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ISSN: 0740-817X (Print) 1545-8830 (Online) Journal homepage: https://www.tandfonline.com/loi/uiie20

A distribution inventory model with


transshipments from a support warehouse

Sven Axsäter , Christian Howard & Johan Marklund

To cite this article: Sven Axsäter , Christian Howard & Johan Marklund (2013) A distribution
inventory model with transshipments from a support warehouse, IIE Transactions, 45:3, 309-322,
DOI: 10.1080/0740817X.2012.706375

To link to this article: https://doi.org/10.1080/0740817X.2012.706375

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Aug 2012.
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IIE Transactions (2013) 45, 309–322
Copyright 
C “IIE”

ISSN: 0740-817X print / 1545-8830 online


DOI: 10.1080/0740817X.2012.706375

A distribution inventory model with transshipments from a


support warehouse

SVEN AXSÄTER, CHRISTIAN HOWARD∗ and JOHAN MARKLUND


Department of Industrial Management and Logistics, Lund University, Lund 22100, Sweden
E-mail: sven.axsater@iml.lth.se, christian.howard@iml.lth.se, johan.marklund@iml.lth.se

Received January 2011 and accepted May 2012

This article considers a distribution inventory system consisting of N retailers and a regional support warehouse, all being replenished
from a central warehouse/outside supplier. For the case where stock-outs occur, the retailers receive transshipments from the support
warehouse at an extra cost. A model is presented for cost evaluation and optimization of the reorder points in the system under fill
rate constraints. The solution method is designed to handle large real-life systems and is fast enough to be directly implemented in
practice. A numerical study illustrates that (i) the model renders near-optimal solutions; (ii) the value of using a support warehouse
can be significant even for large transshipment costs; and (iii) significant cost savings can be obtained using the proposed model.
Using real data for a sample of 50 representative products, the proposed model reduces the expected holding and transshipment costs
by 29% while still meeting target fill rates.
[Supplemental materials are available for this article. Go to the publisher’s online edition of IIE Transactions to view the supplemental
file.]
Keywords: Inventory, multi-echelon, stochastic demand, transshipments, spare parts

1. Introduction central warehouse using an (R,Q) policy with a fixed batch


size.
Distribution and inventory control of spare parts are im- The motivation for analyzing this type of distribution
portant activities in managing after-sales service for many system stems from a research collaboration with Volvo
companies. In this article we consider one particular type of Parts Corporation, which is a global spare parts service
inventory system used in practice to deal with these issues. provider with its headquarters in Sweden. Volvo Parts is
The system consists of a central warehouse that serves sev- responsible for the worldwide distribution of spare parts
eral markets; one local warehouse on each market, referred for vehicles and engines made by the Volvo Group, in-
to as a support warehouse; and a large number of retailers cluding Volvo Trucks, Mack, Renault Trucks, Volvo Buses,
(or dealers) that serve the end customers. The different in- Volvo Construction Equipment, Volvo Penta, and Volvo
ventory locations are connected through the replenishment Aero. The research cooperation with Volvo Parts has pri-
structure. Focusing on a single market, customers demand marily focused on the distribution of spare parts for trucks
items from the retailers, who use reorder point policies with and buses, where the described support warehouse struc-
fixed batch quantities (so-called (R, Q) policies in which a ture is used in almost every market. However, the consid-
batch of size Q is ordered when the inventory position ered system structure is not unique to Volvo Parts; it is,
drops to or below R) to place (regular) orders with the for example, used by some of their competitors. It is also
central warehouse. In the case of shortages at a retailer, a common in other industries, as described in Rijk (2007).
quick response order (typically associated with some extra Hence, the considered model is quite general even though
transshipment costs) is placed with the support warehouse. it is grounded in the specific conditions at Volvo Parts. A
Provided that the item is in stock at the support warehouse, closer look at these conditions reveals that some of the re-
it can be delivered very quickly to the retailer in ques- tailers are owned and operated by Volvo, but many of them
tion. The support warehouse replenishes its stock from the are independent, privately owned companies that purchase
products from Volvo Parts. Thus, from an organizational
point of view, the distribution system can be seen as be-
ing decentralized. However, in terms of inventory control,
∗ Volvo Parts has successfully negotiated a vendor-managed
Corresponding author

