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

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  • Aadhaar Chaturvedi
  • Victor Martínez-de-Albéniz

Abstract

type="main" xml:id="poms12406-abs-0001"> 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.

Suggested Citation

  • Aadhaar Chaturvedi & Victor Martínez-de-Albéniz, 2016. "Safety Stock, Excess Capacity or Diversification: Trade-Offs under Supply and Demand Uncertainty," Production and Operations Management, Production and Operations Management Society, vol. 25(1), pages 77-95, January.
    • Handle: RePEc:bla:popmgt:v:25:y:2016:i:1:p:77-95
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    File URL: http://hdl.handle.net/10.1111/poms.2016.25.issue-1
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    Citations

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    Cited by:

    1. Zied Bahroun & Nidhal Belgacem, 2019. "Determination of dynamic safety stocks for cyclic production schedules," Operations Management Research, Springer, vol. 12(1), pages 62-93, June.
    2. Barros, Júlio & Cortez, Paulo & Carvalho, M. Sameiro, 2021. "A systematic literature review about dimensioning safety stock under uncertainties and risks in the procurement process," Operations Research Perspectives, Elsevier, vol. 8(C).
    3. Linh N. K. Duong & Lincoln C. Wood & William Y. C. Wang, 2018. "Effects of Consumer Demand, Product Lifetime, and Substitution Ratio on Perishable Inventory Management," Sustainability, MDPI, vol. 10(5), pages 1-17, May.
    4. Musen Kingsley Li & ManMohan S. Sodhi & Christopher S. Tang & Jiayi Joey Yu, 2023. "Preparedness with a system integrating inventory, capacity, and capability for future pandemics and other disasters," Production and Operations Management, Production and Operations Management Society, vol. 32(2), pages 564-583, February.
    5. Bo Li & Antonio Arreola‐Risa, 2022. "Minimizing conditional value‐at‐risk under a modified basestock policy," Production and Operations Management, Production and Operations Management Society, vol. 31(4), pages 1822-1838, April.
    6. ap Gwilym, Rhys & Ebrahim, M. Shahid & El Alaoui, Abdelkader O. & Rahman, Hamid & Taamouti, Abderrahim, 2020. "Financial frictions and the futures pricing puzzle," Economic Modelling, Elsevier, vol. 87(C), pages 358-371.
    7. Gonçalves, João N.C. & Sameiro Carvalho, M. & Cortez, Paulo, 2020. "Operations research models and methods for safety stock determination: A review," Operations Research Perspectives, Elsevier, vol. 7(C).

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