Multi-sourcing and Miscoordination in Supply Chain Networks

This paper studies the endogenous formation of supply chain networks when procurement is subject to disruption risk. We argue that the presence of non-convexities in the chain (e.g., due to non-convex production technologies or financial constraints) may create a wedge in the sourcing incentives of firms at different tiers, leading to the formation of overly fragile supply chains. More specifically, we show that even though upstream firms may find it optimal to employ multi-sourcing strategies as a way of mitigating supply disruption risks, such strategies lead to a more intertwined supply chain, which may exacerbate the extent of risk propagation further down-stream: multi-sourcing by upstream firms may increase the likelihood of simultaneous disruptions in all procurement channels available to the downstream firms. We establish that under fairly general conditions, the losses due to such system-wide disruptions outweigh the benefits of multi-sourcing, thus, implying that the endogenously formed supply networks may be excessively interconnected.