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Managing stock-outs effectively

with order fullment systems


Richard Pibernik
MIT-Zaragoza International Logistics Program, Zaragoza Logistics Center,
Zaragoza, Spain
Abstract
Purpose When approaching a stock-out situation, a company should be able to actively manage
the allocation of available products on the basis of customer requirements and priorities as well as
contractual relationships. The purpose of this paper is to describe different order promising
mechanisms and analyze how well they can contribute to the effective management of stock-out
situations.
Design/methodology/approach The paper provides a formal description and analysis of
alternative order promising mechanism applicable in make to stock systems. Numerical analysis is
conducted based on the data of a pharmaceutical company.
Findings The paper clearly points out the potential of alternative order promising mechanisms to
alleviate the negative consequences associated with a temporary stock-out situation.
Research limitations/implications The paper does not consider implications of inventory
pre-allocation to customer classes. Further research should address the interplay between
pre-allocation and different order allocation mechanisms.
Practical implications The results obtained from this analysis provide guidelines for
manufacturers, retailers, and vendors of supply chain software on how to design and utilize order
promising systems.
Originality/value The paper provides a consistent formal approach to modelling order promising
mechanisms, introduce new and innovative order promising mechanisms and provide valuable insight
into their performance through numerical analysis.
Keywords Order processing, Stock control, Resource allocation, Customer requirements
Paper type Research paper
Introduction
In recent years, companies have been striving for increased supply chain efciency
through higher resource utilization and inventory reduction. To a certain extent,
efcient supply chains with limited slack and buffer in terms of capacity and inventory
become more vulnerable in regard to demand uctuation, supply shortages and
uncertain manufacturing yields. In this context, the management of stock-out situations
becomes animportant issue. Acompany should be able to anticipate stock-out situations
and should actively manage the allocation and re-allocation of available products on the
basis of customer requirements and priorities as well as contractual relationships. Order
fullment systems, which are increasingly being employed, play an important role in
managing stock-out situations. These commercial applications provide functions for
receiving orders through multiple channels (e.g. call centers, e-mail, internet platforms),
for order promising, i.e. for checking product availability and quoting delivery
quantities and due dates, as well as for order execution and monitoring. When
approaching a stock-out situation, order promising as part of the overall order fullment
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1741-038X.htm
Managing stock-
outs effectively
721
Received August 2005
Revised January 2006
Accepted March 2006
Journal of Manufacturing Technology
Management
Vol. 17 No. 6, 2006
pp. 721-736
qEmerald Group Publishing Limited
1741-038X
DOI 10.1108/17410380610678765
process is crucial. It determines how the remaining available inventory/capacity is
allocated to incoming orders. These allocation decisions can have signicant impact ona
companys short and long term protability. In the short run, not meeting customer
requirements in terms of delivery dates and delivery quantities can, for example, cause
lost sales, and contractual penalties. Long-term impacts can be decreased customer
retention rates and lower future sales potential, resulting in diminishing customer
lifetime values. In a stock-out situation, the order promising logic has to take these short-
and long-term implications into account; order promising decisions should be made in
such a way that overall negative impacts on protability are minimized.
In this paper, we describe different order promising mechanisms and analyze how
well they can contribute to effectively managing a stock-out situation. We characterize
the logic implemented in commercial order fullment systems and identify and
evaluate alternative allocation mechanisms. One basic idea we are pursuing is that a
company may be able to switch from a standard mode of order promising into an
emergency mode as soon as a stock-out situation is anticipated. We utilize data from
a specic stock-out situation in the pharmaceuticals sector to conduct numerical
analysis. The results obtained will illustrate the effects of different allocation
mechanisms and provide insight into their short- and long-term implications.
Literature review
So far, only a limited number of publications address order fullment in stock-out
situations. Traditional inventory management literature mainly focuses on optimal
stocking decisions when facing uncertain demand. Stock-out costs are modeled as cost
of lost sales or backorder cost on a per unit (and time) or per stock-out occasion basis.
Alternatively, they are incorporated implicitly through a service level constraint.
A number of publications (Ha, 1997; de Vericourt et al., 2002) propose approaches to
pre-allocation of inventory to different customer classes (so-called inventory rationing).
By making pre-allocation decisions based on individual stock-out cost, the authors
acknowledge that cost resulting from unlled demand can depend on specic types of
customers, and that available inventory should be allocated in such a way that overall
cost are minimized. In contrast to pre-allocation, where demand of different customer
classes is considered to be uncertain, order fullment has to allocate received orders to
available inventory/capacity in order to determine order specic due dates and
delivery quantities. Major contributions in this eld of research have been made by
Ball et al. (2004), Chen et al. (2002) and Chen et al. (2001). Next to an overview of
so-called available to promise functions in commercial order fullment systems and
of a number of industry applications, the authors develop mixed-integer programming
models for allocating orders arriving within a pre-determined time interval to available
components and assembly capacity. The proposed models are specically addressing
order promising in a congure to order environment. Allocation decisions are made on
the basis of prots calculated by subtracting tangible and intangible cost, which also
account for penalties induced by order denial, from overall revenue. Fleischmann and
Meyr (2003) develop linear and mixed integer programming models for allocating
orders to nished goods inventory as well as available resources of an assemble to
order system. Allocation decisions are based on a penalty cost parameter that includes
costs for backlogging, early allocation and order denial. Kilger and Schneeweiss (2000)
give an overview of the order allocation functions provided by commercial order
JMTM
17,6
722
fullment systems. They point out that order allocation is typically performed on the
basis of a set of heuristic allocation rules that can be customized to accommodate
company specic requirements. Due-date setting in a make to order environment has
been addressed in numerous publications (an overview is provided by Gordon et al.,
2002). As this paper focuses on the allocation of nished goods inventory, we will omit
a further discussion of the proposed approaches.
Although, some techniques for allocating orders to available inventory have been
proposed, their performance has not been assessed in regard to stock-out situations. The
research presented in this paper specically focuses on order allocation in a stock-out
situation. We analyze how well different allocation mechanisms can contribute to
effectively managing a stock-out situation. In our analysis, we include both heuristic
allocation mechanisms, implemented in commercial order fullment systems and an
optimization-based approach similar to the models proposed by Chen et al. (2001, 2002).
Order fullment in stock-out situations
One important task of an order fullment system is the allocation of incoming orders to
available inventory/capacity while accounting for customer preferences in regard to
delivery quantities and due dates. In the following, we will focus on a
manufacturer/retailer delivering goods from a single production facility or warehouse.
For simplicity, we will only consider one product which is being produced to stock.
Finished goods inventory supply is assumed to be xed in the short term, determined by
planned receipts from production or purchase. For modeling the allocation problem, we
assume a discrete time structure with a planning horizon spanning over T - 1 periods.
With t
b
, we denote the current period in which orders are being received and allocation
decisions have to be made. With t
e
= t
b
- T; we denote the nal period of the planning
horizon. Typically, the periods t [ [t
b
,t
e
] represent working days for which due dates of
individual orders are being quoted. In the current period t
b
, the order fullment system
receives a number of orders. With O(t
b
), we will denote the set of orders received in period
t
b
. We assume that each order i [ O (t
b
) can be characterized by a triple (q
i
; d
l
i
; d
u
i
) of
ordered quantity q
i
, earliest date of delivery d
l
i
and latest date of delivery d
u
i
; with
d
l
i
; d
u
i
[ [t
b
- 1; t
e
] specied by the customer. In period t
b
, the planned inventory inv
t
(t
b
)
available int canbe calculatedonthe basis of the initial inventoryinv
t
b
(t
b
) at the endof the
current period, the planned receipts s
t
, determined by MPS or procurement orders, and
inventory quantities r
t
, which have been reserved for orders committed previously:
inv
t
(t
b
) = inv
t
b
(t
b
) -
X
t
t=t
b
-1
s
t
2
X
t
t=t
b
-1
r
t
;t [ t
b
- 1; t
e

