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Industrial Management & Data Systems
Procurement risk management under uncertainty: a review

Zhen Hong, C.K.M. Lee, Linda Zhang,
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PRM under
Procurement risk management uncertainty: a
under uncertainty: a review review
Zhen Hong
School of Mechanical Aerospace Engineering,
Nanyang Technological University, Singapore
C.K.M. Lee Received 9 October 2017
Department of Industrial and Systems Engineering, Revised 6 January 2018
22 March 2018
The Hong Kong Polytechnic University, Hunghom, Hong Kong, and Accepted 22 May 2018
Linda Zhang
IESEG School of Management, Lille, France
Abstract
Purpose – The purpose of this paper is twofold, first providing researchers with an overview about the
uncertainties occurred in procurement including applicable approaches for analyzing different uncertain
scenarios, and second proposing directions to inspire future research by identifying research gaps.
Design/methodology/approach – Papers related to supply chain risk management and procurement risk
management (PRM) from 1995–2017 in several major databases are extracted by keywords and then further
filtered based on the relevance to the topic, number of citations and publication year. A total of over 156 papers
are selected. Definitions and current approaches related to procurement risks management are reviewed.
Findings – Five main risks in procurement process are identified. Apart from summarizing current
strategies, suggestions are provided to facilitate strategy selection to handle procurement risks. Seven major
future challenges and implications related PRM and different uncertainties are also indicated in this paper.
Research limitations/implications – Procurement decisions making under uncertainty has attracted
considerable attention from researchers and practitioners. Despite the increasing awareness for risk
management for supply chain, no detail and holistic review paper studied on procurement uncertainty.
Managing procurement risk not only need to mitigate the risk of price and lead time, but also need to have
sophisticated analysis techniques in supply and demand uncertainty.
Originality/value – The contribution of this review paper is to discuss the implications of the research
findings and provides insight about future research. A novel research framework is introduced as reference
guide for researchers to apply innovative approach of operations research to resolve the procurements
uncertainty problems.
Keywords Procurement, Risk management, Supply chain management, Literature review, Supply risk
Paper type Literature review
1. Introduction
Manufacturing industry nowadays has a very fierce competition and competes with price,
quality and logistics (Roberta et al., 2014). To keep pace with the industry, many
manufacturing companies begin to outsource the business which is not their core
competency (Kremic et al., 2006). Indeed, the trend of outsourcing makes the supply chain
more complex and hard to control. From a survey conducted by Computer Science
Cooperation, there are about 43 percent of firms reporting that their companies are facing
disruption risk (Tang, 2006a). Enterprises may face negative consequence of risk if they do
not realize the impact and occurrence of the risk. Risk has been well defined as the variance
of return in financial industry and risk can adversely affect the expected yield (Markowitz,
1952). Risk management is not only an important issue of financial industry and it also has
a growing concern in supply chain management as uncertainty of the occurrence of an event
in one function of supply chain can brings to undesirable chain effect for the supply chain
network (Finch, 2004; Tummala and Schoenherr, 2011). Industrial Management & Data
Systems
The importance of procurement in the supply chain can be also realized from the © Emerald Publishing Limited
0263-5577
percentage of cost it takes in the industry. Maucher and Hofmann (2011) mentioned that the DOI 10.1108/IMDS-10-2017-0469
IMDS material cost are at 45 percent in German automobile industry. Furthermore, price
fluctuation may be difficult to predict. In addition, quality level of supply is important as
defective items would cause larger lost and make buyers recall products if defects are
discovered by the downstream partners. Therefore, when designing the optimal lot sizing
policy, the existence of defective items should be considered as one source of the random
yield factor. To mitigate the risk, Mahapatra et al. (2017) suggested to combine contract and
open market to obtain the optimum procurement under the uncertain market price.
It is obvious that the optimal decision making in PRM under uncertainty should
incorporate many potential risk sources, such as demand, price and supply yield. Scholars
have done considerable research in this area. Martel et al. (1995) studied the problem of
procurement planning over rolling planning horizons facing the stochastic demand. In face
of uncertain demand and price in spot market, Seifert et al. (2004) tried to find the optimal
order quantity from forward contract and spot market in a single period setting. In a single
period setting, Federgruen and Yang (2008) developed a model to configure the supply base
and figure out order allocation among suppliers in the presence of yield and demand
uncertainties. However, before implementing PRM strategies, it is necessary to find out the
source of uncertainty which leads to procurement risk. Procurement risk is predominantly
reliant on the manager’s experience and intuition as there is no systematic way for them to
classify the source of procurement risk and myopic risk management strategy is formulated
once the unexpected risk occurred. Although there are several review papers in supply
chain risk management, according to author’s knowledge, there is no review paper
published in PRM. In this paper, the topology of the PRM is devised so as to help
management to realize the source of uncertainty in the procurement process. The adverse
consequence of procurement risk is come from ignoring the uncertainty or wrong estimation
of impact due to the lack of risk management knowledge, this paper provides the body
of knowledge about procurement risk for both practitioners and researchers. Section 1
provides a brief introduction about the background of PRM. Section 2 describes the review
methodology which is manly based on the seven steps of Comprehensive Literature Review
(CLR) approach. Section 3 provides the overview of the PRM. Section 4 is about the
classification of PRM. Section 5 shows PRM strategies and modeling method. The
conclusion and future trend of research direction are shown in Section 6.
2. Review methodology
Review methodology is based on CLR (Onwuegbuzie and Freis, 2016) which is a
methodology of literature review. A flow chart of literature search procedure is depicted
in Figure 1 to provide a clear picture of the review process and results. The selected papers
were mainly published within 1995–2017 and the main electronic database includes Science
Direct, Emerald, Scopus and Google Scholar. The keywords used to retrieve the relevant
papers include risk management, supply chain management, supply risk, procurement,
contract and sourcing. The papers are further filtered based on the relevance to the topic,
number of citations and publication year. As described in Figure 1, over 153 papers from
various journals, such as European Journal of Operational Research, International Journal of
Production Economics and Operations Research are selected.
3. Overview of PRM
In this section, a PRM classification is outlined and positioned within the supply chain risk
management structure proposed by Tang (2006a) who defined Supply chain risk management
as “the management of supply chain risk through coordination or collaboration among the
supply chain partners so as to ensure profitability and continuity.” Furthermore, common
procurement risks are identified to set our review scope in Subsection 3.1. In Subsection 3.2,
the procurement risks and the related approaches are presented.
Literature search criteria: PRM under
• Between 1995–2017 uncertainty: a
• Published journal paper review
• Related to procurement uncertainty
• Goods purchasing, not service purchasing
Google Emerald
Science direct Scopus Springer
Scholar Insight
Over 300 Articles

fulfilled all the criteria
Over 114 not fulfilled

Title and Abstract No one of the following
Evaluation. Fulfilled criteria:
selected criteria? • Supply uncertainty
• Goods purchasing
Yes
186 paper
Around 30 not fulfilled

Full text evaluation one of the following
No
Fulfilled selected criteria:
criteria? • Procurement uncertainty
• Goods purchasing
Yes Figure 1.
Literature search
156 paper flowchart
3.1 Proposed definition of procurement risks

Procurement is a series of coordination process to obtain the resource including materials,
skills, capabilities and facilities to undertake their core business activities (Turban et al.,
2008). From the perspective of external resource management, procurement was defined as
to obtain external sources for maintaining and managing a company’s activities at the most
favorable conditions ( Jessop, 1994). Although there is no specific definition on procurement
risk, the grounded definition of supply risk is stated by Zsidisin (2003) as “the probability of
an incident associated with inbound supply from individual supplier failures or the supply
market occurring, in which its outcomes result in the inability of the purchasing firm to meet
customer demand or cause threats to customer life and safety.” Kraljic’s (1983) supply
IMDS matrix has categorized different type of purchased items by realizing the correlation
between supply risk and profit impact so as to decide the appropriate procurement strategy.
HP is pioneer in setting up PRM framework for measuring uncertainties of price, demand
and availability by scenario analysis (Nagali et al., 2008). Having realized those
uncertainties, the contract is set up and valuated. Numerous researches have been
undergone and various purchase portfolios by considering operational cost, product
availability and demand information are formulated so as to have optimal control of supply
or minimizing the risks or variance (Agrawal and Nahmias, 1997; Aouam et al., 2010; Arnold
et al., 2009; Babich et al., 2011). According to the authors’ knowledge, there is no clear
definition of PRM. With the aim of setting a review scope and better guiding scholars
through the published articles related to PRM under uncertainty, we define PRM as follows:
PRM is the management of procurement risk through reducing the exposure and uncertainty in
price, lead time and demand so as to ensure continue flow of supply (material, skills, capabilities,
facilities) with minimum disruption.

