Operational Hedging and Diversification und Correlated Supply and Demand Uncertainty

Abstract

When facing supply uncertainty caused by exogenous factors such as adverse weather conditions, firms diversify their supply sources following the wisdom of “not holding all eggs in one basket”. We study a firm that decides on investment and production levels of two unreliable but substitutable resources. Applying real options thinking, production decisions account for actual supply capabilities whereas investment decisions are made in advance. To model triangular supply and demand correlations, we adopt the concepts of random capacity and stochastic proportional yield and use concordant ordered random variables. Optimal profit decreases monotonously in supply correlation and increases monotonously in supply–demand correlation. Diversifying resources becomes less attractive in supply correlation, however, optimal resource selection is more nuanced depending on the trivariate interplay of supply and demand uncertainty. Moreover, supply hedges can be optimal even if supply resources are perfectly positively correlated under exogenous as well as endogenous supply uncertainty. For optimal allocation, the firm uses particularly lower margin capacities to accommodate for changing correlation under exogenous supply uncertainty, whereas the availability of “scale hedges” under endogenous supply uncertainty entails sensitive reaction of both capacities.
 

About the Presenter

Fabian Sting is Assistant Professor of Operations Management. His research and teaching interests are in the areas of Operations and Technology Strategy, Supply Chain Management, and Operations Management. He is particularly interested in managing uncertainty and complexity in operations and projects, and in strategy implementation. Fabian Sting's research has been published in international journals such as in European Journal of Operational Research, Naval Research Logistics, and Harvard Business Review, and has received coverage at such media outlets as The Economist, The Sunday Times (UK), Wirtschaftswoche (Germany), and CBSnews (USA). He teaches courses on undergraduate, graduate, and executive levels. For his courses "Operations Management" and "Primaire Processen" Fabian Sting was nominated for and received the "Best Professor Award", respectively. Collaborating with the business schools IESE (Spain), INSEAD (France) and WHU (Germany), he serves as Academic Director of the Industrial Excellence Award in Europe.

more info on Professor Dr. Fabian Sting

About the Seminar

The KLU research seminar series is a regular meeting of PhD students, Post-Docs and professors who conduct research in the field of logistics and supply chain management. The research seminar is open to the public and we happily welcome guests.