Quality Cost and Failure Risk in the Choice of Single versus Multiple Sourcing
The advantage of multiple sourcing to protect against supplier failures arising from undependable (or even unsafe) products due to latent defects is examined using a quality-cost model of supply base composition. Prior models have focused on supplier failures arising from unreliable supply, such as late/ insufficient/ no delivery, due to random yields. This model focuses on non-linear external failure costs leading to a desire for risk diversification. I derive a closed-form characterization of the optimal production quota allocation, which determines the optimal supply base with two intuitive properties. If a supplier is selected, any supplier of higher quality must also be selected. Moreover, larger production quotas should be assigned to higher-quality suppliers. These properties hold under a mild condition on the differences among suppliers’ production costs. The condition includes the special case of equal costs but also allows unequal costs without any particular order (e.g, higher-quality suppliers may or may not have higher production costs). I also derive a necessary and sufficient condition for determining the exact size of the optimal supply base, provided the mild condition holds. An alternative necessary and sufficient condition is derived to determine whether single or multiple sourcing is optimal, without requiring any precondition.
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