Procurement risk is the probability of variance associated with supply disruption in which
its outcomes result in the inability of the purchasing firm to meet customer demand or
cause threats to the subsequence process in the supply chain operation. According to
Chambers and Quiggin (2000), uncertainty is defined as a state of having limited
knowledge to exactly describe an existing state or future outcome. It is measured by the
assigned probabilities of each possible state or outcome. Uncertainty is the inability to
predict the consequence or outcome of activity accurately (Milliken, 1987). Rao and
Goldsby (2009) provided a comprehensive review about the definition of risk. Lowrance
(1980) mentioned that risk is a measure of the probability and severity of adverse effects.
Simon et al. (1997) realized that the likelihood of the occurrence of an uncertain event or set
of circumstance that would have an adverse result on the achievement of activities. Holton
entailed the exposure to the event and uncertainty of possible outcome. In general,
when the organization cannot manage a variety of uncertainty and brings the adverse
effect on the business, it can be regarded as risk.
Procurement is part of supply chain but the consequence of poor PRM can be similar or
same as supply chain risk management. Authors attempt to differentiate procurement risk
from supply chain risk as procurement risk concerns more about the risk related to supply
discontinuity and the contract between the buying firm and suppliers. Wrong estimation of
demand and poor coordination between internal customer and supply source are main
source of procurement risk and procurement risk is also under the umbrella of supply chain
risk. According to a grounded definition of supply risk by Zsidisin (2003), author attempts to
define the following component of procurement risk which is exclude from source of supply
risk. Risk from new product development problems, outbound logistics and finished product
quality rather than incoming material quality is included in the classification of supply risk
rather than procurement risk.
3.2 Procurement risks and related PRM approaches

Specifically, within today’s volatile and dynamic market, procurement is exposed to many
kinds of uncertainties, such as variable lead time, uncertain demand and volatile price.
Generally, these uncertainties and risks can be classified into two groups: operational risks
and disruption risks. Operational risk is the potential loss due to the lack of good
coordination of supply chain activities among different parties in supply chain. Disruption
risk is mainly referred to the loss from unexpected event due to natural disaster, strike,
political instability or malfunction of equipment (Kleindorfer and Saad, 2005). After a
comprehensive review of literature paper, a summary about all possible procurement
uncertainties is described in Table I.
Lots of risks have been studied by researchers over the years and a considerable PRM under
amount of papers have been published. These papers generally deal with two kind of uncertainty: a
procurement: physical products and service subscription. As different purchasing review
categories require different types of procurement strategy, we focus on those common
uncertainties existing in physical product purchasing, such as demand, price, lead time,
yield and disruption risks. Furthermore, according to Tang (2006a), supply chain risk
management has the following four parts: product management, supply management,
demand management and information management. To further delineate the scope of our
review, we expand Tang (2006a)’s supply chain risk management structure and put our
PRM under supply management.
For the purpose of a thorough review, related databases and journals are searched from
1995 to 2017. Furthermore, the keywords include price uncertainty (or risk, volatile),
demand uncertainty (or risk), yield uncertainty (or risk, random), lead time uncertainty
or risk, variable) and disruption risks and those terms are used to describe procurement
risks. In order to make robust procurement decisions, buyers put several uncertainties
under consideration. In fact, these uncertainties would not only affect the configuration
of supply base, but also the lot sizing. Therefore, it is critical to identify the possible risks
first and the suitable strategies are selected and adopted for PRM. Figure 2 illustrates the
typical procurement risks and the related PRM approaches. For instance, supplier
Operational risks Disruption risks
Uncertain supply yield; variable lead time Information system disruption

Poor data reliability; low efficiency information system Political unrest or warfare
Budget limitation; interest rate fluctuating Extreme weather or fire
Wrong inventory record; fluctuating exchange rate Legal risks
Uncertain demand; shortage of key employees Supplier default Table I.
Uncertain price Risks in procurement
Procurement Risk
Management
Uncertain Uncertain Uncertain Lead

Demand Price Uncertain Yield Time Disruption
Back Up Back up
Information Flexible Capital
Supply Supply
Updating Contract Investment
Channel Channel
Coordination Supplier Optimal

Joint Decision
with Inventory Diversification Ordering Time
Making
Decision
Back-up
Price Risk
Supply
Hedging
Channel
Figure 2.
Procurement risk
Supplier and
Contract
management and
Selection related approaches
IMDS diversification can be used to control the risk of uncertain supply while backup supply
channel can be used to deal with uncertain lead time and disruption. In the following
subsections, in-depth study and developed models under these different risks are discussed.
4. Classification of PRM
In general, there are five main risks that occur in procurement process which are demand
fluctuation, vague price information, unreliable yield uncertain lead time and disruption
risks. To deal with the procurement risk, buyers may diversify the risk with multiple
suppliers and purchase in multiple periods so as to enhance flexibility, adaptability and
responsiveness to the business environment. Table II provides a general classification
of procurement risk and the related research papers in particular type of risk.
4.1 Demand fluctuation

A lot of products’ demands are not stable, especially those high-tech and trendy products.
Companies should be capable of dealing with the uncertainty of demand in order to survive.
A considerable amount of research work has been done by scholars (e.g. Li and Wang, 2010;
Choi and Ruszczyński, 2011; Seifert and Langenberg, 2011) in the past years. These research
work and models are mostly developed under single period (one stage or two stages) or
multi period. For one-stage decision making, it is often the case that buyer needs to design
the procurement plan such as supply base configuration, lot sizing and forward contract
selection before the demand is realized (e.g. Swaminathan and Shanthikumar, 1999; Zimberg
and Testuri, 2006). While two-stage decision-making process divides the single period into
two stages: the first stage is similar as one-stage model, and the second
stage tries to figure out how many products need to be bought from spot market or via
instance order after obtaining more accurate demand information (e.g. Burnetas and Gilbert,
2001; Erhun et al., 2008; Fu et al., 2010). The third type is those seeking the optimal solution
for multiple periods (e.g. Martel et al., 1995; Bonser and Wu, 2001; Yan et al., 2003; Nagar and
Jain, 2008). Comparing with the single period model, more research can be done for multiple
period model as long-term inventory planning is important, thus making it impossible to
directly extend single period conclusion into multiple periods.
Scholars have proposed several risk management approaches to handle demand risk.
First, demand information is continuously updated so as to obtain a more accurate order
quantity. Second, in order to reach the win–win solution, it is suggested to design the
production and procurement plan together, or making integrated sourcing and inventory
decision. The third approach is to have a backup supply channel. After demand has realized,
buyer could place an instant order or purchase from spot market to meet demand. Fourth,
demand uncertainty can be mitigated using financial products, for example, options and
futures. Option contract is a useful tool to mitigate demand risk by giving buyers the right
but not the obligation to execute the contract.
4.2 Vague price information