0740-817X 
C 2013 “IIE”
310 Axsäter et al.
inventory contract with their retailers, which gives Volvo method. These solutions are then compared with an alter-
the mandate to control the retailers’ inventories of Volvo native decentralized system in which the retailers can only
products. This means that reorder points and order quan- place regular orders with the central warehouse. The results
tities are determined by Volvo through a centralized IT show that the value of the support warehouse can be signifi-
system. Consequently, from an inventory control perspec- cant even if the per unit transshipment costs are fairly high,
tive, the system can be viewed as being highly centralized. especially when the lead times from the central warehouse
An important aspect is that the support warehouses (as are long and the target fill rates are high. Using simulation
well as the central warehouses) are owned and operated by we also compare the performance of the support warehouse
Volvo Parts. This means that Volvo in the current system system with that for an alternative structure with complete
has full control over all transshipment operations, and they pooling through lateral transshipments among all retail-
avoid complicated gaming and incentive issues, which typi- ers. As may be expected, this study illustrates that com-
cally arise if independent firms are to share inventories; for plete pooling is advantageous as long as the transshipment
example, through regular lateral transshipments. costs in both systems are the same. However, if transship-
The challenge we address in this article is how to ana- ments are more expensive in the complete pooling system,
lyze and control the considered multi-echelon system. More the support warehouse structure can be preferable. Lower
precisely, we present a model for cost evaluation and opti- transshipment costs in the support warehouse system can
mization of the reorder points at a support warehouse and be argued because of scale effects and improved efficiency
the associated retailers under fill rate constraints. The rea- in transshipment operations.
son for choosing a fill rate constraint model is that meeting Looking at the literature, there is an obvious relation-
target fill rates is one of Volvo Part’s main performance in- ship between our work and the literature that deals with
dicators. The model assumes constant lead times for regular different types of lateral transshipment models. Examples
orders placed at the central warehouse and normally dis- of early contributions to this area are Allen (1958) and
tributed customer demand. An important characteristic is Gross (1963). Most papers consider lateral transshipments
that the developed method is computationally fast enough between parallel retailers. It is common to assume that a
to be directly implemented in practice for large systems. transshipment takes place, if possible, as soon as a shortage
Apart from being a concrete tool for inventory control of occurs. Both periodic review and continuous review mod-
real systems, the model enables us to investigate when it els are frequently considered in the literature. In periodic
makes sense to use a support warehouse structure. models it is common to assume that the system will be reset
The main contributions of our work lie in the deriva- at the end of each period. Essentially, this means that the
tion of the analytical approximation model and its useful- problem setting is reduced to a single period; see, for exam-
ness for control of real systems. Important aspects of the ple, Cohen et al. (1986). Quite a few of the available contin-
model’s usefulness are the quality of its solutions and its uous review models are related to the papers by Lee (1987)
computational feasibility. These issues are investigated in and Axsäter (1990). Examples include Alfredsson and Ver-
two different numerical studies. In the first one, focusing rijdt (1999), Grahovac and Chakravarty (2001), Kukreja
on the model accuracy, comparisons are made with opti- et al. (2001), and Kranenburg and Van Houtum (2009).
mal solutions found through enumeration and simulation For example, Alfredsson and Verrijdt (1999) uses the same
of all possible solutions. The results show that as long as approach as Axsäter (1990) when modeling transshipments
Q > R at the retailers—i.e., at most one regular order is out- between parallel retailers but also consider the possibility of
standing at each retailer—the average relative deviation in direct deliveries to customers. Typically these papers con-
total costs (expected inventory holding and transshipment sider spare parts with relatively low demand that can be
costs) is only −0.4%, and the average deviation in fill rate modeled as Poisson processes. Normal replenishments are
is −0.4 percentage points. For the examples where more often triggered by base-stock policies. For recent overviews
than one order may be outstanding the average deviation of the literature we refer to Wong et al. (2006) and Paterson
in total costs is 2.5% and the deviation in fill rate is one et al. (2011).
percentage point. A second numerical study is based on One of the aforementioned papers that is, in a sense,
real data for a sample of 50 representative products from related to our scope and system structure is Kranenburg
Volvo Parts’ stock list for the Spanish market. It illustrates and Van Houtum (2009). Motivated by collaboration with
