TABLE OF CONTENTS

I. INTRODUCTION ....................................................................................................... 2
II. METHODOLOGY .................................................................................................... 4
III. THEORETICAL BACKGROUND ......................................................................... 4
1. Procurement ............................................................................................................ 4
2. Procurement risk ..................................................................................................... 4
3. PRM and related PRM approaches ......................................................................... 5
3.1. Procurement risk management (PRM) ............................................................. 5
3.2. PRM approaches ............................................................................................... 6
IV. CLASSIFICATION OF PROCUREMENT RISK .................................................. 8
1. Demand fluctuation ................................................................................................. 8
2. Price instability ........................................................................................................ 9
3. Unreliable yield ..................................................................................................... 10
4. Uncertain lead time ............................................................................................... 11
5. Disruption risks ..................................................................................................... 13
V. IMPLEMENTATION STRATEGIES FOR PROCUREMENT RISKS ................ 14
1. Supplier diversification ......................................................................................... 14
2. Backup sourcing with information updating ......................................................... 15
3. Integrated sourcing and production decision making ........................................... 16
4. Hedging ................................................................................................................. 16
VI. CONCLUSION ...................................................................................................... 18
REFERENCE ............................................................................................................... 19
GROUP EVALUATION .............................................................................................. 25

TABLE OF FIGURES

Figure 1: Risk management approaches in procurement flowchart ............................... 7

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I. INTRODUCTION

In today's manufacturing industry, there is intense competition that revolves

around pricing, quality, and logistics (Roberta et al., 2014). With the popularity of
outsourcing from the 1980s, many companies outsource the business which is not their
core competency (Kremic et al., 2006). Outsourcing becomes a business strategy for
business partners, so enterprises can focus on its core technology and enhance their
competency. However, the practice of outsourcing contributes to greater intricacy and
challenges in supply chain management. Businesses might encounter negative
consequences of risk if they do not realize the impact and occurrence of the risk.
Therefore, the increasing focus on risk management within supply chain management
stems from the uncertainty surrounding the potential occurrence of an event in one part
of the supply chain, which could trigger an undesirable chain reaction throughout the
supply chain network (Finch, 2004; Tummala and Schoenherr, 2011).

Procurement plays a vital role in supply chain management, aiming to efficiently

replenish materials to meet customer demand while acquiring them at the right price, in
the right quantities, and at the right times. The significance of procurement within the
supply chain becomes evident when considering the substantial percentage of industry
costs it entails. As noted by Maucher and Hofmann (2011), material costs constitute a
significant 45 percent of expenses in the German automobile industry. Furthermore,
price fluctuation may be difficult to predict. Additionally, the quality of the supplied
materials is of utmost importance, as defective items can result in significant losses and
product recalls if identified by 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 alleviate the effect of demand uncertainty and
hence inventory risk, a supply contract with a quantity adjustment option can be
employed.

It is obvious that the optimal decision making in PRM under uncertainty should
incorporate many potential uncertain supply environments. In fact, there are many
uncertainties that exist in procurement, such as variable lead time and uncertain
demand. Since the lead times of these contracts are usually quite long, the buyer doesn't
have enough time to place a second order when the uncertain demand or uncertain yield
is realized. Or when the supply is affected by natural disasters, part or all of suppliers'
production capability is halted.

Extensive research has been conducted in this field by scholars. Martel et al.
(1995) examined the challenge of procurement planning over rolling planning horizons

2
when confronted with stochastic demand. When dealing with uncertain demand and
fluctuating prices in the spot market, Seifert et al. (2004) aimed to identify the optimal
order quantity by considering both forward contracts and the spot market in a single-
period context. In a single-period scenario, Federgruen and Yang (2008) devised a
model for configuring the supply base and determining order allocation among suppliers
while taking into account uncertainties in yield and demand. Yet, prior to putting PRM
(Procurement Risk Management) strategies into action, it's essential to identify the
underlying sources of uncertainty that give rise to procurement risk. Procurement risk
largely depends on the manager's experience and intuition because there is currently no
systematic method for them to categorize the origins of procurement risk. Typically, a
short-sighted risk management approach is crafted only after an unforeseen risk
materializes. Despite the existence of numerous review papers on supply chain risk
management, to the best of the author's knowledge, there hasn't been a review paper
published specifically on PRM (Procurement Risk Management).

