Network Flexibility Design Under Endogenous Uncertainty

Abstract

Manufacturing firms face uncertainty in both supply and demand. They implement process flexibility, enabling plants to produce multiple products, to hedge against supply--demand mismatches. Assigning more products to a plant results in efficiency losses at the plant, whereas limited flexibility may improve efficiency because of the specialization effect. Furthermore, the flexibility design determines the sourcing locations of products, thereby affecting demand due to the country-of-origin effect and exposure to tariffs. We incorporate these mechanisms into the supply network flexibility design problem by modeling supply and demand uncertainties as endogenous, that is, as functions of the first-stage design decisions. We propose a two-stage stochastic program and solve it via a decomposition scheme that relies on distribution-specific optimality cuts. To avoid exhaustive enumeration of all distributions, we derive distribution-free formulations that are valid for all distributions and for subsets of supply and demand distributions. Through extensive computational experiments, we demonstrate the superior performance of our solution approach and distribution-free formulations relative to exhaustive distribution enumeration and state-of-the-art inequalities, respectively. Moreover, we explain how the problem structure affects the effectiveness of the proposed formulations. From a managerial perspective, we show the trade-offs between endogenous effects and how they affect the optimal flexibility design.