Drop-Shipping and Backup-Sourcing Strategies Under the Risk of Supply Disruption

In recent years, an increasing number of e-retailers have adopted drop-shipping strategy to save logistics costs, and used backup-sourcing strategy to mitigate supply risks. However, the existing literature ignores the significant relationship between the two strategies. In this study, we develop a multi-stage game-theoretical model to investigate the optimal procurement decisions for an e-retailer who can activate both drop-shipping and backup-sourcing strategies. Specifically, our model considers the e-retailer sourcing some units of a product from a supplier to meet the random demand of online customers. The units of the product are held by the supplier, and then are directly shipped to the customers from the supplier side (i.e., drop-shipping strategy). However, there is disruption risk for the supplier; thus, after the randomness of the supplier is realized, the e-retailer can urgently order some units of the product from an expensive but perfectly reliable outside option (i.e., backup-sourcing strategy). We examine the optimal order decisions of the e-retailer and the optimal wholesale price decision of the supplier. Our study shows that for the retailer, the activation of both backup-sourcing and drop-shipping strategies increases its profit, and there is substitutability between the two strategies. For the supplier, the implementation of the drop-shipping (backup-sourcing) strategy increase (decreases) its profit, but the drop-shipping and backup-sourcing are complementary strategies. For the supply chain, when the logistics cost is low or high and the backup-sourcing cost is low, the backup-sourcing and drop-shipping are complementary strategies, whereas in other cases, they are substitutive strategies. Our study not only brings some academic contributions to supply chain management, but also provides significant management insights for the operational practice in terms of drop-shipping and backup-sourcing.