The price of raw materials and electrical components are not constant in the market. Another
uncertain price scenario is when suppliers offer periodic price discount campaigns. In order to
compete with other companies, buyers have to make better procurement decision underprice
uncertainty, including the time to purchase and purchasing amount. Different purchasing time
usually means different purchasing price and the inventory holding length, thus resulting in
different level of costs. Das and Abdel-Malek (2003) suggested developing a flexible
buyer–supplier relationship to reduce price uncertainty. Sun et al. (2010) proposed a two-stage
fuzzy programming to model uncertain spot market price. Efforts to reduce price risk can be
also found in Seifert et al. (2004), Spinler and Huchzermeier (2006) and Woo et al. (2006).
Single channel and single Multiple channels and multiple

Risks period Single channel and multiple periods Multiple channels and single period periods
Operational Demand Burnetas and Gilbert (2001), Martel et al. (1995), Burnetas and Martel et al. (1995), Bollapragada and Swaminathan and Shanthikumar
risks Chen et al. (2006), Zimberg Gilbert (2001), Weng and McClurg Morton (1999), Burnetas and Gilbert (1999), Bonser and Wu (2001), Yan
and Testuri (2006), Erhun (2003), Chen et al. (2006), Zimberg and (2001), Weng and McClurg (2003), et al. (2003), Nagar and Jain (2008),
et al. (2008), Mukhopadhyay Testuri (2006), Erhun et al. (2008), Chen et al. (2006), Zimberg and Tapiero (2008), Hazra and Mahadevan
and Ma (2009) Chen and Xiao (2011), Fleischhacker Testuri (2006), Erhun et al. (2008), (2009), Li et al. (2009), Zhanga and Mab
and Zhao (2011) Lin and Ng (2011) (2009), Keskin et al. (2010), Zhang and
Zhang (2010), Li et al. (2011), Feng and
Shi (2012)
Price Siripatanakulkhajorn et al. Chaouch (2007) Das and Abdel-Malek (2003), Seifert Li and Kouvelis (1999), Bonser and
(2006), Fotopoulos et al. et al. (2004), Fu et al. (2010), Spinler Wu (2001), Tapiero (2008), Li et al.
(2008), Arnold et al. (2009) and Huchzermeier (2006), Woo et al. (2009), Aouam et al. (2010), Zare et al.
(2006), Yang et al. (2007), Sun et al. (2010), Şen et al. (2014)
(2010), Xu (2010), Cheng (2011), Li
and Gupta (2011), Li and Li (2011),
Reiner et al. (2014)
Yield Erdem and Özekici (2002), Bollapragada and Morton (1999), Agrawal and Nahmias (1997), Swaminathan and Shanthikumar
Lin and Hou (2005), Keren Swaminathan and Shanthikumar Federgruen and Yang (2008), Burke (1999), Maddah et al. (2009), Keskin
(2009), Mukhopadhyay and (1999), Erdem and Özekici (2002), et al. (2009), Federgruen and Yang et al. (2010), Ju et al. (2015), Chen and
Ma (2009), Luo and Chen Grasman et al. (2007), Kelle et al. (2009), Sun et al. (2010), Xu (2010), Tan (2016)
(2017) (2009), Yeo and Yuan (2011) Giri (2011), Rowe et al. (2017)
Lead Hariga and Ben-Daya Weng and McClurg (2003), Hsu et al. Das and Abdel-Malek (2003), Kouvelis and Li (2008), Chauhan et al.
time (1999), Hsu et al. (2009), (2007) Sajadieh and Thorstenson (2014), (2009), Kouvelis and Li (2012)
Wang and Tomlin (2009) Sazvar et al. (2014)
Disruption Wilson (2007) Ruiz-Torres and Mahmoodi (2007), Yan and Liu (2009), Costantino and
risks Wagner et al. (2009), Yu et al. (2009), Pellegrino (2010), Ellis et al. (2010),
Campbell and Jones (2011), Meena et al. (2011), Qi (2013), Sawik
Chaturvedi and Martínez-de-Albéniz (2013), Silbermayr and Minner (2014),
(2011), Lu et al. (2011), Fang et al. Qi and Lee (2015), Silbermayr and
(2013), Meena and Sarmah (2013), Minner (2016), Ledari et al. (2018)
Ruiz-Torres et al. (2013), Hu and
Kostamis (2015), Zhu (2015)
Multiple Wang et al. (2010), Meena and Shi et al. (2011), Schmitt and Snyder
uncertainties Sarmah (2014), Guo et al. (2016), Ray (2012), Hali (2013), Amorim et al.
and Jenamani (2016), Li (2017), (2016), Tan et al. (2016), Nie et al.
Merzifonluoglu (2017) (2017)
PRM under
review
Classification of
uncertainty: a
procurement risk
according to specific
research papers
Table II.
IMDS Reiner et al. (2014) developed a scenario-based multi-stage stochastic programming to
minimize the expected procurement cost under various uncertain price event like price
discount or a change in a price-index.
In order to handle price risk, three most commonly used strategies are as follows. First,
different procurement time and quantity would affect the inventory holding cost and
inventory level, so one way to reduce price risk is to integrate sourcing and inventory
decision. Furthermore, flexible contract is also a useful method to mitigate price risk. An
inflexible contract requires the buyer to determine not only the optimal quantity but also
optimal purchasing time, while flexible contract usually gives buyer the freedom to collect
items within a period. Last but not the least; with the continuous development of financial
market, many items can be bought in the form of option contract or futures contract. These
financial tools can also help to hedge price risk such as fluctuated exchange price. Liu and
Nagurney (2011) has studied about how the competition intensity and exchange rate can
affect the risk-neural and risk-averse firm to allocate off-shore-outsourcing activities as

international sourcing can help hedge the risk of exchange rate fluctuation (Lowe et al.,
2002). In the findings of (Kim et al., 2006; Allayannis et al., 2001), it is realized that financial
hedging is more effective compared with operational hedging.
4.3 Unreliable yield

Uncertain supply yield can come from a number of sources. For instance, because of
the supplier’s limited production capability, they could not deliver all the products on time
(Erdem and Özekici, 2002; Yang et al., 2007; Keren, 2009). Another situation is that not all the
supplier’s products meet the requirement, so only a fraction of products can be further used
(e.g. Agrawal and Nahmias, 1997; Bollapragada and Morton, 1999; Maddah et al., 2009).
Maddah et al. (2009) studied a problem with two types of supplies: one is Type A which is of
perfect quality but higher cost; while type B is the one with imperfect quality and lower cost.
The classical single period (newsvendor) and economic order quantity model are extended
by incorporating random supply and yield uncertainty in their work. After comparing with
traditional models, only Type A product should be considered and the proposed model
proves that accounting Type B would significantly increase profits. For more detail of yield
uncertainty, readers can refer to Yano and Lee (1995) which is a comprehensive and
excellent literature review of lot sizing under uncertainty. Besides, Chen and Tan (2016)
studied the inventory model to show that the ordering policy will be relatively stable if there
is only one Type A while the others are Type B.
Facing uncertain yield, two approaches are most widely used. First, supplier
diversification is using multiple suppliers when the available suppliers are not reliable.
This could help to reduce the yield uncertainty. Collaboration with supplier is another
mechanism to minimize uncertain yield. Capital investment to improve production line or
inspection center is an instance (Talluri et al., 2010).
4.4 Uncertain lead time

