Supply Chain Uncertainty and Diversification

Supply chain uncertainty is becoming increasingly frequent, generating unpredictability for firms that need to source inputs to produce. We aim to understand how this uncertainty affects firms’ sourcing decisions. To answer this, and following Antràs et al.(2017), we write a multi-country sourcing model where firms’ self-select into importing based on productivity, cost minimization, and trade uncertainty that can alter the cost of importing. Our findings reveal that, even in the presence of aggregate or idiosyncratic uncertainty, a pecking order emerges, with larger firms self-selecting into importing from a more extensive set of suppliers. Despite the quantitative significance of marginal cost reduction as the primary driver of firms’ sourcing decisions, risk introduces a nuanced dimension. Firm-specific risk introduces a positive option value associated with diversifying the set of suppliers. Meanwhile, aggregate uncertainty has a theoretically ambiguous impact, since it also affects the market demand. In our structural analysis, we estimate both aggregate and idiosyncratic uncertainty and fixed costs of sourcing using firm-level data from Chile. We then obtain a counterfactual using the change in aggregate uncertainty from 2020 to 2023 and find a positive relationship between the change in uncertainty and the change in both intensive and extensive margins. This research contributes to under-standing how firms navigate supply chain risk and make strategic sourcing decisions in the face of uncertainty.