Supply Disruptions and Optimal Network Structures

Tuesday, October 20, 2015 - 9:00am - 9:50am
Keller 3-180
Utku Ozan Candogan (University of Chicago)
This paper studies multi-tier supply chain networks in the presence of disruption risk. We focus on a model where firms compete with one another by participating in one of K intermediate production stages. Firms decide how to source their inputs from upstream suppliers so as to maximize their expected profits and prices of intermediate goods are set so that markets clear. We establish that a pure strategy supply equilibrium exists and provide an explicit characterization of the equilibrium prices, profits, and sourcing decisions. Our characterization allows us to derive insights on how the network structure and the reliability of production in different tiers affect firms’ profits and the prices of intermediate goods. Furthermore, we identify the supply chain network structures that maximize aggregate industry profits, welfare, and consumer surplus respectively. Interestingly, these networks can be ranked in terms of how “balanced” the supply chain is: networks that maximize consumer surplus are over-diversified in upstream tiers, whereas at networks that maximize aggregate industry profits firms are evenly distributed across the different stages. Finally, we turn our attention to the question of endogenous chain formation, i.e., we consider a simultaneous game of entry where firms decide whether to engage in production forming beliefs about their profits in the post-entry supply chain. We argue that endogenous entry leads to chains that are inefficient both in terms of the number of firms that engage in the production process as well as in terms of the network structure resulting from the firms’ entry decisions.

This is a joint work with Kostas Bimpikis (Stanford GSB), and Shayan Ehsani (Stanford MS&E).