On the value of mix flexibility and dual sourcing in unreliable newsvendor networks

We connect the mix-flexibility and dual-sourcing literatures by studying unreliable supply chains that produce multiple products. We consider a firm that can invest in product-dedicated resources and totally flexible resources. Product demands are uncertain at the time of resource investment, and the products can differ in their contribution margins. Resource investments can fail, and the firm may choose to invest in multiple resources for a given product to mitigate such failures. In comparing a single-source dedicated strategy with a single-source flexible strategy, we refine the common intuition that a flexible strategy is strictly preferred to a dedicated strategy when the dedicated resources are costlier than the flexible resource. We prove that this intuition is correct if the firm is risk neutral or if the resource investments are perfectly reliable. The intuition can be wrong, however, if both of these conditions fail to hold, because there is a resource-aggregation disadvantage to the flexible strategy that can dominate the demand pooling and contribution-margin benefits of the flexible strategy when resource investments are unreliable and the firm is risk averse. We investigate the influence that resource attributes, firm attributes, and product-portfolio attributes have on the attractiveness of various supply-chain structures that differ in their levels of mix flexibility and diversification, and we investigate the influence these attributes have on the optimal resource investments within a given supply-chain structure. Our results indicate that the appropriate levels of diversification and flexibility are very sensitive to the resource costs and reliabilities, the firm's downside risk tolerance, the number of products, the product demand correlations and the spread in product contribution margins.