Integrated operational and financial hedging in outsourced/offshored supply chains

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Across virtually all industries and geographic regions, manufacturers share one common goal: to increase profitability by decreasing costs. To significantly reduce their overall costs, many firms have contracted with suppliers located in much lower-cost countries to help them access a large pool of workers at a fraction of the cost of similar domestic facilities. While the allure of dramatic savings is undeniable and the use of offshore facilities is virtually unavoidable, risks involved in offshoring/outsourcing are significant. Among all, the greatest risk is the expectations about how much the savings from offshoring will be. A typical example of hidden costs is the impact of currency revaluation, which can have a dramatic effect on the success of offshoring endeavors. In addition, a lot of unexpected and sudden events such as terrorist strikes, political instability and natural disasters have awakened managers as never before to find ways to mitigate outsourcing risks. In this research program, we will investigate the inverse relationship between the risks and cost efficiency. Our research is divided into two phases in the next five years. In the first phase, we focus on coping with uncertainties in exchange rates and product demand and the objective is to study how strategic capacity planning as well as operational and financial hedging can mitigate the risks related to demand and exchange rates. Theoretical results are expected to be derived to explain the effect of operational and financial hedging. In the second phase, we will extend the research in the first phase from two-stage problems to multi-stage problems to incorporate the dynamics in the uncertainty of demand and exchange rate. The objective is to propose an optimal long-term capacity portfolio. In addition, rare events such as natural disasters and political events in the low-cost countries where suppliers are located will also be considered. Scenario-based large-scale stochastic dynamic programming models will be developed. The combination of analytical and optimization models will provide complementary results in understanding the importance of capacity planning and the roles of operational and financial hedging in short- and long-terms.