Mitigating Disruption Cascades in Supply Networks

The losses to supply chains from disasters such as the Tohuku earthquake in Japan and Thai floods in 2011 arise not only through direct damage at firms, but also from the interruption of normal operations due to lack of supply; that is, due to disruption cascades from suppliers in the adjacent tiers and beyond. To curtail such losses, firms can make ex ante investments in mitigation and recovery strategies. However, given the complexity of the network topology, the assessment and mitigation of disruption risk pose formidable managerial challenges. In this paper, we address these challenges by analyzing an investment game for a given network structure, in which firms’ investments in risk mitigation are best responses to their suppliers’ investments. We determine the equilibrium payoffs in both decentralized and centralized settings and find that, under either setting, the investment and payoff of a firm typically depend only on the properties of its extended local neighborhood; that is, up to its tier-2 suppliers, thus making knowledge of the remaining network structure redundant. We also characterize the efficiency gap (difference between centralized and decentralized payoffs) in terms of the network structure. To resolve the efficiency gap, we then exploit the network topology to propose a coordinating payment-transfer mechanism that induces firms to make efficient investments in a decentralized manner.