(1)
The available to promise quantity can be calculated as atp
t
e
(t
b
) = inv
t
e
(t
b
) for period t
e
and atp
t
(t
b
) = min inv
t
(t
b
); atp
t-1
(t
b
) for periods t
e21
; . . . ; t
b-1
: Dening by x
i
(t) the
quantityquoted for order i [ O(t
b
) inperiodt, we can represent the result of the allocation
of all orders received in period t
b
by a (}O(t
b
)} T 2 1)-dimensional matrix x
t
b
: x
t
b
is a
feasible allocation if the condition:
inv
t
b
(t
b
) -
X
t
t=t
b
-1
s
t
2
X
t
t=t
b
-1
r
t
2
i[O(t
b
)
X X
t
t=t
b
-1
x
i
(t) $ 0 (2)
Managing stock-
outs effectively
723
is satised for all t [ [t
b
- 1,t
e
]. Order allocation is typically performed on an innite
rolling time horizon basis. In every period, a set of orders is allocated to the available to
promise inventory. The individual allocations are linked through the available to promise
quantities: The allocation x
t
/
b
determines the available to promise quantities atp
t
(t
//
b
)
(;t [ [t
//
b
- 1; t
//
e
]) for the allocation x
t
//
b
in period t
//
b
(= t
/
b
- 1); etc.
From an order fullment perspective, a stock-out occurring in a specic period t
/
b
can be dened as a situation, in which atp
t
(t
/
b
) is zero (or less than a minimum level) for
a time period [
_
t;

t] [ [t
b
- 1; t
e
] (stock-out period). As a consequence, incoming orders
i [ O(t
/
b
) with a required delivery time window bd
l
i
; d
u
i
c [ [t
b
;

t] cannot be fulled
according to customer requirements. If no prior measures are taken, the remaining
available to promise inventory atp
t
(t
b
) for periods t [ [
_
t;

t] is consumed by orders
received in periods . . . ; t
/
b
22; t
/
b
21 until a specic period t
/
b
is reached, in which at
least one order cannot be fulled. The number of subsequent periods t
/
b
- 1; t
/
b
- 2; . . .
in which all or a subset of orders of O (t
/
b
- 1), O (t
/
b
- 2), . . . remain unlled depends on
the overall order quantities in these periods as well as the dates and quantities of
planned receipts, which determine the duration of the stock-out period [
_
t;

t]:
When approaching a stock-out situation, two questions are of major importance:
(1) How should the remaining quantities atp
t
(t
/
b
) available in [
_
t;