When buyer asks for quotation, supplier usually replies with price and lead time. If the
uncertainty of lead time cannot be controlled properly, it would increase total cost and
reduce customer service level. Conducting proper ways to control the uncertainty of lead
time is important and necessary. Some of the following approaches are commonly used by
buyers, such as deciding the optimal ordering time and using backup supply channel.
In fact, the variable lead time requires buyer to optimize and obtain the optimal ordering
time decision. Hariga and Ben-Daya (1999) took the variable lead time and the partial lead
time distributions into consideration, so as to determine the optimal reduction in
procurement lead time distribution with optimal ordering policy. Hsu et al. (2007) also
examined the effects of lead time uncertainty, product expiration date and capital limitation
for setting the ordering policy. The results showed that the retailer’s profit is highly PRM under
influenced by the uncertain lead time and there should be compensation mechanism to uncertainty: a
enhance supplier collaboration. review
There is another situation where component costs are too high to be kept as inventory.
Therefore, many firms optimize the best ordering time with the distribution of lead time,
expected holding and backlogging cost. Chauhan et al. (2009) investigated such a model and
proposed an algorithm to solve it. Moreover, many firms begin to place orders overseas,
which would bring low purchasing unit cost but would also increase lead time risk.
However, from another perspective, a more accurate demand forecasting would help buyers
to manage the lead time uncertainty. Wang and Tomlin (2009) studied how a firm
continuously updated its demand during selling season and design the optimal procurement
policy when facing lead time risk. The results showed that the firm became less sensitive to
the lead time uncertainty as the demand forecast updating process becomes more efficient.
Kouvelis and Li (2012) proposed two contingency strategies which are dynamic emergency
response and disruption safety stock. Through the strategies, safety stock can be released
appropriately when late delivery occurred and emergency order can be decided at the right
time easily, as a result, the cost of handling uncertain lead time would be reduced.
4.5 Disruption risks

In the face of supplier disruption risk, buyer may configure the supply base with backup
suppliers. However, a larger number of suppliers may result in higher cost. Therefore, it is
important to find the optimal number of suppliers. Ruiz-Torres and Mahmoodi (2007) used
decision tree to determine the number of suppliers. In fact, the model investigated two
situations: same failure probability of each supplier or different failure probability of
each supplier. The results showed that when the reliability of supplier is really high, sole
supply strategy may be the optimal. But as the supplier becomes less reliable, additional
suppliers may be needed to obtain the lowest cost. Meena et al. (2011) developed an
algorithm to obtain the number of suppliers under catastrophic events disruption through
considering the combination of failure rate, inefficient capacity and it is important to find the
optimal solution for minimizing the total costs.
Regarding the supplier failure, most of the models assume that the failure probability of
suppliers is independent. Actually this may not be true in all situations. Wagner et al. (2009)
used copula functions to capture the default dependence between suppliers. Copula function
is a way to represent joint distribution. An empirical data from automotive suppliers helped
to illustrate the importance to investigate supplier default dependence in a supplier
portfolio. Costantino and Pellegrino (2010) investigated both single and multiple sourcing
when there is supplier default risk. Monte Carlo simulation model is adopted and the
advantages of multiple sourcing in risky environments are examined. Silbermayr and
Minner (2014) studied a buyer procures from multiple supplier who are having the risk of
supply interruption, the author modeled a Semi-Markov decision process to show the benefit
of multiple sourcing over single sourcing. The result provided an insight for the company to
select multiple sourcing instead of single sourcing so as to reduce the risk of getting penalty.
Later, Silbermayr and Minner (2016) investigated more about the optimal dual sourcing
strategy on disruption risk reduction by considering the saving on procurement cost,
improvement the learning rate and reduction of reliability, the optimal robust strategy can
be set as 75:25 dual sourcing option.
4.6 Multiple uncertainties

Due to the current complex business environment, the above-mentioned risks would be
interrelated, which cause a more destructive economic consequence. In addition, mistakenly
identifying the risk causes the under-utilization of the regular supplier and over-utilization
IMDS of the backup supplier (Guo et al., 2016). In order to better address the supply chain risks,
considering multiple uncertain factors would be more important. Li (2017) considers
a company procures from two suppliers that are subjected to “all-or-nothing” disruption risk
and random yield risk respectively, to fulfill its deterministic demand. The researcher
conducts three models for the above scenarios including no resource and ordering resource
from one suppliers. As a result, the author can determine which strategies including single
sourcing and dual sourcing should be adopted for each scenario to obtain the optimal order
quantity. Guo et al. (2016) studied the contingent capacity strategy when sourcing from
a regular supplier having the above uncertainties with an uncertain demand, the author
pointed out that the contingency planning of ordering quantity from regular supplier should
be more than backup supplier if the overall supply risk remains unchanged.
Apart from considering disruption and yield risk, Shi et al. (2011) considered the
uncertain demand and price in China market. The authors developed a portfolio
procurement approach to alleviate the procurement risk using various procurement means
including long-term contracts, spot procurements and option-based supply contracts. They
constructed a multi-stage stochastic programming model to determine the effectiveness of
implementing the portfolio approach along a time horizon. The result shows that the
proposed portfolio approach performs well in terms of profit and procurement risk
exposure. Hali (2013) also considered the uncertain demand and price with respect to the
procurement, production and delivery planning. The author developed a stochastic chance
constraint programming with PSO algorithm approach to minimize the cost. The result
shows that applying multi-time periods integrated planning of supply chain can reduce the
cost and make the decision effectively.
5. PRM strategies and modeling method

In order to explore the PRM from different point of view, the PRM structure in Figure 3 is
proposed. First, as described in Section 1, buyers carefully review their purchasing
requirement, whether it is cost sensitive or urgent. Different purchasing requirement may
need totally different strategies. After understanding clearly about the requirements, it is
then necessary to identify the procurement risks. In this paper, the various uncertainties
existed in procurement are identified and examined in Sections 2 and 3, especially that the
uncertain demand, price, yield, lead time and disruption risks are thoroughly investigated.
These risks can be used as reference when buyers need to identify their own specific
risks. In addition, this paper also provides a review of the latest strategy to deal with these
uncertainties (Subsection 5.1–5.4). If the chosen strategy cannot fulfill the purchasing
requirement, a second round of risk management analysis is needed. In the references of risk
management, only a few strategies are commonly adopted. For instance, supplier
diversification and utilization of financial products are widely adopted for mitigating
demand uncertainty and backup sourcing is suitable for volatile lead time scenario. Hedging
strategy is usually adopted to reduce price and demand uncertainty. Some specific methods
are used to mitigate the lead time and disruption risks. Therefore, the following subsections
would focus on discussing in detail about specific PRM methods.
5.1 Supplier diversification

Supplier diversification is one of the methods to mitigate risk and researchers have
formulated models with objective mainly for minimizing the cost. Table III summarizes the
findings in supplier diversification.
Facing uncertain yield, demand and price, buyers try to diversify their supply base in
order to prepare for the risks, because small orders from a large number of suppliers can
reduce yield uncertainty. On the other hand, the fixed cost with each supplier would increase
the total cost, so diversification approach does not mean having as many suppliers as
PRM under
Procurement Requirement Analysis Procurement Risk Identification
uncertainty: a
Business Requirements: Met 100% demand; Risk Factors: Demand risk; Price risk; Lead time review
Time urgency; Minimal Quality level; Flexible risk; Yield risk; Exchange rate risk; Logistics risk;
supply quantity IT system risk; Disruption risk
Identification Methods: Risk Map; Risk Solver
(Monte Carlo simulation); Failure Mode and
Effects Analysis
Procurement Risk Evaluation Risk Management Strategies Selection

Evaluation Criteria: Maximum expected profit Uncertain Demand: Supplier diversification;
(with or without minimal demand fulfillment); Integrated decision making; Back up sourcing
Minimal total cost; Shortest lead time;
Maximum or minimal utility function (e.g. Uncertain Price: Price hedging using options;
Mean-variance framework) Flexible contract
Types of Modeling: Single period and single Uncertain Yield: Supplier diversification; Supplier
channel; Single period and multiple channels; development through capital investment
Multiple period and single channel; Multiple
period and multiple channels Uncertain Lead Time: Back up sourcing; Flexible
contract
Solution Techniques: Analytical procedure;
Linear programming; Goal programming; Mixed Disruption Risk: Back up sourcing
integer programming; Dynamic programming;
Monte-Carlo; Discrete-event; Simulated
appealing; Genetic algorithm Figure 3.
Procurement risk
management structure
Lead
Reference Demand Price Yield time Disruption Correlation Objective
Agrawal and Fixed Fixed Random × × × Minimal expected cost

