Inventory Outsourcing and Risk Management

This paper considers the "inventory outsourcing problem" as a VaR (Value at Risk) problem providing a mechanism for managing outsourcing firms when the supplier is a leader having full information of the outsourcing firm's demand distributions and cost parameters. This leads to a Stackleberg game which is solved under a number of assumptions. Both demand dependent and independent models are considered, the latter resulting from (statistical) risk aggregation. A number of examples are solved as well to highlight essential issues underlying the practice of inventory outsourcing-price and supply priorities. These solutions can be be expressed as nonlinear optimization problems which can be solved by standard numerical routines.