Second Sourcing Vs. Sole Sourcing: The Impact Of Demand Uncertainty

We study the decision of a manufacturer (buyer), expecting new sourcing opportunities in the future, to select between a sole and a second sourcing mechanism for a non-commodity component. In a sole sourcing mechanism, the buyer commits to source from the current supplier. In a second sourcing mechanism, the buyer keeps the option open to source from a new supplier in the future. Capacity investment of a supplier is required to produce the component. While the new supplier may be cheaper, the current supplier may improve over time on costs due to learning. The decision is further complicated by uncertainty on the downstream demand for the component.