Abstract: Random yield of the upstream supplier is often seen in the semiconductor, electronics and chemical industries, which has a significant negative impact on the downstream manufacturer's operations. Since the major supplier's (risky supplier) yield is random, to mitigate supply risk, the manufacturer can procure from an alternative reliable supplier (QF supplier) with quantity flexibility contract. So, the manufacturer faces a problem of how to determine its procurement strategy in the presence of random yield. Using stochastic modelling and optimization, the manufacturer's optimal procurement decisions are investigated under deterministic and stochastic demand, respectively. The structural properties of optimal solutions are analyzed and the conditions under which the quantity flexibility procurement policy should be used are identified. Furthermore, by theoretical analysis and numerical computations, the effect of random yield, flexibility, wholesale price and demand risk on the procurement decisions are examined. It is found that the higher supply risk and demand risk reduce the manufacturer's expected profit but have different impacts on the manufacturer's order decisions. For the QF supplier, it may not obtain more orders by providing larger flexibility to the buyer,on the contrary, doing this may benefit the risky supplier. For the QF supplier or risky supplier, given its competitor's wholesale price, it can increase its order share by lower wholesale price. Our results can facilitate the manufacturer to mitigate its supply risks.

Key words: supply uncertainty, yield uncertainty, quantity flexibility contract