Problem definition: With heightened global uncertainty, supply chain managers are under increasing pressure to craft strategies that accommodate both supply and demand risks. Although product flexibility is a well-understood strategy to accommodate risk, there is no clear guidance on the optimal flexibility configuration of a supply network that comprises both unreliable primary suppliers and reliable backup suppliers. Academic/practical relevance: Existing literature examines the value of flexibility with primary and backup suppliers independently. For a risk-neutral firm, research shows that (a) incorporating flexibility in a primary supplier by replacing two dedicated ones (in absence of backup supply) is always beneficial and that (b) adding flexibility to a reliable backup supplier (in absence of product flexibility in primary suppliers) is always valuable. It is unclear, however, how flexibility should be incorporated into a supply network with both unreliable primary suppliers and reliable backup suppliers. This research studies whether flexibility should be incorporated in a primary supplier, a backup supplier, or both. Methodology: We develop a normative model to analyze when flexibility benefits and when it hurts. Results: Compared with a base case of no flexibility, we prove that incorporating flexibility in either primary or backup suppliers is always beneficial. However, incorporating flexibility in both primary and backup suppliers can be counterproductive because the supply chain performance can decline with saturated flexibility, even if flexibility is costless. A key reason is that the risk-aggregation effect of consolidating flexibility in an unreliable supplier becomes more salient when flexibility is already embedded in a backup supplier. Managerial implications: This research refines the existing understanding of flexibility by illustrating that flexibility is not always beneficial. When there is a choice, a firm should prioritize incorporating flexibility in a reliable backup supplier.
Operational Choices for Risk Aggregation in Insurance: PSDization and SCR Sensitivity
