Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
1032483 | Omega | 2015 | 12 Pages |
•We model a multi-location supply chain where supply may be disrupted.•We show that decentralizing inventory reduces cost risk through risk diversification.•Risk diversification tends to have a stronger effect than demand risk pooling.•Therefore a risk-averse firm should typically choose to decentralized inventory.
We investigate optimal system design in a multi-location system in which supply is subject to disruptions. We examine the expected costs and cost variances of the system in both a centralized and a decentralized inventory system. We show that, when demand is deterministic and supply may be disrupted, using a decentralized inventory design reduces cost variance through the risk diversification effect, and therefore a decentralized inventory system is optimal. This is in contrast to the classical result that when supply is deterministic and demand is stochastic, centralization is optimal due to the risk-pooling effect. When both supply may be disrupted and demand is stochastic, we demonstrate that a risk-averse firm should typically choose a decentralized inventory system design.