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 comes 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. Section 3 provides the overview of the PRM. Section 4 is about
the classification of PRM. Section 5 shows PRM strategies and modeling methods. The
conclusion and future trend of research direction are shown in Section 6.

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II. METHODOLOGY

This research uses secondary data collected from previous papers. Specifically,
papers related to supply chain risk management and procurement risk management
(PRM) from 1995–2017 in several major databases (including ScienceDirect, Emerald,
and Google Scholar) are extracted by keywords and then further filtered based on the
relevance to the topic, number of citations and publication year. Definitions and current
approaches related to procurement risks management are reviewed.

III. THEORETICAL BACKGROUND

1. Procurement
Procurement is the process encompassing all activities associated with acquiring
and managing the organization’s supply inputs (Ambekar, 2020). Procurement is
responsible for obtaining the essential resources from external sources to sustain
internal operations, thereby managing the supply inputs of the organization. From the
perspective of external resource management, procurement was defined as to optimize
the value and efficiency of the procurement process of external sources, while
mitigating risks and ensuring compliance with relevant regulations for undertaking a
company’s core business activities and managing it under favorable conditions (Jessop,
1994)

Procurement encompasses various aspects such as sourcing, supplier selection,

contract negotiation, and contract management. There are studies which distinguish
procurement as an evolution of purchasing which was fundamentally focused on cost-
reduction in the past Miemczyk et al., 2012). Consequently, procurement is no longer
considered a simple business function accountable for planning,
implementing,evaluating and controlling purchase decisions (Paulraj and Chen, 2007);
it also encompasses the management of resources and suppliers (Lindgreen et al., 2013)

In today’s dynamic market environment, procurement is positioned as a critical

integrative business process, expanding its scope beyond short-term cost reduction to
encompass long-term value generation and delivery.

2. Procurement risk
In response to dynamic and competitive market environment, procurement
practices become more complex and carry higher risks. Sotic and Ivetic (2016) posited
that risk is an unfavorable situation that deviates firms attention from achieving
4
expected outcomes.. Wrong estimation of demand and poor coordination between
internal customer and supply source are main sources of procurement risk and
procurement risk is also a part of supply chain risk. Although there is no specific
definition on procurement risk, the grounded definition of supply risk is stated by
Zsidisin (2003) as “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.” In general, when the organization cannot manage a variety of uncertainty
and brings the adverse effect on the business, it is considered as a procurement risk.

Procurement risk is a common occurrence within a business unit or in an

organization. Some of the most common procurement risks include delays in delivery,
rise in costs, decrease in sales and production malfunctioning. The procurement risks
exists in an organization whenever the supply market behavior, and the organization‘s
dealings with suppliers, create outcomes which harm company reputation, capability,
operational integrity and financial viability (Trkman & McCormack, 2010).

Procurement risks are inevitable in the procurement process. If the organization is

unable to find proper solutions, it can have negative impacts not only on the quality
procurement process but also on the entire supply chain operation. Therefore,
implementing risk management in procurement is imperative to mitigate the potential
negative consequences..

3. Procurement risk management (PRM) and related PRM approaches

3.1. Procurement risk management (PRM)
Risk management is not only a critical concern in the financial sector; it is
also a developing worry in the supply chain, as the unpredictability of an incident
happening in one part of the supply chain might result in an unpleasant string
effect for the supply chain channel. Procurement risk management is the method
of decreasing risk and uncertainty in prices, lead-times, and demands to assure a
continuous supply flow such as materials, expertise, capacity, and services with
minimum disruption.

