Supplier Diversification Strategies in the Presence of Yield Uncertainty and Buyer Competition

The benefits of supplier diversification are well established for price‐taking firms. In this paper, we investigate the benefits from supplier diversification for dual‐sourcing duopolists. We consider a two‐echelon supply chain in which suppliers sell components to buyers who produce and sell substitutable products. The suppliers' output processes are uncertain and modeled as having a proportional random yield. Buyers engage in a quantity‐based Cournot competition. We find that an increase in supplier correlation leads to more correlated buyers' outputs and a decrease in their profits. In the presence of end‐market competition, dual sourcing still brings value by reducing the inefficiency caused by random yield: Namely, when the suppliers' yield processes are strongly negatively correlated, dual sourcing increases the expected market output and improves the firms' profits over sole sourcing. However, unlike a monopolist firm, a duopolist does not necessarily allocate its supplier orders to minimize output variability. We generalize the main results to a two‐stage order‐quantity–output‐quantity game and to one with asymmetric suppliers.