Yield uncertainty and strategic formation of supply chain networks

Abstract

AbstractTo understand how supply uncertainty affects the structure of supply chain networks we consider a setting where retailers and suppliers must establish a costly relationship with each other prior too engaging in trade. Suppliers, with uncertain yield, announce wholesale prices, while retailers must decide which suppliers to link to based on their wholesale prices. Subsequently, retailers compete with each other in Cournot fashion to sell the acquired supply to consumers. We find that in equilibrium retailers concentrate their links among too few suppliers, that is, there is insufficient diversification of the supply base. We find that either reduction in supply variance or increase in mean supply, increases a supplier's profit. However, these two ways of improving service have qualitatively different effects on welfare: improvement of the expected yield by a supplier makes everyone better off, whereas change in the variance of the yield impacts system members differently.