Abstract: Dual sourcing and backup production are two operational strategies that firms most commonly use to mitigate supply risk. In this paper, the updating of information on supplier reliability is considered, and the firm strategic use of dual sourcing and backup options in two stages are examined. In the first stage the firm orders from one or two unreliable primary suppliers, and then in the second stage decides whether to order from a backup supplier with complete reliability contingent on the updated information. The optimal sourcing and ordering decisions of the firm are completely characterized in the two stages. When there is no backup option, the firm prefers dual sourcing to single sourcing if the fixed procurement cost is low. When there is the backup option, the optimal procurement strategy depends on the market potential. Under low fixed procurement cost, the results show that when the market potential is small, dual sourcing excludes backup options from the sourcing strategy due to the high cost of backup; when the market potential is large, dual sourcing and backup production coexist to satisfy the high demand; when the market potential is moderate, dual sourcing may be excluded by backup production, and the two may also contingently coexist. Furthermore, when the market potential is moderate, the firm tends to exercise the backup option rather than using dual sourcing, especially when the probability of reliability improvement increases or the backup cost decreases. Contingent coexistence of both dual sourcing and backup production becomes more likely when reliability improvement probability decreases, fixed procurement cost decreases or backup cost increases. In summary, the choice between exclusive and coexistence of dual sourcing and backup production balances the profit loss from over ordering, the fixed procurement cost and the additional production cost of backup.

Key words: dynamic ordering, dual sourcing, backup production, information updating