Numerous studies have been conducted, and various purchasing portfolios

have been developed, taking into account operational costs, product availability,
and demand information, to achieve optimal control over supply while also
minimizing risks or variances (Babich V, 2012). Although procurement is a part of
the supply chain, the implications of insufficient risk management in procurement

5
might be comparable to or the same as those of a lack of risk management in
the supply chain . If a risk that is usually multi-dimensional, by the concept of having
multiple consequences occur at the primitive node between buyer and supplier it would
be proliferated and amplified throughout the entire supply chain and therefore, it would
reveal the phenomenon of the “snow-ball effect” (Świerczek, 2014). Risks are often
inter-connected, which results in the exacerbation of some risks when the mitigation
strategies of other risks are performed. Therefore, it is essential for organization to set
up a PRM framework to proactively identify, assess, and mitigate risks, thereby
minimizing potential disruptions, protecting organizational interests, and promoting
successful procurement outcomes.

3.2. PRM approaches

A typical risk management process of an enterprise may be presented by the
following four sequential steps (Marie BELGODERE, 2021):
● Step 1. Risk identification
● Step 2. Risk assessment
● Step 3. Risk treatment (Decision and implementation of risk management
actions)
● Step 4. Risk monitoring

In this study, the risk management stages only have the risk identification and risk
treatment stage have been used in order to approach risk management in procurement.
Figure below shows the proposed approach framework of PRM that has been used in
this paper. This approach has been classified into risk management stages that can be
used in identifying the possible risks first and adopting the suitable strategies for each
type of procurement risk.

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 Figure 1: Pprocurement risk management flowchart

Risk identification is a fundamental phase of the risk management practice. In

order to recognize the risks, a decision-maker or a group of decision-makers should be
aware of the events or phenomena that result in uncertainty. The goal of risk
identification is identifying future uncertainties to manage these scenarios proactively
(Hallikas et al., 2004). In procurement risk, many factors have been bringing
uncertainty, potentially damages and variations to the goals of organization. The
procurement risk factors would be affected under some circums-tances like supplier
dependence, customer dependence, supplier concentration, single sourcing, global
sourcing, trust towards customers, trust towards suppliers, relationship quality with
suppliers, relationship quality with the customers, and information sharing with
suppliers (Mandal, 2012). According to study (Shi et al., 2011), procurement is very
often performed within uncertain supply environments such as uncertain customer
demand, fluctuation of price, unavailability of supply and variable lead time . As
different purchasing categories require different types of procurement strategy, we
focus on the risks concerned with uncertainties existing in physical product purchasing
that have been referenced in previous research studies and disruption risks.

Risk treatment or mitigation strategy has been one of the risk management steps
that have been commonly used. Since most of the risks are naturally unavoidable or
some-times risk taking or risk reduction is making less cost than eliminating or
transferring them. According to Tang (2006a), supply chain risk management has the

7
following four parts: product management, supply management, demand management
and information management. Risks are often intercon-nected, which results in the
exacerbation of some risks when the mitigation strategies of other risks are per-formed.
Traditional risk management plans may fail because of not considering the relationships
between risks and also not being thorough (Aqlan and Lam, 2015). When used in this
study, we expand Tang (2006a)’s supply chain risk management structure and put our
PRM under supply management and select the right PRMs for each potential
procurement risk.

Effective procurement risk management is crucial for organizations to achieve

cost savings, maintain supply chain reliability, and support overall business success. It
requires collaboration, transparency, and adherence to best practices to ensure that the
procurement function adds value to the organization and meets its strategic objectives.

IV. CLASSIFICATION OF PROCUREMENT RISK

1. Demand fluctuation
According to Paul et al. (2014), demand fluctuation refers to variations in the
demand for products or services over a given period. It encompasses variations in both
the level and timing of demand that can disrupt the procurement activities (Paul et al.,
2014). This can be caused by various factors, including seasonality, market trends,
economic conditions, and unforeseen events. The increasing consumer expectations for
customization, faster delivery, and instant gratification also have further intensified
demand volatility in recent years (Vela, 2023). Demand fluctuation can pose significant
risks to the procurement process in various ways.

