Strategic Formation and Reliability of Supply Chain Networks

Abstract

Supply chains are the backbone of the global economy. Disruptions to them can be costly. Centrally managed supply chains invest in ensuring their resilience. Decentralized supply chains, however, must rely upon the self-interest of their individual components to maintain the resilience of the entire chain. We examine the incentives that independent self-interested agents have in forming a resilient supply chain network in the face of production disruptions and competition. In our model, competing suppliers are subject to yield uncertainty (they deliver less than ordered) and congestion (lead time uncertainty or, "soft" supply caps). Competing retailers must decide which suppliers to link to based on both price and reliability. In the presence of yield uncertainty only, the resulting supply chain networks are sparse. Retailers concentrate their links on a single supplier, counter to the idea that they should mitigate yield uncertainty by diversifying their supply base. This happens because retailers benefit from supply variance. It suggests that competition will amplify output uncertainty. When congestion is included as well, the resulting networks are denser and resemble the bipartite expander graphs that have been proposed in the supply chain literature, thereby, providing the first example of endogenous formation of resilient supply chain networks, without resilience being explicitly encoded in payoffs. Finally, we show that a supplier's investments in improved yield can make it worse off. This happens because high production output saturates the market, which, in turn lowers prices and profits for participants.