t] be allocated to
orders i [ O(t
/
b
) if not all orders can be fulled according to customer
requirements?
(2) Which appropriate measures can be taken prior to the stock-out situation,
enabling a company to effectively allocate orders i [ O(t
/
b
- 1), O(t
/
b
- 2) to
remaining available to promise quantities?
Whereas the rst question mainly refers to mechanisms for generating an allocation
x
t
/
b
; the second question relates to approaches which shift consumption of the available
to promise inventory to later periods.
If remaining available to promise inventory is xed (i.e. planned receipts are given
and orders committed previously are not rescheduled), the main task of an order
promising system is the allocation of orders to the given remaining inventory
quantities in such a way that the overall negative consequences for a company are
minimized. An order fullment system should therefore be able make order promising
decisions on the basis of order specic effects on a companys short- and long-term
protability. In contrast to planning tasks, in which decisions are commonly based on
aggregate measures (e.g. demand ll rates used in inventory management),
order-promising decisions should be based on order specic measures, capturing the
short- and long-term effects of not meeting customer requirements. Short-term
consequences can be lost prots, contractual penalties and additional cost, e.g. for
expediting or upgrading orders. Generally, these short-term implications can easily be
captured in a sufciently accurate way. Long-term implications are more difcult to
account for. In the long run, late fullment can result in lower future sales potential and
a decreased retention rate. Customer dissatisfaction and consequently also the reaction
in terms of future order placement are specic to individual customers and will
especially depend on the tardiness of the quoted due date. If we assume that order
specic short- and long-term consequences c
s
i
(x
i
(t
b
- 1); . . . ; x
i
(t
e
)) and c
l
i
(x
i
(t
b
-
1); . . . ; x
i
(t
e
)) can be quantied, a value C(x
t
b
) reecting overall negative consequences
can be assigned to any allocation x
t
b
: The objective of an order fullment system is to
JMTM
17,6
724
generate a sequence of allocations . . . ; x
t
/
b
21
; x
t
/
b
; x
t
/
b
-1
; . . . minimizing the total
negative consequences for the time, a stock-out situation persists.
The most precise approach to capturing c
l
i
( ) would be based on an estimate of the
impact, order promising decisions have on customer lifetime value. The decrease in
customer lifetime value induced by assigning a specic (late) due date would then have
to be estimated for every individual order. In most cases, however, this approach will
not be practicable. Apart from the fact that only few companies actually use customer
lifetime value approaches, it is unlikely that a mapping between the decrease in
customer lifetime value and order specic tardiness or partial fullment measures can
be established.
In the following section, we will analyze alternative allocation mechanisms and
examine how well order promising decisions are aligned with the objective of
minimizing overall negative impacts.
Order promising logic
FCFS allocation
In order fullment systems, rst-come-rst-served (FCFS) is the predominant form of
allocating orders to available to promise inventory. The incoming orders are allocated
in the sequence of their arrival; the allocation of a specic order i
/
[ O(t
b
) to available
to promise inventory atp
t
(t
b
) is performed immediately after the order arrives. After
every allocation of an order, atp
t
(t
b
) is recalculated. If we assume that the set O(t
b
) is
ordered and that index i reects the sequence in which orders arrived, the basic FCFS
allocation mechanism for any specic order i
/
(i.e. the i
/
-th order received in period t
b
)
can be described as follows:
(1) Initialization
Customer order i
/
has been received.
Record customer requirements
(q
u
i
/
; d
u
i
/ ; d
l
i
/ ):
(2) Check availability
Determine atp
t
(t
b
) for all
t [ [t
b
- 1; t
e
]:
Is atp
t
(t
b
) $ q
i
/ for at least one
t [ [d
l
i
/ ; d
u
i
/ ]?
yes: go to 3a.
no: Is atp
t
(t
b
) $ q
i
/ for at least one
t [ [d
l
i
/ - 1; t
e
]?
yes: order late; go to 3b.
no: reject order; end.
(3) Assign due date
^
d
i
/
3a: x
i
/ (
^
d
i
/ ) = q
i
/ with
^
d
i
/ = min t atp
t
(t
b
) } $ q
i
/ ; t [ d
l
i
/ ; d
u
i
/
h i n o
3b: x
i
/ (
^
d
i
/ ) = q
i
/ with
^
d
i
/ = min t atp
t
(t
b
) } $ q
i
/ ; t [ d
l
i
/ - 1; t
e
h i n o
:
Managing stock-
outs effectively
725
(4) Reservation and conrmation.
Reserve quantity x
i
/ (
^
d
i
/ ):
Conrm due date.
Update r
t
.
End.
Due to the fact that the FCFS allocation will commit to every incoming order as long as
inventory is available to promise, it cannot account for order specic short- and
long-term consequences. When approaching a stock-out in [
_
t;

t], an order promising
system employing FCFS will consume atp
t
(t
/
b
) (t [ [t
b-1
;

t]) until it reaches a point
after which all subsequent orders i [ O(t
/
b
) with bd
l
i
; d
u
i
c [ [t
b-1
;

t] will be quoted late
or will have to be rejected. FCFS is an appropriate allocation mechanism as long as
available inventory is sufcient to full all incoming orders. In a stock-out situation,
however, FCFS allocation is not aligned to the objective of minimizing overall negative
consequences.
Commercial order fullment systems offer partial delivery generation. If the
quantity q
i
/ of an order i
/
is not available in bd
l
i
/ ; d
u
i
/ c, the order can be split up and fulled
through two or more partial deliveries. Generally, the due date of the rst partial
delivery should be quoted within the time interval bd
l
i
/ ; d
u
i
/ c and be at least of size a q
i
/ ;
where a(0 , a , 1) denes the minimum fraction of the order quantity to be fulled
with the rst partial delivery. The FCFS allocation mechanism can easily be extended
to account for partial deliveries:
3b. Partial deliveries
Is atp
t
(t
b
) $ a q
i
/ for at least one t [ bd
l
i
/ ; d
u
i
/ c?
yes: x
i
/ (
^
d
1
i
/ ) = atp
t
(t
b
) with t =
^
d
1
i
/ = d
u
i
/ .
Determine atp
t
(t
b
) for all t [ bd
u
i
/ - 1; t
e
c.
Is atp
t
(t
b
) $ q
i
/ 2x
i
/ (
^
d
i
/ ) for at least one t [ bd
l
i
/ - 1; t
e
c?
yes: x
i
/ (
^
d
2
i
/ ) = q
i
/ 2x
i
/ (
^
d
1
i
/ ) with
^
d
2
i
/ = min {t}atp
t
(t
b
) $ q
i
/ 2x
i
/ (
^
d
1
i
)}.
no: x
i
/ (d
u
i
/ ) = 0; x
i
/ (
^
d
i
/ ) = q
i
/ with
^
d
i
/ = min{t}atp
t
(t
b
) $q
i
/ ; t [bd
l
i
/ -1; t
e
c}.
no: go to 4.
Incorporated into an FCFS allocation mechanism, the potential for generating partial
deliveries will be limited. Depending on the minimum delivery quantity a q
i
partial
deliveries will only be applicable to very few orders. Prior to a stock-out period [
_
t;