Nahmias (1997)
Swaminathan and Discrete Fixed Fixed × × × Minimal total cost under
Shanthikumar single and multiple
(1999) periods
Federgruen and Random Fixed Random × × × Minimal cost with
Yang (2008) service constraint
Federgruen and Random Fixed Random × × × Minimal total cost and
Yang (2009) Service constraint
Hazra and Random Variable × × × × Minimal total cost
Mahadevan (2009)
Federgruen and Random Variable Random × × × Minimal cost under
Yang (2011) multiple periods
Fu et al. (2010) Random Fixed Random × × Demand and Minimal total cost for
price single and two periods
Xu (2010) Random Random Random × × Yield and Maximal profit for
instant price buyer and manufacturer
Zhang (2010) Random Random × × × Price and Maximal expected profit Table III.
demand An overview of
Zhang and Zhang Random Fixed × × × × Minimal total cost procurement risk
(2010) management models
Şen et al. (2014) Fixed Random × × × × Minimize expected cost with supplier
Rowe et al. (2017) Fixed Variable Random × × × Maximize expected diversification
profit strategy
IMDS possible and there is a tradeoff between the cost and supply continuity risk. Many scholars
have studied this situation in single period setting. In the presence of uncertain supply yield,
Agrawal and Nahmias (1997) adopted the strategy of using multiple suppliers and optimized
the order policy. It is proved that receiving small orders from a large number of suppliers could
help to reduce the random yield risk. Specifically, Agrawal and Nahmias (1997) examined how
many suppliers are needed to be selected when the yield of each supplier’s products is
different. By trying to order the optimal order quantity, they optimized the total profit:
Profit ¼ Revenue–Purchasing Cost–Shortage Cost–Holding Cost–Fixed Cost:
The result shows that the optimal expected profit is concave in the number of suppliers n. The
concavity means the optimal solution exists. Under the assumption of no fixed cost, it is
proved that the optimal profit is concavely increasing with the number of suppliers because
the variance of yield decreases with n. However, if there is a fixed cost, the optimal number of
supplier is chosen to make the tradeoff between fixed costs and the benefit of supplier
diversification. Swaminathan and Shanthikumar (1999) studied supplier diversification under
demand uncertainty using both single period and multi-period models. Moreover, two types of
suppliers are considered: one with high cost and high reliability while the other is offering low
price. The reliability is also low and the expected cost is expressed with parameters of cost and
demand. Fu et al. (2010) decided the sourcing quantity to be executed from the option contract.
They first select a supply base which has the following characteristics. No particular option
contract can dominate the other one in term of the reservation cost and holding costs.
Otherwise, this kind of option contract will not be engaged in the market. A new concept of
measuring the effects of portfolio is proposed by Fu et al. (2010):
C ns C nm
PE ¼ : (1)
C nm

PE is used to show the relative error of an optimal single contract cost C ns compared to the
optimal portfolio procurement cost C nm . In addition, a two-period model is also examined
and optimal properties are discovered to show the effect of inventory. Their study also shows
that correlation between demand and spot price can greatly affect the order decisions. In
a high demand-spot price correlation environment, option contract plays a more important
role in serving the demand. Unlike the previous papers which consider only cost, Zhang (2010)
took the total purchase quantity attribute and service level attribute into account when
designing the optimal procurement mechanism. It also pointed out that the optimal
procurement plan consists of a list of nonlinear contracts with different quantity and service
level. To further simplify the results, the value of the two attributes are checked and found to
have different implications. Thus, a fixed level which consists of a target service level and
price-quantity menu is proved to help buyer yield optimal profit. Zhang and Zhang (2010)
tried to purchase products from a group of suppliers which quoted different prices and order
restrictions (minimum and maximum order sizes). Purchasing and holding cost are also
considered in the model. This problem is formulated as a mixed integer programming and
solved with branch and bound algorithm. Hazra and Mahadevan (2009) conducted similar
research, but the difference of Hazra and Mahadevan (2009) and Zhang and Zhang (2010) is
that Hazra and Mahadevan (2009) adopted the equal allocation strategy among the suppliers.
Closed-form analytical solutions are provided and the results provide the following
managerial insight. It is better to have a pre-qualified supply base with greater capacity
heterogeneity rather than simply increasing the number of suppliers.
To examine the effects of supplier diversification under uncertain supply, Federgruen
and Yang have done a lot of contributions. Federgruen and Yang (2008) selected which
suppliers to retain, and how much to order from which supplier. The objective is to minimize
the total procurement cost and meet the uncertain demand with a given probability. Two PRM under
kinds of situations are considered. First, all the n potential suppliers have same fixed cost and uncertainty: a
yield distribution. Secondly, under the general case that suppliers have different fixed costs review
and yield factor distributions, large-deviations technique and the central limit theorem based
approximations are used to obtain the optimal solution. Federgruen and Yang (2009) made
further contribution of supplier diversification by differentiating the service constraint model,
where the delivered and usable units must cover the demand at a certain probability and the
total cost model is set that the orders are determined so as to minimize the total cost. One of
the most important contributions of this paper is to prove the difference of service constraint
model and total cost model under multiple suppliers with unreliable yields. These two models
are known to be the same with single and fully reliable supplier. To further analyze the
utilization of supplier diversification strategy, Federgruen and Yang (2011) developed a model
to find the optimal procurement decision under multiple periods. An important contribution of
their paper is to propose a two-part fee structure paid to supplier i in period t:
cit ¼ coit þceit pit ; i ¼ 1; . . .; N ; t ¼ 1; . . .; T; (2)
where coit is the price charged by supplier i in period t for every ordered unit and ceit is the
additional price charged by supplier i in period t for every effective unit delivered.
They developed an efficient algorithm and identified the optimal procurement strategy.
For example, it is no longer optimal to use a base-stock policy in contrast to the classical
model. Instead, it suggested retaining k* suppliers that are cheapest in terms of the effective
cost rates. The value of k* depends on suppliers’ yield characteristics, demand distribution
and cost parameters.
With the development of financial markets, another emerging direction of using supplier
diversification is for mitigating uncertain price. Buyers may choose to buy some financial
products to control risks, such as option contracts, futures and other derivatives. Woo et al.
(2006) used the case of a local distribution company to explain how to determine the extent
to which it should rely on spot markets, forward contracts and long-term tolling agreement.
The result showed that efficient frontier is a useful decision-making tool. An alternative
dynamic strategy models the problem as a mean-risk stochastic problem which is proved
to be better comparing with the naïve strategy. Rocha and Kuhn (2012) also used the
mean-variance optimization model for the management of electricity procurement from spot
market and other financial derivatives. By aggregating periods into macro periods and
restricting the decision rules to those affined in the history of the risk factors, the complex
multiple stage model is converted into a tractable quadratic program. The numerical
experiments highlighted the superiority of LDR method in enabling scalability for multiple
stage models.
5.2 Backup sourcing with information updating

Backup sourcing is a commonly used strategy to meet customer’s uncertain demand. As
demand information is not accurate until the selling season approaches, it is quite common
for buyers to have backup sourcing with demand information updating. Table IV shows the
overview of PRM model with backup sourcing strategy.
The benefit of information updating is also examined by Yan et al. (2003) and it is modeled
in a dual supply mode. There exists two suppliers with unit cost ci and lead time
Li, i ¼ 1, 2, where c1 oc2 and L2 oL1. This means the convenience of using a supplier with
short lead time always goes along with paying for a high unit price. An initial order can be
given to the low cost but slow supplier; and reactive supply can be ordered from the relatively
high cost and fast suppliers to meet demand. The obtained analytical optimal order solutions
are validated and tested by purchasing micro-controller by an industrial company.
IMDS Lead
Reference Demand Price Yield Time Disruption Correlation Objective
Yan et al. (2003) Random Fixed × Fixed × × Minimize total

cost
Fu et al. (2010) Random Random × × × Demand and price Minimize cost
Sting and Random × × × × Supply and Maximize profit
Huchzermeier demand
(2010)
Xu et al. (2010) Random Variable Variable Variable × × Minimize cost
Kouvelis and Fixed Fixed Random Random × × Minimize cost
Li (2008)
Table IV. Qi (2013) Fixed Variable × × Yes × Minimize cost
An overview of Fang et al. (2013) Fixed × × × Yes × Minimize the
procurement risk expected
management models operational cost

