On the Value of a Threat Advisory System for Managing Supply Chain Disruptions

Most firms face some risk of disruption to their supply due to labor strikes, supplier bankruptcies, manufacturing quality failures, natural disasters, terrorism, or other events. In recognition of the fact that the risk of disruption may change over time, some firms have begun to continually monitor their disruption risk and to adjust their safeguards, e.g., inventory, in accordance with the current risk level. Such a system allows the firm to increase its protection level when the disruption risk is high and to operate “lean” otherwise. In this paper, we propose and investigate a threat advisory system in which the firm, operating a periodic-review inventory system, dynamically adjusts its inventory in response to changes in the threat level. We consider a model in which the firm has a single unreliable supplier, for which inventory is the only disruption-management tactic, as well as a model in which a second, perfectly reliable supplier is available, and, thus, sourcing becomes an additional disruption-management tactic. We consider both infiniteand finite-horizon settings. We characterize the optimal threat-dependent inventory levels and show that a threat advisory system can result in substantial cost savings. We establish that supplier capacity and the structure of the disruption risk process (the relative disruption risk in different threat levels and the nature of transitions between threat levels) significantly influence the value of a threat advisory system. We find that the presence of a threat advisory system and the structure of the disruption risk process can have a significant impact on the optimal disruption-management strategy, i.e., the choice of tactics (inventory and/or sourcing) used to manage the firm’s disruption risk.