t],
FCFS allocation will full every incoming order i with bd
l
i
; d
u
i
c [ [t
b-1
;

t] as long as
atp
t
(t
b
) $ q
i
for at least one t [ bd
l
i
; d
u
i
c. For the rst order i
/
in the sequence of
incoming orders with q
i
/ . atp
t
(t
b
);t [ bd
l
i
; d
u
i
c and atp
t
(t
b
) $ q
i
a for at least one
t [ bd
l
i
; d
u
i
c; the system will generate a partial delivery x
i
/ (
^
d
1
i
/ = d
u
i
/ ) $a q
i
/ if the
remaining quantity q
i
2x
i
/ (
^
d
1
i
/ ) can be quoted for a period t[ [

t - 1; t
e
]. After
consuming x
i
/ (
^
d
1
i
/ ); the ability of the system to generate further partial deliveries
depends on the order quantities q
i
/ of subsequent orders i
//
. i
/
with required delivery
dates bd
l
i
// ; d
u
i
// c[ [t
b-1
;

t].
One way to attenuate the effects of a stock-out situation is to enforce partial
deliveries. As soon as the stock-out situation in [
_
t;

t] is anticipated, the order fullment
JMTM
17,6
726
system can be operated in a mode, in which partial deliveries are automatically
generated either for all or for certain pre-dened orders. Consumption of available to
promise inventory will then be shifted to later periods t [ [

t - 1; t
e
]:
Rank-based allocation
Next to FCFS allocation, order fullment systems commonly support a rank-based
approach. When employing a rank-based allocation mechanism, incoming orders are
rst collected and then sequentially allocated to the available to promise inventory. The
sequence in which orders are allocated is dened by a ranking, which is typically
determined on the basis of a parameter reecting the (relative) priority of the customer
placing the order. From an order fullment systems viewpoint, customer priorities are
usually endogenous, provided by CRM or sales applications. Calculated on the basis of
historical sales volumes or margins, they are originally determined to support allocation
of sales and marketing resources to individual customers or customer classes.
For the individual orders, the allocation mechanism is identical to the FCFS
mechanism described previously; only the sequence in which orders are allocated is
being altered, i.e. the order book is re-sorted based on customer priorities. Therefore,
we omit a formal description of the allocation mechanism.
In comparison to FCFS allocation, a rank-based allocation mechanism will increase
the average response time to customer requests. Thus, rank-based allocation does not
support real time order promising. Facing a stock-out situation, however, a company
may choose to switch from a real time FCFS allocation to an emergency batch mode
if this contributes to a more benecial allocation of orders to available to promise
inventory. At the cost of an increased average response time, a rank-based allocation
mechanism allows for a prioritization of customer orders. A higher ranking will
increase the likelihood of the order being fulled according to customer requirements.
The effectiveness of rank-based allocation depends on how well the priorities assigned
to the orders represent the consequences of not meeting customer requirements.
Assuming that customer priorities perfectly reect the negative consequences,
rank-based allocation appears to be an appropriate approach to allocating customer
orders.
However, customer priorities are typically not determined to support allocation of
customer orders to available to promise inventory but rather to support marketing
decision. Even if the priorities do reect future sales potential as one component of
customer lifetime value, they may not adequately capture possible customer reactions
to late or incomplete fullment. It is a moot question whether customer priorities
obtained from CRM systems and the impact of order promising on customers retention
rate are strongly related.
Another inherent problem of a rank-based approach is prevalent when order
quantities vary signicantly. The sequential allocation does not take into account that
due setting for one individual order has an impact on the systems capability to full
remaining orders with a lower rank. As a consequence, a large order may be committed
at the cost of having to delay or reject several smaller orders of the same or a lower
priority class. Not taking these interdependencies between individual order promising
decisions into account may lead to an allocation of orders to available to promise
inventory, which is not aligned with the objective of minimizing overall negative
effects induced by a stock-out situation.
Managing stock-
outs effectively
727
Optimization-based allocation
In this section, we introduce an optimization-based approach for allocating orders
collected in period t
b
to available to promise inventory. In comparison to a rank-based
allocation, an optimization-based approach allows for more detailed modeling of the
short- and long-term effects of order promising. By simultaneously allocating the
orders to the available to promise inventory it considers the interdependencies between
order promising decisions for individual orders and can therefore alleviate inherent
problems of an FCFS and rank-based approach. For allocating orders to available to
promise inventory, we utilize a mixed integer programming model which allows for
order rejection, late and partial deliveries. For partial deliveries, we make the same
assumptions as previously, i.e. a maximum of two partial deliveries, rst delivery is
quoted for a period t [ bd
l
i
; d
u
i
c and a minimum quantity of a q
i
for the rst delivery.
In addition to the notation used previously, we introduce the binary variables u
1
i
(t) and
u
2
i
(t) to specify due dates for the rst and second delivery. u
1
i
(t) takes on the value 1 if
the due date of the rst (partial) delivery of order i is t and 0 otherwise. Likewise, u
2
i
(t)
is dened for the second partial delivery. With binary variable v
i
, we model
acceptance/rejection decisions. v
i
indicates whether a due date has been assigned to
order i(v
i
= 1) or not (v
i
= 0). With Dd
i
, we denote the tardiness of an order as the
positive deviation of the quoted due date for the rst delivery (denoted by
^
d
i
) from d
u
i
.
The following mixed-integer-programming formulation can be employed for
determining due dates and order quantities for a set of orders O(t
b
) :
min C =
i[O(t
b
)
X
c
s
i
(x
1
i
; x
2
i
) -
i[O(t
b
)
X
c
l
i
(x
1
i
; x
2
i
) (3)
s.t.
x
1
i
(t) $ a q
i
u
1
i
(t) ;i [ O(t
b
); t [ bd
l
i
; d
u
i
c (4)
x
1
i
(t) # q
i
u
1
i
(t) ;i [ O(t
b
); t [ bd
l
i
; d
u
i
c (5)
x
1
i
(t) = q
i
u
1
i
(t) ;i [ O(t
b
); t [ bd
u
i
- 1; t
e
c (6)
x
2
i
(t) # (1 2a) q
i
u
2
i
(t) ;i [ O(t
b
); t [ bt
b
- 1; t
e
c (7)
X
t
e
t=d
l
i
(x
1
i
(t) - x
2
i
(t)) = q
i
v
i
;i [ O(t
b
) (8)
inv
t
b
-
X
t
t=t
b
-1
s
t
2
X
t
t=t
b
-1
r
t
2
i[O(t
b
)
X X
t
t=t
b
-1
x
1
i
(t) - x
2
i
(t)

