Inventory Management with Disruption Risk

Initiatives like lean manufacturing, pooling, and postponement have been effective in mitigating the cost-service trade-off by maintaining high levels of service while reducing system inventories. However, such initiatives exacerbate supply chain disruptions during a catastrophic event, thereby creating a new trade-off between robustness during disruptions and efficiency during normal operations. We evaluate stocking decisions in the presence of operational disruptions, which represent different risks from those associated with demand uncertainties as they stop production flow and typically persist longer. Operational disruptions can therefore be much more devastating though their likelihood of occurrence may be low. Using stochastic simulation, we combine the newsvendor and order-up-to models capturing demand uncertainty costs with catastrophe models capturing not only the cost of supply disruption, but also the cost of recovery, to obtain insights for managing inventory under disruption risk.