Firstly, procurement professionals often find it difficult to predict the quantities of

products or materials required, a challenge that can result in either overstocking or
understocking. Overstocking ties up valuable capital and warehouse space, while
understocking can lead to stockouts and production delays, both of which come with
substantial costs. The financial implications of demand volatility are notable as well.
Procurement costs can rise when demand is unpredictable, making it harder to negotiate
favorable long-term supply contracts or leverage economies of scale. In such
circumstances, suppliers may charge higher prices for handling last-minute or small-
quantity orders, further straining the budget. Lead time management is another area
affected by demand volatility. Suppliers may struggle to meet shorter lead times for
urgent orders, disrupting production schedules and potentially harming customer
satisfaction. In addition, quality control is also at risk in this scenario. Rushed or
irregular orders may compel suppliers to compromise on quality, potentially leading to
8
issues that impact the overall product or service quality. Finally, managing cash flow
becomes more challenging when demand is volatile. Companies may need to maintain
higher levels of working capital to cover unforeseen procurement expenses, further
underscoring the financial risks associated with fluctuating demand.

For example, in early 2020, as the COVID-19 pandemic swept across the globe,
consumer demand for cleaning supplies and disinfectants skyrocketed (Kidd, 2023).
Retailers, healthcare facilities, and individuals were all clamoring for these products to
keep their spaces safe and sanitized. This surge in demand led to a situation where
Cleaning Supplies Inc. couldn't keep their products on the shelves. As a result,
procurement department of this company had to source these goods rapidly and in larger
quantities, often facing shortages and price fluctuations.

2. Price instability
Prices of goods and services can fluctuate over time. This is attributable to several
factors, including supply and demand imbalances, economic events like inflation,
natural disasters, geopolitical issues, currency exchange rate changes, government
policies, global supply chain disruptions, technological advances. In order to compete
with other companies, buyers have to make better procurement decision underprice
uncertainty, including the time to purchase and purchasing amount. Other of challenges
and risks within the procurement process including:

Budget uncertainty, presents challenges for procurement professionals in

effectively planning and allocating resources. This unpredictability can lead to the risk
of budget overruns or underutilization of funds, affecting financial planning within an
organization. Moreover, frequent price fluctuations can strain supplier relationships, as
suppliers may become frustrated when they cannot provide consistent pricing or meet
their commitments. This can potentially cause disruptions in the supply chain and hinder
the smooth flow of goods and services. Along with this, there is the risk of overpayment
for goods and services during certain periods, which can negatively affect an
organization's overall cost-effectiveness and profitability. Additionally, managing
contracts with fluctuating prices becomes a complex endeavor for procurement
professionals. They may need to invest more time and effort in contract negotiation and
administration to ensure pricing terms remain competitive and fair. This complexity
extends to the supply chain, which can experience disruptions due to price instability.
Procurement teams may need to adapt rapidly to rapid price changes, seek alternative
suppliers when prices become uncompetitive, or address unpredictable lead times, all
of which can impact the supply chain's efficiency. Resource allocation is another
concern when dealing with unstable prices. Procurement professionals may need to

9
divert resources to manage these price risks, which could otherwise be allocated to
strategic activities such as supplier development or quality improvement, affecting
long-term business goals. These interconnected challenges highlight the multifaceted
impact of price instability on procurement and the broader organizational landscape.

For example, inflation is a common form of price instability where the general
price level of goods and services in an economy rises over time (McKinsey, 2023).
Inflation erodes the purchasing power of money. As inflation increases, the cost of
goods and services tends to rise. This can lead to uncertainty in budget planning for
procurement professionals because they need to account for price increases when
allocating funds (Luo et al., 2023). Consequently, the procurement team may initially
allocate budgets based on current prices, but as inflation takes hold, they might find that
their allocated budgets are insufficient to cover the rising costs of goods and services
(McKinsey, 2023).

3. Unreliable yield
Uncertain supply yield, in this context, refers to the unpredictability of the quantity
and quality of goods or services that a supplier can provide. This uncertainty can
manifest in various ways, such as the supplier's inability to meet production targets
thereby could not deliver all the products on time (Erdem and Özekici, 2002; Yang et
al., 2007; Keren, 2009), inconsistent product quality so only a fraction of products can
be further used (e.g. Agrawal and Nahmias, 1997; Bollapragada and Morton, 1999;
Maddah et al., 2009), or fluctuations in the quantity of available goods. It can create
several challenges and risks in the procurement process.

