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Abstract:
This paper studies multi-tier supply chain networks in the presence of disruption risk. Firms decide how to source their inputs from upstream suppliers so as to maximize their expected profits, and prices of intermediate goods are set so that markets clear. We provide an explicit characterization of equilibrium prices and profits, which allows us to derive insights into how the network structure, i.e., the number of firms in each tier, production costs, and disruption risk, affect firms’ profits. We discuss the prescriptive implications of our findings by exploring how a firm should prioritize among its (direct and indirect) suppliers when investing in improving their production reliability. Furthermore, we establish that networks that maximize profits for firms that operate in different stages of the production process, i.e., for the upstream supplier and the downstream retailer, are structurally different. In particular, the latter have relatively less diversified downstream tiers and generate more variable output than the former. Finally, we consider supply chains that are formed endogenously; i.e., firms decide whether to enter and engage in production by forming beliefs about their profits post-entry. We argue that endogenous entry leads to chains that are inefficient in terms of the number of firms that engage in production.