Product substitution and dual sourcing under random supply failures

Product substitution can mitigate supply chain disruptions. However, it may not be very effective without multiple sourcing. In this paper, we consider a supply chain with two downward substitutable products. The products can be ordered from an unreliable supplier or a reliable but more expensive supplier. It is found that in an optimal sourcing policy the higher-grade product should be preferred over the lower-grade product. A sufficient condition is given for an optimal policy where only the higher-grade product is dual-sourced. The effect of substitution is contrasted with the non-substitution case. Numerical study shows the impact of demand variability and correlation on the effect of product substitution and the corresponding optimal sourcing policy.