Inventory risk allocation

Our main interest in this chapter is to get a better understanding of inventory risk allocation issues in drop-shipping supply chains as well as the impact of power distribution between the channel entities. To keep focus and to not diffuse economic insights, we do not explicitly reflect other issues encountered in e-commerce fulfillment, since many are hard to include in a formal model. Among these issues are possible differences in transportation costs and responsiveness, coordination issues arising when multiple wholesalers are needed to fulfill a single order, and the rationing of inventory when a wholesaler serves multiple retailers. These and other issues are treated qualitatively in Randall et al. (2002). 

Cachon, G. (2004). The allocation of inventory risk in a supply chain Push, pull, and advance-purchase discount contracts. Management Science, 50, 222-238. 

You allocate and purchase for specific orders without any inventory risk. 

Some papers consider a multiproduct inventory problem with substitution. For example, Bassok et al. [13] consider a model with N products and N demand classes with full downward substitution, i.e., excess demand for class i can be satisfied using product j for i > j. They show that a greedy allocation policy is optimal. However, there are no pricing decisions in their model. Meyer [106] considers a multiproduct monopoly pricing model under risk. The firm must make decisions for prices, productions, and capacities before actual demand is known. However, his model does not consider explicitly the inventory related costs. 

A different but somewhat similar contract works for Model D. We need a contract that would allocate some inventory-related risk to the retailer, while at the same time allocating some marketing expenses to the wholesaler. One such contract would be for the retailer to compensate the wholesaler for each unit of the inventory carried over while the wholesaler subsidizes a portion of... 

Next, we discuss an important aspect of supply chain network design, called Risk Pooling. Risk pooling refers to the use of a more consolidated distribution network with fewer facilities, each serving a large allocation of customer demand. A consolidated distribution system reduces supply chain costs—inventory holding cost (IHC), order costs, and facilities cost. However, customer service suffers, as time to fulfill customer demand increases. We will study the tradeoff between supply chain cost and customer service under risk pooling. 

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