$ 0 ;t [ t
b
- 1; t
e

(9)
X
t
e
t=d
l
i
u
1
i
(t) = v
i
;i [ O(t
b
) (10)
X
t
e
t=d
u
i
-1
u
2
i
(t) # 1 ;i [ O(t
b
) (11)
JMTM
17,6
728
^
d
i
=
X
t
e
t=d
l
i
u
1
i
(t) t ;i [ O(t
b
) (12)
Dd
i
= max(0;
^
d
i
2d
u
i
) ;i [ O(t
b
) (13)
u
1
i
(t); u
2
i
(t) [ 0; 1 ;i [ O(t
b
); t [ t
b
- 1; t
e

(14)
v
i
[ 0; 1 ;i [ O(t
b
) (15)
The generic objective function (3) accounts for both for short-and long-term effects of
order promising. The models objective is to determine an allocation for orders
i [ O(t
b
) that overall negative effects are minimized. Below we will propose an
adequate formulation representing short- and long-term consequences.
Constraints (4) and (5) dene lower and upper bounds for the rst (partial) delivery.
Constraints (6) ensure a delivery quantity of q
i
for all orders fulled late, i.e. no late
(rst) partial deliveries are quoted. The logical constraints (7) link the variables u
2
i
(t)
and x
2
i
(t) that specify the second partial deliveries quoted for a period t [ bd
u
i
- 1; t
e
c:
Constraints (8) ensure that quantity q
i
is assigned to every accepted order. Constraints
(9) ensure non-negativity of planned inventory. Constraints (10) link due date quoting
decisions with order acceptance/rejection decisions. Constraints (11) ensure that only
one second partial delivery is quoted. Constraints (12) and (13) provide quoted due
dates and tardiness. Equations (14) and (15) are integrality constraints for the binary
variables.
As pointed out previously, order allocation is performed on a rolling time horizon
basis. In any period t
/
b
; the model is employed to allocate orders O(t
/
b
) to the available to
promise inventory. Thereupon, atp
t
(t
//
b
= t
/
b
- 1) is determined for all t [ [t
//
b
- 1; t
//
e
]
and utilized for allocating the set of orders O(t
//
b
) arriving in t
//
b
: This procedure is
repeated in all following periods in which orders are received.
The allocation of orders to available to promise inventory is dependent on the
specic denition of the terms representing short- and long-term effects of order
promising. One possible representation of the short-term consequences can, for
example, be:
c
s
i
(x
1
i
; x
2
i
) = m
i
p(Dd
i
) - cp
i
(1 2
X
d
u
i
t=d
l
i
u
1
i
(t)) -
X
t
e
t=t
b
-1
tc u
2
i
(t) (16)
The rst term represents expected lost sales, based on the margin associated with
order i (m
i
) and a probability p(Dd
i
) of the customer not placing the order, depending
on the tardiness Dd
i
. By this, we capture that the customer may decide not to place the
order after knowing its tardiness. The second term represents a xed contractual
penalty cp
i
for not meeting customer requirements. The last term accounts for
additional (xed) handling and shipping costs (tc), resulting from a second partial
delivery. The values of Dd
i
, u
1
i
(t) and u
2
i
(t) are implicitly determined by the vectors
x
1
i
= (x
1
i
(t
b
- 1); . . . ; x
1
i
(t
e
)) and x
2
i
= (x
2
i
(t
b
- 1); . . . ; x
2
i
(t
e
)); specifying the
allocation of order i.
As stated previously, the long-term effects, modeled by c
l
i
(x
1
i
; x
2
i
), should ideally
reect the expected decrease in customer lifetime value depending on the assigned due
Managing stock-
outs effectively
729
date and quoted delivery quantity. If this data is not available, the long-term effects
will have to be represented by an order specic penalty cost. Determining these penalty
cost is, however, a difcult task for the decision maker. On the one hand, penalty costs
have to reect the relative negative effects of not fulling a specic customer order i
/
in
comparison to all other orders. On the other hand, the assigned values implicitly
determine the trade-off between short term and long-term effects. If penalty costs are
assigned on an order specic basis, c
l
i
(x
1
i
; x
2
i
) can, for example, be dened as
c
l
i
(x
1
i
; x
2
i
) = lp
i
Dd
i
- rp
i
(1 2v
i
); where the rst term represents a long term penalty
increasing proportionally in the tardiness of the quoted due date and the second term
represents a penalty, denoted by rp
i
, for rejecting an order.
Pre-allocation
In contrast to sequential allocation, the optimization-based approach considers
interdependencies between allocation decisions for individual orders within every set
O(t
b
): With respect to future orders arriving in later periods, both sequential and
optimization-based allocation mechanisms are of a myopic nature. When allocating the
orders i [ O(t
b
) to the available to promise inventory, they do not take into account
that the allocation generated for O(t
b
) impacts the ability to allocate orders arriving in
O(t
b
- 1); O(t
b
- 2); . . . : Therefore, they cannot explicitly determine a sequence of
allocations . . . ; x
t
/
b
21
; x
t
/
b
; x
t
/
b
-1
; . . . minimizing the total negative consequences
resulting from a stock-out situation.
Pre-allocation of available to promise inventory to distinct classes of customers or
individual customers can be employed to mitigate the problems associated with
myopic allocation mechanisms. Commercial order fullment systems provide so-called
allocation planning functions, which apply certain rules to pre-allocate available to
promise quantities to sales regions and customer classes (Kilger and Schneeweiss,
2000). A typical pre-allocation scheme would, for example, employ a xed split policy
to rst allocate overall available to promise quantities to sales regions and would then
assign the regional quantities to individual customers or customer classes based on
customer priorities. If we assume that customers in one sales region are grouped into
k = 1; . . . ; K pre-dened customer classes with index k reecting an ordinal ranking
based on customer priorities (with k = 1 highest and k = K lowest priority), we can
employ the following set of rules, based on forecasted quantities f
k;t
for every class k,
for allocating the available to promise inventory to the K customer classes:
atp
k=1
t
(t
b
) = min f
1;t
; atp
t
(t
b
)

