarily allocate its supplier orders to minimize output variability. We generalize the main results to a two-stage order-quantity-output-quantity game and to one with asymmetric suppliers.