with backup Silbermayr and Random Random × Random Yes × Minimize cost
sourcing strategy Minner (2014)
Another most commonly studied problem is to try to determine the optimal procurement
quantity at the beginning of the ordering stage and the amount to order from backup sourcing
channel during the selling season. To have a quick response to the urgent demand, backup
sourcing supplier tends to offer a very short lead time to buyers. At the same time, the price of
products from backup supplier is higher compared with other suppliers who have a relatively
longer lead time. Within the single channel and single period setting, Hariga and Ben-Daya
(1999) studied the optimal ordering decisions making with the reduction of procurement lead
time duration in complete and partial lead time demand distributions. After observing that the
price of some short life cycle product increases as the selling season advances, Burnetas
and Gilbert (2001) made the decision whether to pay low price when demand information
is limited or pay a higher price when demand information is more accurate. This problem is
examined under both single period and multiple periods. Chen et al. (2006) developed a model
so that the manufacturer determines the production quantity in the first stage when there is
limited information about the demand. In the second stage, when demand information is more
accurate, the buyer specified his order quantity. A risk sharing contract is proposed to
promote the coordination between the manufacturer and the buyer. When facing uncertainties
resulted from both demand and yield, Mukhopadhyay and Ma (2009) developed a model and
made the optimal procurement decision under different amount of information situations
about the yield rate. Similarly, the problem considered by Arnold et al. (2009) also tried to solve
more than one risk factor: namely uncertain demand and purchasing cost. All these efforts
would help companies to reduce hidden cost in the dynamic business environment. Sting and
Huchzermeier (2010) studied a case with one overseas supplier and one backup supplier.
The shortages of overseas supplier are the lack of reliability and flexibility. A backup supplier
can help to improve the responsiveness. Xu et al. (2010) had a totally different assumption of
whether overseas supplier is reliable or not. They considred to source from two urgent supply
options rather than from the long lead time overseas supplier. The overseas supplier is prime
and the product’s quality is good, whereas the urgent supplier’s products are inferior in
quality and expensive. The contribution of their paper is to adopt Stackelberge game model to
evaluate the involvement of two urgent backup supply: the common price-only contract,
and a contract menu consisting of a transfer payment and a lead time quotation (L, T ).
Furthermore, with senstivity analysis, it is found that (L, T ) contract has higher advantages
over the common price-only contract when the market acceptance of substituable modules
and the uncertain nature of urgent supplier are high. Some prime suppliers can also offer
instance orders. Instead of finding multiple backup sourcing channels, some of the buyers PRM under
obtian the benefits from the same prime supplier. Li et al. (2011) considered how to place both uncertainty: a
initial order and supplementary order in a multi-period situation. The uniqueness of Nash review
equilibrium is proved and closed-form Nash equilibrium solution is found when parameters
are stationary. The numerical study shows the backup order option is beneficial for the
following scenarios: lower cost, lower value, lower inventory cost of supplier, higher inventory
cost of buyer and higher demand variation.
With the development of financial markets, a lot of industry professioanls and
researchers try to protect company from risks by tapping into these products. Seifert et al.
(2004) studied the usage of spot market for meeting customer’s demand. They analyzed
and compared four procurement senarions: pure contract sourcing, contract soucing with
buying only from spot market, contract sourcing with selling only from spot market; spot
market buying and selling. Demand and spot price are modeled as bivariate normal
distribution. The proposed objective function for both buying and selling is to minimize
the utility function Z(Q):
Z ðQÞ ¼ E ðqÞkV ar ðqÞ; where k 40: (3)
After deriving the equation of expected profit E(q) and profit variance Var(q), buyer links
them to form a comprehensive evaluation measure by the risk aversion k of the buyer. The
analytical form of procurement quantity from contract supplier is discovered. The result
tells us that the optimal order quantity is positively related to the mean of demand and
spot price, while it has a negative relationship with risk aversion parameter, demand
standard deviation. This means that backup sourcing is more important when market is
not stable and buyer is much more risk averse. Similarly, Fu et al. (2010) also suggested
buyers to use spot market. Furthermore, they also used a portfolio of option contract to
reduce risks. The option contracts enable buyers to hedge the risk of volatile price and
uncertain demand. Different from other studies, the authors studied the correlation of
demand and spot price, the procurement cost is inversely proportional to the volatility
of spot price and it is found that two suppliers is effective enough to have nearly-optimal
performance.
The adoption of backup supplier is also a useful method to deal with lead time
uncertainty. Kouvelis and Li (2008) examined when and how many to order from a backup
supplier to minimize the total cost. The benefits of using flexible backup supplier in the form
of dual sourcing are investigated using numerical analysis.
5.3 Integrated sourcing and production decision making

Coordination is another approach being used substantially when facing procurement
uncertainty. Risk and cost can be reduced by a flexible cooperation mechanism between
buyer and supplier, such as a flexible sourcing contract and integrated decision
making. Table V shows an overview of PRM modeling with integrated decision strategy.
Signing a flexible contract with supplier can also be used to reduce price risk. Li and
Kouvelis (1999) tried to figure out the optimal purchasing time and quantity of “time-inflexible
contract” and “time-flexible contract” individually. Time-inflexible contract requires buyer to
determine not only the exact order quantity but also the purchasing time, while time-flexible
contract allows buyer to purchase the specified quantity over a given period of time. In
addition, risk sharing mechanism is also incorporated. The optimal result is obtained by
calculating the net present value of the sum of purchasing cost and inventory cost. Actually
Li and Kouvelis (1999) also proved that multiple sourcing is also beneficial for procurement
underprice uncertainty. Similar time-flexible contract is also used by other researchers to
mitigate procurement risk (e.g. Fotopoulos et al., 2008; Xiong et al., 2011; Buzacott and Peng,
IMDS Lead
Burnetas and Random Variable × × × × Maximize expected

Gilbert (2001) profit
Mukhopadhyay Random Fix Random × × × Maximize expected
and Ma (2009) profit
Yan et al. (2003) Random Fixed × Fixed × × Minimize total cost
Keskin et al. (2010) Random × × Fixed Yes × Minimize total cost
Zhao et al. (2010) Random Variable × × × × Maximize profit
Table V. Inderfurth and Fixed Fixed Random × × × Maximize profit
An overview of Clemens (2014)
procurement risk Reiner et al. (2014) Fixed Random × × × × Minimize the total
management models procurement cost
with integrated Sajadieh and Fixed × × Random × × Minimize the cost
decision strategy Thorstenson (2014)
2011; Babich et al., 2011). Option contract is another form of flexible contract. If the spot
market price is lower than price specified in option contract, buyer could withdraw the right to
execute option contract (e.g. Spinler and Huchzermeier, 2006; Fu et al., 2010).
Another effective way is the integrated production and procurement decision making.
Chen et al. (2006) developed a two-stage decision model. The manufacturer determined the
production quantity at the first stage when there is little information about the actual
demand. In the second stage, as the selling season approaches, the buyer would place the
order. At the last stage, a risk sharing contract was proposed to maximize the overall profit
and each partner’s interest is also ensured. Burnetas and Gilbert (2001) made a tradeoff
between more accurate demand information and the increasing price as selling season
approaches. After modeling the uncertain demand using Bernoulli process and deriving the
optimal solution, a numerical study is provided to give management insights on stocking
policy with cost function. Mukhopadhyay and Ma (2009) studied a case when the used parts
and new parts can be used as input for the production process. The yield of the used parts
resulted in the demand uncertainty for new parts. Production and procurement plan are
optimized simultaneously to reduce risks; the same approach is also used by Xu (2010).
In addition, the procurement decision would also affect the inventory holding cost,
integrated sourcing and inventory decision. Keskin et al. (2010) considered inventory
replenishment, holding and backorder costs to meet stochastic demand. A simulation-
optimization approach is adopted to obtain the procurement and inventory decision.
One innovative approach of promoting cooperation between buyer and retailer is to use
option contract. Zhao et al. (2010) suggested using the negotiating of option contract price
and the exercise price instead of wholesale price mechanism to facilitate the production and
procurement in the supply chain. To obtain the system-wide optimal expected profit for the
supply chain, they took the whole supply chain as a centralized entity. The result is
compared with the wholesale price mechanism in manufacturer-retailer cooperation and it is
realized that the option contract can bring in Pareto improvement.
5.4 Hedging strategy