Firstly, effective risk management is essential since it requires procurement

professionals to invest additional time and resources in assessing and mitigating the
risks associated with supply uncertainties. This effort may encompass thorough due
diligence on suppliers, supplier diversification, and the development of contingency
plans to handle potential disruptions. Uncertainty in supply also has implications for
inventory management. Procurement teams often find themselves compelled to
maintain elevated safety stock levels to safeguard against potential supply interruptions.
However, this precaution ties up capital and warehouse space, which can have financial
repercussions for the organization. The strain of uncertain supply extends to supplier
relationships. Suppliers may struggle to fulfill their commitments, leading to frustration
and potential disruptions in the supply chain. In such circumstances, maintaining open
and effective communication with suppliers becomes even more critical. Managing lead
times becomes intricate when supply yields are uncertain. Longer lead times may be
necessary to accommodate potential delays, which can impact production schedules and

10
the organization's ability to meet customer demands promptly. Quality control is not
immune to the pressures of uncertain supply. Suppliers under duress to meet fluctuating
demands may compromise on product or material quality to fulfill orders quickly. This,
in turn, can lead to potential quality issues that affect the overall quality of the final
product or service. Resource allocation is another concern. Procurement professionals
may need to divert resources to address supply uncertainty, resources that could
otherwise be channeled toward strategic activities such as supplier development or
process improvement. This diversion can have implications for the organization's long-
term goals and improvements. Lastly, contract management is further complicated in
the face of uncertain supply yields. Procurement teams may need to negotiate more
flexible contract terms or introduce clauses to address supply fluctuations, necessitating
additional effort and potentially influencing contract negotiations.

For example, according to Sanders (2019), Apple announced a partnership with

GT Advanced Technologies to manufacture sapphire glass, which is known for its
durability and scratch resistance. Apple had ambitious plans to use sapphire glass for
its device screens, particularly in the iPhone. However, the partnership faced several
issues such as quality control and supply delay. To be specific, GTAT's sapphire glass
had variations in the sapphire's strength and thickness, affecting the product perfection
level of Apple. Also, the supplier failed to meet the agreed-upon production deadlines,
causing delays in Apple's product launches. This disrupted Apple's supply chain and
affected its ability to meet consumer demand. Ultimately, Apple had to abandon its
plans to use sapphire glass for iPhone screens due to the unreliable supply and quality
issues from GTAT.

4. Uncertain lead time

Lead time refers to the amount of time from the point of order placement to the
arrival of a product at your warehouse or retail location. It encompasses all the phases
of the procurement process, including ordering, production, transportation, and customs
clearance. The role of lead time in procurement is critical, as it directly influences
customer satisfaction, production scheduling, and the management of cash flow. That
is also the reason why one of the most challenging aspects of procurement is dealing
with uncertain lead times, which refers to the variability and unpredictability associated
with the time it takes for suppliers to deliver goods or services. This is due to the
inherent uncertainties associated with the processes such as the reliability of suppliers,
transportation-related issues, the impact of natural disasters, economic variables, and
changes in political and regulatory landscapes. First, the variability in supplier
performance, including delays in production or shipping, is a common source of
uncertain lead times. Suppliers' capacity to consistently meet delivery schedules can be

11
inconsistent, leading to uncertainty in lead times. Moreover, shipping delays, customs
clearance bottlenecks, and other logistical challenges can create unpredictability in lead
times. Factors such as traffic congestion, infrastructure problems, or labor strikes can
lead to transport-related delays. Environmental events such as earthquakes, floods,
hurricanes, or pandemics can also be considered as the factors that disrupt production
and shipping schedules. Another objective variable that causes uncertain lead time is
economic fluctuations, affecting production costs and in turn, influencing lead time
reliability. Changes in trade policies, international regulations, tariffs, or political
situations can significantly impact lead times and create unpredictability in
procurement, especially for organizations involved in global supply chains.

