Foundations and Trends® in Technology, Information and Operations Management > Vol 11 > Issue 1-2

Operational Hedging through Dual-Sourcing under Capacity Uncertainty

By Xin Chen, University of Illinois at Urbana-Champaign, USA,

Suggested Citation
Xin Chen (2017), "Operational Hedging through Dual-Sourcing under Capacity Uncertainty", Foundations and Trends® in Technology, Information and Operations Management: Vol. 11: No. 1-2, pp 46-64.

Publication Date: 21 Dec 2017
© 2017 X. Chen
G20 Financial ServicesG32 Financial Risk and Risk ManagementM11 Production management
Operational risk managementContingency planningCommodity price riskSupply chain disrutpions

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In this article:
1. Motivation and Description of the Problem
2. Modeling Approach and Methodology
3. Results and Insights
4. Future Research


This paper studies a periodic-review dual-sourcing inventory system with demand and supply capacity uncertainty. Compared with dual-sourcing models with deterministic supply capacities, a challenge here is that the objective functions in the dynamic programming recursions are not convex in the ordering quantities. To address this challenge, a powerful transformation technique is developed which converts a non- convex minimization problem to an equivalent convex minimization problem. In addition, the transformation preserves L\-convexity, allowing one to derive structural properties of the optimal policies for the dual-sourcing problem with random supply capacity. Dual-index policies are shown to be optimal under certain conditions. The effects of supply capacity uncertainties on the system performance are investigated.

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Table of contents:
Integrated Risk Management in Supply Chains: Overview and Future Directions
Part 1: Buffering Supply Chain Risk with Operational Flexibility
The Interaction between Operational Flexibility and Financial Flexibility
Investments in Lead-Time Reduction: How to Finance and How to Implement
Part 2: Supply Disruption
Operational Hedging through Dual-Sourcing under Capacity Uncertainty
Managing Supply Risk in Fixed Price Contracts: A Contingent Claims Perspective
Part 3: Commodity Price Risk
Integrated Production Planning and Risk Hedging
Minimum-Variance Hedging for Managing Risks in Inventory Models with Price Fluctuations
A Cournot-Stackelberg Model of Supply Contracts with Financial Hedging and Identical Retailers
Approximations for High Dimensional Commodity and Energy Merchant Operations Models
Linking Commodity Price Risk and Operations: Evidence from the Gold Mining Industry

Integrated Risk Management in Supply Chains

Integrated Risk Management in Supply Chains examines supply chain risk management. The increased interest in the topic is due to a number of factors including the increased volatility of commodity prices and exchange rates, recent natural disasters, and the increased importance of multinational corporations. The motivation for risk management comes from a variety of sources: financial distress costs, managerial incentives, and other important reasons discussed in the remainder of this book. Understanding the motives is important because they provide insights into which risks should be managed and how a firm’s risk management operations should be organized.

The first part examines Buffering Supply Chain Risk with Operational Flexibility and deals with uncertainty in the form of routine variability, which includes fluctuations in demand. Part 2 reviews Supply Disruption. Both the preponderance of natural disasters and huge economic swings can cause extreme challenges across the supply chains. Although these types of risks are rare, they are highly consequential and buffering is insufficient to mitigate them. Instead, firms facing these risks must engage in contingency planning and must maintain redundancies in the system. This is why contingency planning is on the interface of operations and finance. Part 3 looks at Commodity Price Risks, which includes five papers on managing price risks – the first three papers are fundamental in that they ask “when” and “how” firms should manage price risks with hedging and how hedging affects operating policy and the remaining two papers examine the best practices in specific industries.



Foundations and Trends® in Technology, Information and Operations Management, Volume 11, Issue 1-2 Special Issue: Integrated Risk Management in Supply Chains
See the other articles that are also part of this special issue.