Managing Multiechelon Cycle Inventory in a Supply Chain

A multiechelon supply chain has multiple stages and possibly many players at each stage. The lack of coordination in lot sizing decisions across the supply chain results in high costs and more cycle inventory than required. The goal in a multiechelon system is to decrease total costs by coordinating orders across the supply chain.

Consider a simple multiechelon system with one manufacturer supplying one retailer. Assume that production is instantaneous, so the manufacturer can produce a lot when needed. If the two stages are not synchronized, the manufacturer may produce a new lot of size Q right after shipping a lot of size Q to the retailer. Inventory at the two stages in this case is as shown in Fig­ure 11-6. In this case, the retailer carries an average inventory of Q/2 and the manufacturer car­ries an average inventory of about Q.

Overall supply chain inventory can be lowered if the manufacturer synchronizes its pro­duction to be ready just in time to be shipped to the retailer. In this case, the manufacturer carries no inventory and the retailer carries an average inventory of Q/2. Synchronization of production and replenishment allows the supply chain to lower total cycle inventory from about 3 Q/2 to Q/2.

For a simple multiechelon supply chain with only one player at each stage, ordering policies in which the lot size at each stage is an integer multiple of the lot size at its immediate customer have been shown to be quite close to optimal. When lot sizes are integer multiples, coordination of ordering across stages allows for a portion of the delivery to a stage to be cross-docked on to the next stage. The extent of cross-docking depends on the ratio of the fixed cost of ordering S and the holding cost H at each stage. The closer this ratio is between two stages, the higher is the optimal percentage of cross-docked product. Munson, Hu, and Rosenblatt (2003) provide optimal order quantities in a multiechelon setting with a single manufacturer supplying a single retailer.

If one party (distributor) in a supply chain supplies multiple parties (retailers) at the next stage of the supply chain, it is important to distinguish retailers with high demand from those with low demand. In this setting, Roundy (1985) has shown that a near-optimal policy results if retailers are grouped such that all retailers in one group order together and, for any retailer, either the ordering frequency is an integer multiple of the ordering frequency at the distributor or the ordering frequency at the distributor is an integer multiple of the frequency at the retailer. An integer replenishment policy has every player ordering periodically, with the length of the reor­der interval for each player an integer multiple of some base period. An example of such a policy is shown in Figure 11-7. Under this policy, the distributor places a replenishment order every two weeks. Some retailers place replenishment orders every week, and others place replenishment orders every two or four weeks. Observe that for retailers ordering more frequently than the dis­tributor, the retailers’ ordering frequency is an integer multiple of the distributor’s frequency. For retailers ordering less frequently than the distributor, the distributor’s ordering frequency is an integer multiple of the retailers’ frequency.

If an integer replenishment policy is synchronized across the two stages, the distributor can cross-dock part of its supply on to the next stage. All shipments to retailers ordering no more frequently than the distributor (every two or four weeks) are cross-docked, as shown in Figure 11-7. For retailers ordering more frequently (every week) than the distributor, half the orders are cross-docked, with the other half shipped from inventory, as shown in Figure 11-7.

Integer replenishment policies for the supply chain shown in Figure 11-8 can be summa­rized as follows:

• Divide all parties within a stage into groups such that all parties within a group order from the same supplier and have the same reorder interval.
• Set reorder intervals across stages such that the receipt of a replenishment order at any stage is synchronized with the shipment of a replenishment order to at least one customer. The synchronized portion can be cross-docked.
• For customers with a longer reorder interval than the supplier, make the customer’s reorder interval an integer multiple of the supplier’s interval and synchronize replenishment at the two stages to facilitate cross-docking. In other words, a supplier should cross-dock all orders from customers that reorder less frequently than the supplier.

For customers with a shorter reorder interval than the supplier, make the supplier’s reorder interval an integer multiple of the customer’s interval and synchronize replenishment at the two stages to facilitate cross-docking. In other words, a supplier should cross-dock one out of every k shipments to a customer that orders more frequently than the supplier, where k is an integer.

• The relative frequency of reordering depends on the setup cost, holding cost, and demand at different parties.

Although the integer policies discussed above synchronize replenishment within the supply chain and decrease cycle inventories, they increase safety inventories, because of the lack of flex­ibility with the timing of a reorder, as discussed in Chapter 12. Thus, these polices make the most sense for supply chains in which cycle inventories are large and demand is relatively predictable.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.