; ;t [ t
b
- 1; t
e

(17)
atp
k
t
(t
b
) = min f
k;t
; atp
t
(t
b
) 2
X
k21
k=1
atp
k
t
(t
b
)
( )
; ;t [ t
b
-1; t
e

; k = 2; . . . ; K (18)
Pre-allocation of available to promise quantities can easily be combined with the
allocation mechanisms described previously. Orders are then quoted from the available
to promise quantities reserved for corresponding customer classes. Most commonly,
allocation rules are dened in such a way that orders of higher priority can be fulled
from quantities reserved for orders of lower priority as soon as their corresponding
allotment is exhausted.
JMTM
17,6
730
Clearly, pre-allocation is the most effective way of shifting consumption of available
to promise quantities to future periods. It can prevent a system from reaching a state
where all orders i with a required delivery date bd
l
i
; d
u
i
c [ [t
b
;

t] have to be delayed or
rejected. However, pre-allocation is based on highly disaggregated and uncertain data,
i.e. forecasts for individual customer classes and short time buckets. Therefore, its
effectiveness will largely depend on a companys ability to determine reliable short
term forecasts. A signicant deviation of the ordered quantities from forecasted
quantities used for pre-allocation may lead to late fullment or rejection of orders,
although inventory quantities assigned to other customer classes would have been
available. If customer priorities are used for pre-allocation, it again has to be
questioned, how well they reect the short and long term consequences of not fulling
customer requirements.
Case analysis
Based on the data of a pharmaceutical company, we demonstrate how the different
allocation mechanisms perform in a specic stock-out situation. Although, the results
of the numerical analysis are obtained only for a specic instance of a stock-out
situation, they provide insight into the potential of the different allocation mechanisms
for managing stock-out situations.
The company under consideration is a medium-sized producer of over the counter
and prescription drugs, operating on a European basis. We focus on a stock-out
situation for one product, cough drops, which are made to stock in large batches and
sold to large and medium sized retailers, drugstore chains, and individual chemists.
A stock-out situation was caused by supply shortage for one major ingredient in
combination with unexpected high demand due to a wave of u. The company was
employing FCFS allocation.
Figure 1 shows the planned receipts, the total quantities ordered and the available to
promise quantities for the time period between October 23 and November 19. It should
be noted that ordered quantities refer to specic due dates, and not to the dates at
which orders were received.
In Figure 1, the negative values represent the cumulated order quantities
the company was not able to full. Prior to the actual stock-out from October 31 on, the
company received a number of large orders as a reaction to higher nal customer
demand. During the stock-out period, order quantities decreased for two reasons: due
Figure 1.
Characterization of the
stock-out situation
2
3
-
1
0
2
4
-
1
0
2
5
-
1
0
2
8
-
1
0
2
9
-
1
0
3
0
-
1
0
3
1
-
1
0
1
-
1
1
4
-
1
1
5
-
1
1
6
-
1
1
7
-
1
1
8
-
1
1
1
1
-
1
1
1
2
-
1
1
1
3
-
1
1
1
4
-
1
1
1
5
-
1
1
1
8
-
1
1
1
9
-
1
1
Planned Receipts
2000
1000
0
1000
2000
3000
4000
5000
6000
7000
8000
Periods
Total QuantityOrdered Available Quantity
U
n
i
t
s
Managing stock-
outs effectively
731
to large previous order quantities a number of large customers had not reached
their reorder point and some of the key accounts were asked ahead of time to
postpone their orders. The company was anticipating the stock-out situation one week
prior to its occurrence. Therefore, it would have been possible to switch from FCFS
allocation to a different allocation mechanism.
As described in the previous section, the evaluation of different allocation
mechanisms requires information on short- and long-term consequences of not fulling
specic orders. The pharmaceutical company maintains long-term relationships with
most large- and medium-sized customers. Typically, the companies order on a weekly
or bi-weekly basis. If certain products cannot be delivered, they will most commonly be
reordered the following week. Whether a stock-out of the pharmaceutical company
translates into lost sales depends on the inventory held by its customers. If the
stock-out situation also causes a stock-out on the customers side, overall order
quantities will decrease. There will not be an effect on the overall sales volume if the
customers carry enough inventory to full their nal customer demand during the
pharmaceutical companys stock-out period. The company does not posses information
about customers inventory and lost sales caused by a stock-out situation. Contracts
with some large retailers explicitly dene contractual penalties if the company fails to
deliver the ordered quantities according to the customers due date requirements.
Although, the loss of a customer is not likely, the company anticipates medium- and
long-term implications caused by stock-out situations. In many cases, not fulling
customer requirements, causes a weaker position in future negotiations and leads to
less favorable contractual agreements. These long-term consequences can hardly be
quantied and traced to individual order promising decisions. To evaluate allocation
mechanisms, a specic classication of customers was established on the basis of
anticipated medium and long-term implications of order fullment. Account managers
and sales responsibles jointly evaluated the individual customers and assigned values
from 1 (very high consequences) to 5 (low consequences) to each customer. This ordinal
ranking was used to establish ve customer classes.
For the experiments, we considered a time period of 15 weekdays (starting on
October 23, six days prior to the actual stock-out situation) during which 657 orders
were received. About 10.2 percent of these orders were placed by customers of class 1,
69.2 percent by customers of class 2, 5.3 percent by customers of class 3, 6.4 percent by
customers of class 4 and 8.8 percent by customers of class 5. In the rst set of analyses,
we determined the results of rank-based allocation and optimization-based allocation
with a 1 and 2-day batching interval and compared these to the results obtained from
FCFS allocation. Rank-based allocation was performed on the basis of the established
customer classication. To rank members of one group, the order size (both ascending
and descending) was used as sub-criterion. For the optimization-based approach, we
employed a modied version of the models (3)-(15). As the customers will not accept
late delivery, orders that cannot be fulled within the required time interval have to be
