Strategic Sourcing Under Severe Disruption Risk : Learning Failures and Under-Diversification Bias

We study sourcing behavior in “severe” conditions where supply disruptions are rare, but carry the potential of wiping out several periods' worth of a firm's profit. The trade-off between scale economies from supplier consolidation and risk mitigation from supplier diversification is at the core of firms' sourcing strategy, and one that is empirically understudied. We study supplier diversification through a behavioral lens, and test theoretically derived predictions under controlled laboratory conditions. Our data provides strong evidence for “under-diversification.” We posit that this pattern is partly due to the fact that investing in supplier diversification involves an upfront cost to achieve a delayed, and rarely encountered, benefit. Under-diversification bias is costly and its causes difficult to overcome, presenting firms with the daunting task of devising debiasing mechanisms that reinforce a supplier diversification strategy when the rarity of disruptions almost always render supplier consolidation the ex-post preferred strategy