The research has investigated the far-reaching consequences of uncertain lead

times, which can negatively affect various aspects of an organization's operations. One
of the clearly foreseen results is that the inability to accurately predict lead times can
make it challenging to maintain optimal inventory levels. In other words, it leads to
either overstocked warehouses or stockouts, both of which have cost implications.
Longer lead times often necessitate the holding of excess inventory, leading to increased
carrying costs, including storage, insurance, and depreciation expenses. Customer
satisfaction is also negatively affected associated with variable lead time. Delays in
product availability due to uncertain lead times potentially erode trust and impact an
organization's reputation. As mentioned above, variability in lead times can disrupt
production schedules, leading to increased production costs, operational inefficiencies,
and even potential supply chain disruptions.

Some research has been conducted to investigate lead time uncertainty. Hsu et al.
(2007) studied the impacts of uncertain lead time, product expiration date and capital
limitation for setting the ordering policy. The results showed that the retailer’s profit is
highly influenced by the uncertain lead time and there should be a compensation
mechanism to enhance supplier collaboration. 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 designed the optimal procurement policy when facing
lead time risk. The findings indicated that the firm became less sensitive to the lead time
uncertainty as the demand forecast updating process became more efficient. Compatible
with this viewpoint, Hegedus and Hopp (2001) developed a practical method to
determine the safety component lead times in an assembly system with uncertainties in
the procurement process. Their numerical results show that regardless of the level of
uncertainty on the supplier lead times, a safety lead time is useful to ensure flexibility.
Moreover, Kouvelis and Li (2012) proposed two contingency strategies which are

12
dynamic emergency response and disruption safety stock. By employing these
approaches, safety stock can be effectively deployed in cases of delayed deliveries, and
the decision-making process for emergency orders can be timely and easily executed.
Therefore, the cost of handling uncertain lead time would be reduced.

5. Disruption risks
Disruption risks refer to major disruptive events such as natural disasters, human-
made threats, or employee strikes. These types of events, particularly natural disasters,
are disruptions with low likelihood but high impact which may have short or long term
negative impacts on supply chain operations. (ref)

A study of the exposure level of Ford Motor Company to supply chain disruptions
found that the suppliers whose disruption would cause greatest damage are those from
which Ford's annual purchases are relatively small (Simchi-Levi et al., 2015). That is,
there are some critical suppliers that, when disrupted, lead to significant profit losses
because they are difficult to be quickly replaced. These events demonstrate that
disruptions, particularly natural disasters, can pose a major threat to businesses from the
standpoint of revenue and lost productivity. When dealing with the potential risks of
supplier disruptions, buyers might opt to structure their supply network by including
alternative suppliers. Nevertheless, having a greater number of suppliers can lead to
increased expenses. Therefore, it is crucial to determine the optimal supplier quantity.

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.
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) 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 disruption. 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.

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V. IMPLEMENTATION STRATEGIES FOR PROCUREMENT RISKS

1. Supplier diversification
Supplier diversification is one of the methods to mitigate risk and researchers have
formulated models with objectives mainly for minimizing the cost. Facing uncertainties
in yields, and prices, buyers seek to diversify their sources of supply as a means of risk
preparedness. This is because procuring smaller orders from a wide range of suppliers
can help alleviate uncertainty in yield. However, it's important to note that having
multiple suppliers can lead to increased fixed costs, ultimately raising the overall
expenditure. Therefore, supplier diversification strategy does not mean maximizing the
number of suppliers, as there is a trade off between cost and the risk of disruptions in
the supply chain. Numerous scholars have explored this scenario in a single-period
context. In the presence of uncertain yields, Agrawal and Nahmias (1997) employed a
strategy of utilizing multiple suppliers and optimizing the ordering policy. They
demonstrated that obtaining smaller orders from a broad array of suppliers can
effectively mitigate the unpredictable risk associated with crop yield. 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 suppliers is chosen to make the tradeoff between fixed costs and the benefit of
supplier diversification.

