Optimal inventory policy through dual sourcing
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Optimal inventory policy through dual sourcing Matthew Davison1 · Yuri Lawryshyn2 · Volodymyr Miklyukh2 Received: 24 October 2019 / Accepted: 10 April 2020 © Springer-Verlag GmbH Germany, part of Springer Nature 2020
Abstract Profit maximization in the retail and manufacturing industry is currently focused on offshore production to utilize the resulting low production costs. However, in the face of uncertain customer demand, it is difficult to determine an optimal order quantity which maximizes profit. We consider a risk-averse firm that utilizes dual-sourcing for perishable or seasonal goods with uncertain customer demand. Using real options theories, we provide two models aimed at determining optimal order quantities to maximize the firm’s expected profit. Furthermore, we can consider the demand to be an observable process correlated to a traded asset, which can be hedged to reduce profit uncertainty. A single offshore single local order period model provides a pseudoanalytical solution which can be easily solved to determine optimal offshore and local order quantities based on the manufacturers’ lead times, and a more realistic single offshore multiple local order period model which uses numerical methods to determine optimal order quantities. Finally, a method for matching distributions of expected demands based on managerial estimates can be applied to the two models, providing managers a tool for practical application.
1 Introduction To maximize profit in the manufacturing sector, businesses often turn to offshore production because of low manufacturing costs. However, due to uncertain consumer demand and long lead times, it is difficult to determine an optimal offshoring strategy for risk-averse firms. To effectively hedge the risk associated with offshoring, a dualsourcing model is proposed. In the broad context, dual-sourcing refers to the supply chain management practice of using two suppliers for a given input. In the context of this paper, dual-sourcing refers to the case where business can source product utilizing
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Matthew Davison [email protected]
1
School of Mathematical & Statistical Sciences, Western University Canada, London, Ontario N6A 5B7, Canada
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Department of Chemical Engineering and Applied Chemistry, University of Toronto, Toronto, Ontario M5S 1A1, Canada
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Fig. 1 Effect of drift on future expected demand
local manufacturing, at greater cost but with shorter lead times, or non-locally through “offshoring”, where costs are less but lead times are substantially higher. The dual-sourcing model will enable companies to maximize their profit while eliminating risk by applying a real options approach to decision making. Real options valuation techniques, developed largely by Trigeorgis (1996) and Dixit and Pindyck (1994), give the firm the right—but not the obligation—to undertake projects or initiatives. As a result, future managerial decisions have a direct influence on the value of the project/initiative. In the present context, the fact that managers can optim
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