Managing supply disruptions for risk-averse buyers: Diversified sourcing vs. disruption prevention

Abstract

Diversified sourcing has traditionally been a popular approach for managing supply risk compared to disruption prevention. However, the recent COVID-19 crisis has emphasized the critical importance and necessity of disruption prevention. Additionally, the economic fears and concerns arising from the crisis have led managers to adopt a more risk-averse stance, potentially leading to permanent changes in individuals’ risk preferences. Despite the growing importance of risk aversion, existing studies have primarily focused on examining the impact of risk aversion on a specific approach, disregarding its influence on the selection of different approaches. As companies recognized the importance of investing in reliability to prevent disruptions, this research aims to investigate how risk aversion affects the selection of approaches to mitigate supply disruptions. Within a framework where both diversified sourcing and disruption prevention offer equivalent payoffs for risk-neutral buyers, our study unveils that risk-averse buyers, particularly when the level of disruption risk is relatively low and their risk aversion is relatively high, prefer to “mitigate but retain the risk of disruption” through diversified sourcing or partial prevention. This stands in contrast to risk-neutral buyers who consistently make choices between completely avoiding risk or accepting all risk through sole sourcing or no/complete prevention. More interestingly, the adoption of diversified sourcing and partial prevention yields distinct payoffs for risk-averse buyers. Despite the widespread adoption and popularity of diversified sourcing, it may actually lead to less favorable results in certain situations. If prevention becomes insensitive to increased investment, diversified sourcing may become even less advantageous. In summary, our study underscores the crucial importance of carefully selecting a suitable risk management approach for buyers who are transitioning towards risk aversion due to the post-COVID effect.