Incentive Strategy Considering Observation Period to Manage Supply Disruption under Uncertain Demand

This paper studies the optimal ordering problem of a buyer who sources from an unreliable supplier under uncertain demand. The supplier is subject to a random disruption. If the supply disruption occurs during the observation period, the buyer will proactively invest a fixed setup cost and adjust the unit wholesale price to incentivize the supplier to restore production and fulfill the regular order. Otherwise, the buyer does not adopt any risk handling measurements. We derive the buyer’s optimal ordering decision. It is found that the incentive strategy is not always profitable, and the conditions where the incentive strategy is useful are provided. The results of numerical experiments indicate that the value of incentive strategy is more significant when the disruption probability is moderate, or the demand variability is low.