Disruption and Rerouting in Supply Chain Networks

Abstract

We study systemic risk in a supply-chain network where firms are connected through purchase orders. Each firm’s short-term investment return is subject to a random shock leading to a default. The shock propagates through the supply-chain network via input-output linkages between buyers and suppliers. Firms endogenously take contingency plans to mitigate the impact generated from disruptions. They reroute undelivered orders to alternative buyers and switch excess demand to different suppliers. An equilibrium is reached when contagion from disruption stops. We develop an algorithm to recover the Pareto dominant equilibrium with the greatest amount of delivered orders. We show that lower concentration of orders results in a more fragile network if connectivity is high and firms are highly capitalized. If firms are lowly capitalized, however, lower concentration of orders reduces network fragility. Highly concentrated orders are always preferred in networks with low connectivity.