Federgruen and Yang made significant contributions by investigating the impact

of supplier diversification in the face of uncertain supply. In the research in 2008, they
focused on the selection of suppliers to keep and determining the optimal order
quantities from each supplier. Their goal was to reduce the total procurement costs
while satisfying uncertain demand with a given probability. Two distinct scenarios are
under consideration. In the first scenario, all n potential suppliers have the same fixed
costs and yield distributions. In the second scenario, which represents the more general
case where suppliers have varying fixed costs and yield factor distributions, the optimal
solution is obtained using large-deviations techniques and approximations based on the
central limit theorem. In 2009, Federgruen and Yang further advanced the concept of
supplier diversification by introducing two distinct models: the service constraint
model, which ensures that delivered and usable units meet demand with a specific
probability, and the total cost model, where orders are determined to minimize overall
costs. One of the most significant contributions of this paper is demonstrating the

14
disparity between the service constraint model and the total cost model when dealing
with multiple suppliers with uncertain yields.

2. Backup sourcing with information updating

Backup sourcing with information updating can be a valuable asset in meeting
uncertain demand. 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 the backup sourcing channel during the selling season. To have a quick response
to the urgent demand, backup sourcing suppliers tend to offer a very short lead time to
buyers. At the same time, the price of products from backup suppliers is higher
compared with other suppliers who have a relatively longer lead time. Chen et al. (2006)
devised a framework where the manufacturer determines the production quantity in the
initial phase when there's limited information available regarding demand. In the
subsequent phase, when demand data is more precise, the buyer specifies their order
quantity. All these efforts would help companies to reduce hidden costs in the dynamic
business environment.

To deal with lead time uncertainty, the adoption of backup suppliers and the usage
of the spot market are some popular methods. Seifert et al. (2004) studied the usage of
the spot market for meeting customer’s demand. They analyzed and compared four
procurement senarions: pure contract sourcing, contract sourcing with buying only from
spot market, contract sourcing with selling only from spot market; spot market buying
and selling. A classic example of a spot market dealing with lead-time uncertainty is the
commodity market, especially for agricultural products like grain, where weather
conditions significantly affect the timing of the harvest and the availability of the
product. Farmers cannot precisely predict when their crops will be ready for harvest due
to weather variability, growing conditions, and other factors. As a result, they may not
be able to commit to delivery dates well in advance. The spot market allows them to
bring their produce to market as soon as it's ready without the need for pre-planned
contracts.

When a company faces fluctuations or unpredictability in customer demand,

having backup suppliers readily available provides the flexibility to scale production up
or down as needed. By continuously monitoring and updating information about these
alternative sources, a business can swiftly shift its sourcing strategy to match the
evolving demand patterns. This adaptability ensures that the company can meet
customer requirements without overcommitting to a single source, reducing the risk of
excess inventory or stockouts. It also enhances the company's ability to manage

15
inventory levels efficiently and respond to sudden spikes or drops in demand, ultimately
improving customer satisfaction and minimizing the impact of demand uncertainties.

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.

Flexible contracts offer several benefits in times of uncertainty, providing a

structured approach to navigate and mitigate the challenges that unpredictable
circumstances can pose. These contracts allow for rapid adjustments in pricing, terms,
and quantities, enabling companies to adapt to changing market conditions, supply
chain disruptions, and fluctuating customer demand. Li and Kouvelis (1999) tried to
figure out the optimal purchasing time and quantity of “time-inflexible contract” and
“time-flexible contract” individually. The optimal result is obtained by calculating the
net present value of the sum of purchasing cost and inventory cost. 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. Integrated production and procurement decision-making in the face of
uncertain demand and price fluctuations provides numerous advantages. This approach
allows companies to make data-driven decisions based on real-time information,
improving their ability to respond to changing market conditions.. This not only leads
to cost-efficiency but also enhances customer satisfaction by ensuring that products are
readily available, even in unpredictable demand situations. Chen et al. (2006) developed
a two-stage decision model. The manufacturer determines 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.

4. Hedging
Hedging strategies provide several advantages in the context of uncertain price
and demand. These strategies allow businesses to manage the risks associated with both
price volatility and demand fluctuations simultaneously. By locking in prices for key

16
inputs or products, companies can mitigate the financial impact of price swings.
Hedging strategies also facilitate better risk management, helping organizations
maintain their profit margins and financial stability, regardless of market fluctuations.