The hedging strategy is used to deal with uncertain price and demand. Financial hedging can
be achieved by setting up a forward contract in one foreign currency such as US$ at the
prevailing spot exchange rate to stabilize the earning and avoid volatility of company’s cash
flow due to fluctuations of exchange rate. The operational hedging can be achieved by
setting up a number of supply contracts or distributed manufacturing over the world
(Huchzermeier and Cohen, 1996). Various hedging strategy such as multi-stage hedging PRM under
strategy, minimal-variance hedge and one-stage hedge are studied by scholars to deal with uncertainty: a
price volatility and demand uncertainty. Ni et al. (2012) adopted discrete-time control theory to review
resolve the problem of volatile procurement cost of material by adjusting the futures position
at different stage. Harrison and Van Mieghem (1999) argued about the optimal of capacity
imbalance can never be obtained until the demand is known but applying multi-dimensional
newsvendor model allows firms to plan the capacity of critical resource so as to achieve
near-optimal hedging. Real time pricing hedge contract types are studied in the work of Zhang
and Ma (2009) through analyzing the demand pattern, contract price and hedged load
percentage so as to find out the minimize the expected cost and penalty risk measure of the
cost for electricity procurement. Moreover, Aouam et al. (2010) used both financial and non-
financial contracts as gas procurement source, such as futures, options and storage. The naïve
strategy is to hedge a fixed fraction of winter demand and equally allocated among available
procurement sources. As hedging is commonly used in commodity market, Oum et al. (2006)
has exploited the co-relation between load and price and adopted the hedging strategy by
setting a portfolio of forward contract and call and put option.
For recent study, hedging strategy can also be used to tackle uncertain yield. Luo and
Chen (2017) considered the effect of option contracts in hedging risk from a single period
two-level supply chain with uncertain supply yield and deterministic market demand. The
authors discover option contract can coordinate the quantity between order and
production. As a result, an optimal supply chain performance can be achieved. Table VI
shows an overview of PRM modeling with hedging strategy. Demand is generally
regarded it as random variables while Yield is regarded as variable and random. Price is
set as random and variable and some of studies concerns the correlation between yield
and price. However, until now not many research considers about the lead time in the
hedging strategy.
5.5 Other strategies

Integrated sourcing and inventory decision making is commonly used. It is often the case that
suppliers offer low price when they want to promote sales or clear excess inventory. And the
Lead
Huchzermeier Fixed Random × × × × Maximize expected,

and Cohen (1996) discounted global,
after tax value
Harrison and Random × Variable × × × Maximal operating
Van Mieghem profit function
(1999)
Ni et al. (2012) Variable Variable Variable × × Yield and price Maximize the profit
Zhang and Ma Random Random × × × × Minimize the expected
(2009) cost and penalty risk
measure of the cost
Oum et al. (2006) Variable Variable × × × Load and price Maximize expected
profit
Giri (2011) Fixed Variable Random × × × Minimize the expected
cost Table VI.
Silbermayr and Fixed × × × Yes × Minimize total An overview of
Minner (2016) procurement cost procurement risk
Luo and Fixed Random Random × × Yield and price Maximize expected management models
Chen (2017) profit with hedging strategy
IMDS low price lasts for a certain period before it returns to the normal price level. Chaouch (2007)
considered such a problem and tried to design the optimal replenishment plan by using
stochastic model. The optimal strategy is to replenish the products when the inventory falls
below a certain level. It is the promotion period rather than the common policy that they
should place the order when inventory level is zero or even when the price is high. Inventory
management is seen as a risky investment for future by Tapiero (2008). By using exponential
utility function and two-period model, he proved that zero-inventory can be replicated by
option contract with the optimal order quantity. Facing uncertain raw material price, Arnold
et al. (2009) also took the uncertain holding cost and uncertain demand into consideration
by adopting a deterministic optimal control approach to design the procurement plan.
The optimal policy turned out to be impulse or just-in-time procurement.
Actually the yield uncertainty can be reduced through supplier development program
such as capital investment on improving the production line or quality inspection center.
Therefore, the question is how much resources should be invested. Lin and Hou (2005)
developed a model to reduce the yield variability through proper capital investment and to
search the optimal ordering policies. Numerical studies found that the capital investment
brought about an average savings of 13.6 percent cost. Talluri et al. (2010) also advocated
that manufacturing firms should also allocate resources to improve suppliers’ capabilities
and performance, including quality management, product management and cost reduction.
The originality of Talluri’s (2010) paper is to use Markowitz’s model to assist buyer and
manufacturing firms in allocating supplier development investment among multiple
suppliers optimally. The other contribution is to present an analytical approach to address
the issue of risk in the capital investment for supplier development.
5.6 Implication of the study

Based on the findings of the study, it is realized that backup sourcing are frequently used
to handle the disruption risk, uncertain lead time and uncertain demand. Multiple sourcing
or dual sourcing inventory models are adopted by considering the market with dynamic
cost, suppliers’ responsiveness, inventory availability. Schmitt and Tomlin (2012) consider
and construct a graph of the effect on the performance among each strategy under
disruption frequency, they conclude that supplier diversification is less often preferred
than backup sourcing strategy as fixed supplier cost increase. Zhang and Liu (2011) also
pointed out that although supplier diversification can reduce the dependency on the
supplier, high procurement cost of this strategy is a vital problem for the company.
After the comparison, backup sourcing is more benefit to the current company. Qi (2013)
proposed to include waiting time in the continuous review inventory problem under
random disruption. It comes to the managerial decision whether they should wait for
the primary supplier recover form disruption with lower cost or get the supply from the
backup supplier to reduce the market loss. Flexible contract is a commonly approach for
dealing with the uncertain price and lead time. Among the research methodologies,
stochastic and dynamic programming are mainly used for modeling the uncertainties. As
not all parameters are deterministic and it is difficult to formulate the mathematical model
in certain situation, discrete event simulation is another prefer alternative option
to minimize the supply at risk by considering the demand distribution such as Poisson
demand and yield mean of the selected suppliers.
6. Conclusions
In this paper, various uncertainties in procurement are examined. Especially, the uncertain
demand, price, yield, lead time, disruption risks and multi-uncertainties are thoroughly
investigated. After reviewing the published papers in the procurement risk domain,
research problems are summarized and classified. This work also provides a review of the PRM under
latest strategies to deal with uncertainties. uncertainty: a
It cannot be denied that there is gap between theory and practice. Referring to the studies review
of Sodhi et al. (2012), the gap may be narrowed down by conducting the case study on major
procurement risk event before the empirical studies on PRM. Close collaboration with
industrial partner may help to minimize the gap. The willingness to provide open data
through the consortium platform may enable the theoretical framework to be more realistic.
Having reviewed over 100 papers, authors come up the following concluding remarks and
future research directions.
6.1 Multi-item procurement under uncertainty

Because of the complexities of this kind of problem, there are very few papers about
purchasing multi-item by considering the risks (Dolgui and Ould-Louly, 2002). In reality,
a product is usually made of several components, so the majority of buyer has to purchase
several components at the same time. Under this multi-item situation, it is difficult to solve
procurement decision under uncertainty as the corresponding stochastic models are too
complex to obtain optimal solutions. Therefore, it is better to transform the models
to deterministic models with the following methods such as the branch and bound
algorithm, goal programming and simplex method. Moreover, the uncertainties within each
item are correlated. Therefore, the future work should also consider the correlations among
the various uncertainties (Fu et al., 2010; Xu, 2010; Zhang, 2010; Oum et al., 2006)
6.2 Risk taking awareness

