Failure Risk and Quality Cost Management in the Choice of Single versus Multiple Sourcing

What is it about?

The advantage of multiple sourcing to protect against supplier failures arising from undependable products due to latent defects is examined using a model with non-linear external failure costs. Prior research has focused only on supplier failures arising from unreliable supply, such as late/insufficient/no delivery. I derive a closed-form characterization of the optimal production quota allocation for the LUX (Latent defect-Undependable product-eXternal failure) setting. The allocation determines the optimal supply base, with intuitive properties that hold under a mild requirement. The requirement includes the special case of equal procurement costs charged by suppliers but also allows unequal costs without any particular order. The key result of the paper is a necessary and sufficient condition determining whether single or multiple sourcing is optimal. Another condition is obtained to determine the exact size of the optimal supply base, provided the mild requirement holds. With minor modifications, the results also hold when a buyer-initiated procurement contract can be used to elicit private information on the suppliers’ unit variable production costs.

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Why is it important?

This paper adds a new perspective to the debate on single versus multiple sourcing. Deming (1986) argues that a buying company should take quality costs into consideration and choose single sourcing by selecting a high-quality supplier that minimizes total cost of sourcing. The results of this paper suggest that in minimizing total cost of sourcing, one might need to use multiple sourcing and include suppliers of lower quality.