A General Model for Inventory Management with Dual Sources : Trading off Lead Time and Cost Differences

Manufacturing companies and retail chains often have access to two alternative supply sources for component parts, product modules, finished goods or supply materials. One source is typically low cost but has long lead times, whereas the other provides quicker response but at a higher price. When designing its procurement process, the purchaser may select one of the two sources as its exclusive supplier. Alternatively, it may opt for a dual sourcing strategy which procures from both sources. In the latter case, the challenge is to determine how much of the total procurement volume to allocate to the two sources and how inventory information should be used to make these allocation decisions, dynamically. The same dilemma arises when a firm has two (or more) assembly plants in different parts of the world, with different costs and lead times to service its customer base. The above strategic dilemmas arise, first and foremost when firms decide on offshoring strategies. Offshore outsourcing/production has become increasingly popular in the past two decades. Lower Total Landed Cost (TLC), i.e., the aggregate of labor, material, working capital, freight and customs costs, is the main driver for offshore sourcing. Other benefits include process efficiency, quality, better availability of skilled people, and lower foreign corporate tax rate. According to a recent PricewaterhouseCoopers' survey (PwC 2010), the share of products that are sourced from offshore locations ranges from 51% and 75%, in different European and American countries and it has been projected to grow at more than 10% annually in the next five years. However, the cost savings of the offshore options reduce inventory flexibility, in the sense that deliveries take longer. Longer lead times, in turn translate into a need for larger safety stocks, under a given targeted service level, or inferior service levels under given inventory investments. In contrast, onshore procurement in the local market