In our discussion so far, we have assumed that each stage of the supply chain has a well-defined demand and supply distribution that it uses to set its safety inventory levels. In practice, this is not true for multiechelon supply chains. Consider a simple multiechelon supply chain with a supplier feeding a retailer that sells to the final customer. The retailer needs to know demand as well as supply uncertainty to set safety inventory levels. Supply uncertainty, however, is influenced by the level of safety inventory the supplier chooses to carry. If a retailer order arrives when the supplier has enough inventory, the supply lead time is short. In contrast, if the retailer order arrives when the supplier is out of stock, the replenishment lead time for the retailer increases. Thus, if the supplier increases its level of safety inventory, the retailer can reduce the safety inventory it holds. This implies that the level of safety inventory at all stages in a multiechelon supply chain should be related.
All inventory between a stage and the final customer is called the echelon inventory. Echelon inventory at a retailer is just the inventory at the retailer or in the pipeline coming to the retailer. Echelon inventory at a distributor, however, includes inventory at the distributor and all retailers served by the distributor. In a multiechelon setting, ROPs and OULs at any stage should be based on echelon inventory and not local inventory. Thus, a distributor should decide its safety inventory levels based on the level of safety inventory carried by all retailers supplied by it. The more safety inventory retailers carry, the less safety inventory the distributor needs to carry. As retailers decrease the level of safety inventory they carry, the distributor must increase its safety inventory to ensure regular replenishment at the retailers.
If all stages in a supply chain attempt to jointly manage their echelon inventory, the issue of how the inventory is divided among various stages becomes important. Carrying inventory upstream in a supply chain allows for more aggregation and thus reduces the amount of inventory required. Carrying inventory upstream, however, increases the probability that the final customer will have to wait because product is not available at a stage close to him or her. Thus, in a multiechelon supply chain, a decision must be made with regard to the level of safety inventory carried at different stages. If inventory is expensive to hold and customers are willing to tolerate a delay, it is better to increase the amount of safety inventory carried upstream, far from the final customer, to exploit the benefits of aggregation. If inventory is inexpensive to hold and customers are time sensitive, it is better to carry more safety inventory downstream, closer to the final customer.
Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.
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