Minimum order quantity requirements in the presence of supply disruption risk and retail competition

We study the equilibrium sourcing strategies – single sourcing or dual sourcing – of two competing retailers with access to two suppliers that are subject to disruptions. In the absence of minimum order quantity requirements, we show that both retailers will use dual sourcing. However, while dual sourcing is optimal for a monopolistic retailer, competing retailers would be better off under single sourcing, and the dual-sourcing equilibrium arises as a prisoner's dilemma. We show how minimum order constraints allow the retailers to sustain a more profitable single sourcing equilibrium with lower expected market supply and higher market prices. Imposed by suppliers to enable efficiencies and economies in production and logistics, our results thus suggest that minimum order quantities might benefit competing retailers, enabling them to avoid the prisoner's dilemma of dual sourcing. Minimum order quantity requirements will be harmful to consumers though if they have to pay higher prices in a single-sourcing equilibrium. As minimum order quantity requirements might reduce downstream competition and increase consumer prices, our findings suggest that regulators should carefully consider whether such requirements are truly justifiable by supplier-side process efficiencies, or whether they are primarily employed as a means to facilitate tacit collusion.