The most popular way to treat uncertainty is to calculate the expected value of the objective
function, while the variance of the outcome is also essential and should not be neglected.
Some of the decision models obtain the best expected value but may be not the optimal value
(Harrison and Van Mieghem, 1999). The optimal decision is the one with the best aggregate
performance of both expected value and variance. The Value at Risk (VAR), which
measures the biggest loss over a given period within a fixed confidence level, is a useful
method to represent the variance (Gan et al., 2005). The benefit of VAR is that it could be
used with the conventional statistical method together. Another useful method is the
Conditional Value at Risk (CVAR), which is derived by a weighted average between value at
risk and losses outside value at risk. The incorporation of VAR and CVAR could help
decision makers to get a more detailed and useful result about the outcome (Tomlin, 2006).
6.3 Risk dependency

Currently, many models assume that uncertainties are independent, especially when the
number of risk factors is more than two. But the risks are indeed correlated with each other
(Oum et al., 2006, Sting and Huchzermeier, 2010). Traditionally multivariate normal
distribution is used to model the dependence between uncertain factors. However, the
incorporation of dependence into decision-making models usually makes it too complex to
be solved, and another limitation is that the marginal distribution belongs to the same
family. Copula function is used as a way to formulate a multivariate distribution in such
a way that the general types of dependence can be represented. Copula may be a useful
mathematical tool for further research (Wagner et al., 2009).
6.4 Lead time uncertainty

The accurate estimation of procurement lead time and on time delivery is a prerequisite of
efficient production. It is often the case that buyers select those suppliers with the lowest
cost but do not pay much attention to the lead time uncertainty. When the delivery cannot
IMDS meet the deadline, suppliers could not deliver all the products or even a portion of them. This
shortage would cause manufacturing disruption, resulting in revenue loss. It is necessary to
consider lead time uncertainty when selecting suppliers and making order allocation
decisions (Hariga and Ben-Daya, 1999; Hsu et al., 2009; Wang and Tomlin, 2009). Besides,
more research work can be done to explore the correlation about geographical location of
suppliers and lead time or study the possibility of conducting certain inventory
management strategy through reducing lead time uncertainty.
6.5 Yield uncertainty

Yield uncertainty can be due to the limited supplier capability or the defective items.
Although many papers incorporate random yield in their models, the assumption is
simplistic by assuming binomial yield uncertainty without considering how defective
products are produced and affected by machine lifecycle. In addition linear cost is assumed
in the recourse action and it is not always true in real situation (Yano and Lee, 1995). When
considering yield uncertainty, the assumption should be more general and assumed to be
stochastic. Indeed yield can be further studied if buyer and supplier can develop
a cooperative relationship, for example, a flexible quantity contract is a proper way
to promote sustainable development for PRM.
6.6 Reactive PRM

The majority of the papers try to reduce risks before the risk happens. A lot of mathematical
models are proposed to consider many risks during the procurement decisions-making
process (Haksöz and Kadam, 2009). However, in reality, good contingency plans may be
more important than theoretical model for industrial practitioners. For instance, when
supplier could not deliver on time, buyer could buy from spot market or place instant order.
This may be expensive but the cost is usually smaller comparing with the cost of delay.
Reactive risk management should be considered at the initial step for procurement
decision making.
6.7 PRM using financial instruments

The development of financial instruments brings a lot of opportunities for procurement to
better handle various kinds of risks, such as demand, yield, price and lead time.
Multinational companies make use of financial hedging together with operational hedging
to reduce the foreign exchange risk exposure (Kim et al., 2006). Foreign exchange swaps and
financial derivatives help companies to mitigate the risk of loss. In addition, the application
of Markowitz’s portfolio theory can be used to allocate resources for supplier development.
Therefore, more research work should be conducted to expand the application of financial
instruments for PRM.
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About the authors

Dr Zhen Hong received the PhD Degree from Nanyang Technological University in 2014 and Bachelor
Degree in Logistics System Engineering from Huazhong University of Science and Technology,
People’s Republic of China. His research work focuses on the development of new model for
procurement risk management, supplier selection and logistics outsourcing.
Dr C.K.M. Lee is currently Assistant Professor in the Department of Industrial and Systems
Engineering, The Hong Kong Polytechnic University, Hong Kong. She is Program Leader of BSc(Hons)
Enterprise Engineering with Management. She received PhD and BEng Degrees from The Hong Kong
Polytechnic University. She was awarded Bronze Award of 16th China National Invention Exhibition
Award in 2006 and Outstanding Professional Service and Innovation Award, The Hong Kong
Polytechnic University in 2006. Dr Lee has authored or co-authored more than 100 journal papers.
Her current research areas include logistics information management, smart manufacturing,
application of Internet of Things and data mining techniques. Dr C.K.M. Lee is the corresponding
author and can be contacted at: ckm.lee@polyu.edu.hk
Linda Zhang received the BEng Degree from Tianjin University, Tianjin, China, in 1998, and the
PhD Degree from Nanyang Technological University, Singapore, in 2007, both in industrial
engineering. She is currently Professor of Operations Management with the Department of
Management, Institut d’Économie Scientifique et de Gestion School of Management Lille Economie et
Management-Centre National de La Recherche Scientifique, Lille-Paris, France. She has extensive
teaching experience in a number of countries, including The Netherlands, France, Singapore and China.
She has taught courses at both the undergraduate and graduate levels. Her research interests include
mass customization, design and management of warehousing systems, healthcare service design and
supply chain management. In these areas, she has published many articles in international refereed
journals, such as Decision Support Systems, IIE Transactions, The IEEE Transactions on Engineering
Management, the European Journal of Operational Research, the International Journal of Production
Economics, etc.
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Procurement risk management under uncertainty: a review

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3.1 Proposed definition of procurement risks

facilities) with minimum disruption.

3.2 Procurement risks and related PRM approaches

Operational risks Disruption risks

Uncertain supply yield; variable lead time Information system disruption

Uncertain Uncertain Uncertain Lead

Coordination Supplier Optimal

4.1 Demand fluctuation

4.2 Vague price information

Single channel and single Multiple channels and multiple

affect the risk-neural and risk-averse firm to allocate off-shore-outsourcing activities as

4.3 Unreliable yield

4.4 Uncertain lead time

4.5 Disruption risks

4.6 Multiple uncertainties

5. PRM strategies and modeling method

5.1 Supplier diversification

Procurement Risk Evaluation Risk Management Strategies Selection

Mean-variance framework) Flexible contract

Agrawal and Fixed Fixed Random × × × Minimal expected cost

their paper is to propose a two-part fee structure paid to supplier i in period t:

cit ¼ coit þceit pit ; i ¼ 1; . . .; N ; t ¼ 1; . . .; T; (2)

5.2 Backup sourcing with information updating

Yan et al. (2003) Random Fixed × Fixed × × Minimize total

management models operational cost

Z ðQÞ ¼ E ðqÞkV ar ðqÞ; where k 40: (3)

5.3 Integrated sourcing and production decision making

Burnetas and Random Variable × × × × Maximize expected

decision strategy Thorstenson (2014)

5.4 Hedging strategy

5.5 Other strategies

Huchzermeier Fixed Random × × × × Maximize expected,

5.6 Implication of the study

6.1 Multi-item procurement under uncertainty

6.2 Risk taking awareness

6.3 Risk dependency

6.4 Lead time uncertainty

6.5 Yield uncertainty

6.6 Reactive PRM

6.7 PRM using financial instruments

Manufacturing, Vol. 47 No. 7, pp. 979-992.

of Operations Research, Vol. 257 Nos 1/2, pp. 697-719.

Part A, pp. 98-113, available at: https://doi.org/10.1016/j.omega.2014.07.010

No. 2, pp. 311-334.

About the authors

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