rejected. Optimization was based on lost margins, contractual penalties and additional
transportation costs (if partial deliveries are considered) as short-term consequences of
order rejection. The long-term consequences were incorporated through a xed penalty
cost depending on the customer class.
As described previously, all mechanisms perform equally well as long as sufcient
inventory is available to full all incoming orders. Therefore, differences can only be
JMTM
17,6
732
observed in periods, in which not all orders can be fulled according to customer
requirements. In the specic instance considered in the experiments, the available to
promise inventory was sufcient for fulling all orders received during the rst three
periods (October 25-27). In period 4 between 9 and 22, orders, depending on the
employed allocation mechanism, had to be rejected. The results of the allocation for
period 4 are shown in Figure 2. Because in period 4, all available to promise inventory
was consumed, all orders received during the following seven periods had to be
rejected. By rejecting few large orders, both rank-based (ascending) and
optimization-based allocation were able to commit a larger overall number of orders.
Whether this is benecial in terms of the overall impact on the companys protability
depends on the short- and long-term consequences associated with rejection of the
individual orders. If realistic estimates for long-term consequences cannot be obtained
(e.g. through customer lifetime value analysis), a company will have to compare the
rejection proles in order to evaluate whether the different allocation mechanisms
adequately reect their preferences. The results obtained from a comparison of the
rejection proles can also be used for determining the ratio between parameters
representing short- and long-term effects.
Employing rank-based and optimization-based allocation for customer orders
received in period 3 and 4 (two-day batching) leads to greater discrepancies in
comparison to FCFS allocation. Both approaches reduce the number of rejected
orders of customer class 2 and the total number of rejections. When comparing the
results, it should also be noted that only the specic sequence of order arrival
during period 4 prevented FCFS allocation from rejecting orders of customer
class 1.
The results suggest that as short term measure, switching from FCFS allocation to a
batch mode in which due dates are assigned on the basis of potential negative
consequences leads to favorable results. As the effects are only observed for a small
sample, we cannot generally conclude, that an optimization-based approach will yield
signicantly better results than a rank-based approach.
As the impact of different allocation mechanisms is limited to just one period, we
extended the analysis to measures shifting consumption of available to promise
inventory to later periods. These include generation of partial deliveries and
pre-allocation. A number of customers belonging to customer classes 2-5 accept partial
deliveries. We assumed a minimum delivery quantity of 50 percent for all of the orders
Figure 2.
Results of alternative
allocation mechanisms,
rejections in period 4
(October 28)
Rank (Ascending)
0
5
10
15
20
25
0
5
10
15
20
25
1 2 3 4 5 Overall 1 2 3 4 5 Overall
FCFS
Rank (Ascending)
FCFS Rank(Descending)
Optimization
Rank(Descending)
Optimization
Customer Classes Customer Classes
R
e
j
e
c
t
i
o
n
s
(a) 1-Day Batching 2-Day Batching (b)
Managing stock-
outs effectively
733
placed by these customers. As concluded previously, generation of partial deliveries
does not yield signicant benets in combination with FCFS. In our analysis, partial
deliveries could not be generated; the remaining available inventory was not sufcient
for quoting the minimum delivery quantity. Combined with a rank-based allocation,
generation of partial deliveries also had insignicant impact; partial deliveries could
only be generated for one order. Integrating partial deliveries into the
optimization-based approach has a more signicant impact on order promising. In
comparison to the sequential rank-based and FCFS allocation, the optimization model
specically assigns partial deliveries if this increases overall prot. In our analysis,
partial deliveries were generated for eight orders received in period 4.
As suggested previously, a larger portion of inventory consumption can be shifted
to future periods if partial deliveries are enforced prior to the actual stock-out situation.
To analyze the impacts of this allocation strategy, two deliveries were quoted for all
orders placed by customers, which are willing to accept partial deliveries. In Figure 3(a)
the results of the allocation with enforced partial deliveries are compared to the results
obtained from FCFS allocation. As enforced partial deliveries not only have an effect on
the allocation within one single period, Figure 3(a) now shows the overall rejection
rates for all 15 periods.
By quoting partial deliveries for 50 orders (7.61 percent), the overall rejection rate
was reduced by 53.5 percent in comparison to FCFS-based allocation. When evaluating
the benets of enforced partial deliveries it should be considered that these may also
induce negative short and long term effects. In Figure 3(b), the relative number of
partial deliveries and the relative reduction of rejected orders are displayed for
individual customer classes. Enforced partial deliveries do not have a negative impact
on orders placed by customers of classes 1 and 3. The results indicate a positive overall
effect for customer classes 2 and 4. Merely for customer class 5, the relative number of
partial deliveries exceeds the relative reduction of rejected orders. For this specic
instance of a stock-out situation, we can conclude that enforced partial deliveries are an
appropriate measure for effectively managing a stock-out situation.
As pointed out before, the available to promise inventory can be pre-allocated to
specic customers and customer classes. Owing to a lack of historical data and
forecasting results of the pharmaceutical company, a detailed analysis of the effects of
pre-allocation could not be conducted. To exemplarily illustrate the effects of
pre-allocation, we employed a na ve allocation rule: from period 1 on, all available to
promise inventory was reserved for orders of customers with priority 1 and 2, all
orders placed by customers of classes 3, 4 and 5 were rejected. By rejecting lower class
Figure 3.
Figure 3 Results of an
allocation with enforced
partial fullment
Reduction of Rejected Orders
0
10
20
30
40
50
60
70
Partial Deliveries
O
Customer Classes
0
10
20
30
40
50
60
70
1 2 3 4 5 Overall
Customer Classes
1 2 3 4 5 Overall
FCFS - No Partial Fulfillment
Optimization - Enforced Partial Fulfillment
R
e
j
e
c
t
e
d