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 the company's cash flow due to fluctuations of exchange rate. Various
hedging strategies such as multi-stage hedging strategy, minimal-variance hedge and
one-stage hedge are studied by scholars to deal with price volatility and demand
uncertainty. 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 minimize the expected cost and penalty risk measure of the cost for
electricity procurement.

An example of a forward contract is a food manufacturer. They rely on a steady

supply of wheat to produce its products. The price of wheat can be highly volatile due
to factors such as weather conditions, geopolitical events, and commodity market
fluctuations. The company aims to secure a stable price for wheat to manage
procurement risk and stabilize production costs. The forward contract allows the
company to "lock in" the price of wheat for future delivery. This means that, regardless
of how the market price of wheat fluctuates, the company is committed to buying the
agreed-upon quantity at the predetermined price. However, it's important to note that
forward contracts come with obligations and are legally binding, so both parties must
fulfill their contractual obligations. Additionally, the fixed price in a forward contract
may be higher or lower than the spot market price at the time of delivery, depending on
market conditions, so there are trade-offs to consider.

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 contracts can coordinate the quantity between
order and production. As a result, an optimal supply chain performance can be achieved.

17
VI. CONCLUSION

The manufacturing sector faces intense competition in pricing, quality, and

logistics. Outsourcing allows companies to focus on their core strengths while
introducing supply chain complexities. Neglecting these risks can have adverse
consequences, driving the need for risk management. Procurement plays a vital role in
supply chain management by efficiently acquiring materials at the right cost, quantity,
and time. Material costs, which can make up a significant portion of expenses, create
concerns related to fluctuating prices and material quality. To address demand
uncertainty and inventory risk, supply contracts with quantity adjustment options are
valuable. In procurement risk management (PRM), decision-making must address
uncertain supply scenarios, including variable lead times and uncertain demand,
especially considering that lengthy contract lead times and natural disasters can disrupt
suppliers' production.

This paper delves into several aspects of uncertainty in the field of procurement,
including uncertain factors like demand, price, yield, lead time, disruption risks, and
multiple sources of uncertainty. It conducts a comprehensive examination after
reviewing existing literature in the realm of procurement risk, summarizing and
categorizing research challenges. Furthermore, it offers an overview of the most recent
strategies for managing uncertainties. Specifically, supplier diversification and
utilization of financial products are widely adopted for mitigating demand uncertainty
and backup sourcing is suitable for volatile lead time scenarios. Hedging strategy is
usually adopted to reduce price and demand uncertainty. Some specific methods are
used to mitigate the lead time and disruption risks.

Addressing the disparity between theoretical concepts and practical

implementation in procurement risk management (PRM) requires a multifaceted
approach. Initiatives include conducting case studies on major procurement risk events
before delving into empirical PRM research, collaborating closely with industry
partners, and sharing open data to enhance the practicality of theoretical frameworks.
From a research perspective, exploring the complexities of multi-item procurement
under uncertainty, considering risk-taking awareness, acknowledging risk
dependencies, factoring in lead time and yield uncertainties, emphasizing reactive PRM,
and leveraging financial instruments all contribute to narrowing the gap and advancing
the field of PRM. These avenues of investigation hold promise for bridging the chasm
between theory and real-world application in the domain of procurement risk
management.

18
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24
GROUP EVALUATION

Student
ID Tasks Evaluation
Name

- Introduction
Le Thanh
11200147 - Methodology 5/5
Phuc Anh
- Conclusion

Strategies to implement
- Back up sourcing with information updating
Tran Hoang 11201618 - Integrated sourcing and production decision 5/5
making
- Hedging strategy

Classification of PR
- Uncertain lead time
Vu Khanh - Disruptions
11202317 5/5
Linh
Strategies to implement
- Supplier diversification

Classification of PR
Tran Minh - Demand fluctuation
11202935 5/5
Nguyet - Vague price information
- Unreliable yield

Theoretical background
Do Quynh - Procurement
11208001 5/5
Trang - Procurement risk
- PRM and related PRM approaches

25