Celian Colon joined EEP & ASA

The global fragmentation of production amplifies systemic risk in supply chains

Unexpected localized disruptions can cascade along supply chains and induce disproportionately high losses. Mitigating such risks can be challenging as nowadays, through outsourcing, supply chains are becoming more complex and specialized. We formulate a stylized model in which firms are embedded in a supply chain and mitigate the risk of supply disruption using inventories. The mitigating strategy of one firm influences the profit of the other; we analyze such interactions using evolutionary game theory. We find that the mitigating effort that each firm should commit largely varies according to the position of the firm in the supply chain. Vertical fragmentation, whereby the design and production stages of a good or service are split across multiple firms, reduces their incentives to maintain inventories and gives rise to systemic risk. Finally, we show how decision-makers can mitigate systemic risk using a network indicator based on the ecological concept of “trophic level” to allocate inventory.