O
r
d
e
r
s

(
%
)
P
e
r
c
e
n
t
a
g
e
Order Rejection Partial deliveries vs. reduction of rejected orders (a) (b)
JMTM
17,6
734
orders, available to promise inventory was preserved for future orders of customers
with higher priority. The results of this simple allocation led to acceptance of all orders
placed by customers of classes 1 and 2. However, the amount of available inventory
remaining unallocated would have been sufcient for fulling 52 percent of the total
demand coming from orders of customer class 3. Whether or not pre-allocation is an
appropriate measure for effectively managing stock-out situations can only be
evaluated on the basis of results gained from a more extensive analysis. Especially
allocation accuracy, the effects of forecasting errors, and the risk of rejecting orders
although sufcient inventory would have been available, have to be explored. This
analysis would then also have to investigate potential situations, in which inventory is
allocated and orders are rejected without the anticipated stock-out situation actually
materializing.
Conclusions
Both the general analysis of allocation mechanisms and the results obtained from the
case analysis show that in a stock-out situation, FCFS is not an adequate allocation
mechanism. Switching from a real-time FCFS allocation mode to a rank-based or
optimization-based allocation can lead to a more benecial allocation of orders to
remaining available to promise quantities. The effects, however, are limited; the
benets can only be leveraged immediately before the available to promise quantities
are consumed. If a company is able to anticipate a stock-out situation prior to its actual
occurrence, it can be benecial to shift consumption of available to promise quantities
to future periods. One potential measure is the generation of partial deliveries. The
general analysis and the results of the case analysis show that a major effect of partial
delivery generation can only be expected if they are enforced prior to the stock-out
situation. If applied shortly before available to promise inventory is exhausted, the
effects are again limited. The results of the analysis indicate that this especially
pertains to the case when partial deliveries are combined with FCFS and rank-based
approaches. Although, (enforced) partial deliveries can effect customer satisfaction and
can therefore also result in negative consequences, they can signicantly mitigate the
problems associated with a stock-out situation. As pointed out in the case analysis,
the positive effects can more than offset negative consequences of enforced partial
deliveries. In comparison to pre-allocation, partial delivery generation is less effective
in terms of shifting available to promise quantities to future periods. In return,
however, it does not involve the risk of unnecessarily rejecting orders. The potential of
pre-allocation has not been explored extensively in this paper. A nal evaluation
requires more extensive analysis based on a representative set of data.
References
Ball, M.O., Chen, C-Y. and Zhao, Z-Y. (2004), Available to promise, in Simchi-Levi, D., Wu, S.D.
and Shen, Z-J. (Eds), Handbook of Quantitative Supply Chain Analysis Modeling in the
E-Business Era, Kluwer, Boston, MA, pp. 447-84.
Chen, C-Y., Zhao, Z-Y. and Ball, M.O. (2001), Quantity-and-due-date-quoting
available-to-promise, Information Systems Frontiers, Vol. 3 No. 4, pp. 477-88.
Chen, C-Y., Zhao, Z-Y. and Ball, M.O. (2002), A model for batch advanced available-to-promise,
Production and Operations Management, Vol. 11, pp. 424-40.
Managing stock-
outs effectively
735
de Vericourt, F., Karaesmen, F. and Dallery, Y. (2002), Optimal stock allocation for a capacitated
supply system, Management Science, Vol. 48 No. 11, pp. 1486-501.
Fleischmann, B. and Meyr, H. (2003), Customer orientation in advanced planning systems, in
Dyckhoff, H. et al. (Eds), Supply Chain Management and Reverse Logistics,
Springer-Verlag, Berlin, pp. 297-321.
Gordon, V., Proth, J-M. and Chu, C. (2002), A survey of the state-of-the-art of common due date
assignment and scheduling research, European Journal of Operational Research, Vol. 139,
pp. 1-25.
Ha, A.Y. (1997), Inventory rationing in a make-to-stock production system with several demand
classes and lost sales, Management Science, Vol. 43 No. 8, pp. 1093-103.
Kilger, C. and Schneeweiss, L. (2000), Demand fullment and ATP, in Stadtler, H. and Kilger, C.
(Eds), Supply Chain Management and Advanced Planning, Springer, Berlin, pp. 79-95.
About the author
Richard Pibernik is Professor of supply chain management at the Zaragoza Logistics Center, and
a Research Afliate at the MIT Center for Transportation and Logistics. He currently teaches
supply chain management in the masters program of the MIT-Zaragoza International Logistics
Program. He received both his masters degree and his doctorate in business administration from
the Goethe-University in Frankfurt, Germany. He has active research projects on the
conguration of order promising systems, supply chain process management support
methodology, coordinating distributed decisions in supply chains, and conguring dynamic
supply chain networks. Pibernik has presented the results of his research at various national and
international conferences and has published a number of articles on specic topics in supply
chain management. Richard Pibernik can be contacted at: rpibernik@zlc.edu.es
JMTM
17,6
736
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