that our proposed model is fast enough to be applied to ASML, an original equipment manufacturer in the semi-
large real-life problems. Moreover, by comparison with the conductor industry, they consider a spare parts distribution
current solution used by Volvo Parts using simulation, it network with partial pooling. The network consists of local
is shown that using our proposed model offers significant warehouses that face Poisson demand for spare parts and
reductions in the total costs without compromising the tar- use base-stock policies to replenish their inventory from a
get service levels. On average, the total costs are reduced by central warehouse. The local warehouses are classified as
29% while maintaining average fill rates above target. either regular locals or main locals. If a local warehouse
To gain insights as to the value of using a support ware- runs out of stock it can turn to a designated main local
house structure, we also present a numerical study where the and request a lateral transshipment. Using their model,
support warehouse system is optimized using our proposed the authors illustrate numerically that most of the pooling
A distribution inventory model with transshipments 311
benefits can be achieved by using only a few main locals. Support warehouse Retailers
The support warehouse structure we study is related to 1
one version of their network structure, where the support
warehouse is represented by a main local without direct
customer demand, and the retailers are modeled as regular Outside
locals. However, important differences are that their model supplier j Customers
is designed for low-level discrete Poisson demand and base-
stock policies, which does not suffice in the situations we
consider. They also assume that the central warehouse pro- N
vides a transshipment if neither the local warehouse nor
any main local warehouse can satisfy the demand. Our Fig. 1. The studied inventory system.
model can handle large demands and batch-ordering poli-
cies, and in our system the central warehouse does not pro-
vide any transshipments. The modeling and approximation The retailers face stochastic customer demand and place
techniques are therefore quite different. Kranenburg and replenishment orders (referred to as regular orders) with
Van Houtum (2009) provide an exact Markov analysis as- an outside supplier. The lead times for these orders are
suming exponential lead times for small stylized problems, assumed to be constant. The support warehouse also re-
as well as an approximate model based on analyzing each plenishes with constant lead times from the outside sup-
warehouse as a separate Erlang loss system under the as- plier. These lead time assumptions are motivated by the
sumption of identical lead times for all local warehouses. fact that the outside supplier at Volvo Parts is, for most
Other papers related to our present work consider sys- items, a central warehouse with very high service levels.
tems with unidirectional transshipments; see, for exam- Thus, stochastic delays due to shortages are rare. Clearly,
ple, Axsäter (2003) and Olsson (2010). The transshipments the assumption also simplifies the analysis. Expanding the
from the support warehouse in the present model are uni- model scope to include the central warehouse and ques-
directional, because there are no transshipments from the tioning the high service requirements currently used is an
retailers to the support warehouse. A difference between the interesting and challenging direction for future research.
discussed papers and our current model is that the support The demand data available at Volvo Parts are stored on
warehouse is not subject to direct customer demand. a monthly basis, which makes it difficult to characterize the
Models concerning lateral transshipments are also re- true distribution of the customer demand. Therefore, our
lated to dual supply models that include the possibility of choice of demand distribution varies depending on the pur-
using more than one supplier. In addition to a standard sup- pose. In our analytical derivations and parameter optimiza-
plier, it may, for example, be possible to use a supplier that tion we always assume that customer demand over any time
provides express deliveries at a higher cost. This alternative interval is normally distributed and independent across all
supplier can be used in special situations as needed. Ex- retailers and non-overlapping time intervals. The reason
amples from this stream of literature include Moinzadeh for choosing the normal distribution to approximate the
and Nahmias (1988), Moinzadeh and Schmidt (1991), demand is threefold: (i) it is computationally tractable for
Johansen and Thorstenson (1998), Minner (2003), Axsäter Volvo Parts’ entire range of low- and high-demand items;
(2007), Song and Zipkin (2009), and the references therein. (ii) it can be fitted to all variance-to-mean ratios (which
Compared with this literature, a difference with the current vary considerably between items); and (iii) it is a common
model is the multi-echelon focus, as opposed to the more assumption in the literature and has been proven to work
common single-echelon focus. As a consequence, the gen- well in many situations (see, for example, Axsäter (2011)).
eral modeling techniques in these papers are different from To simulate the solutions obtained from the analytical
ours. continuous review model, we use a discrete event simula-
The remainder of this article is organized as follows. Sec- tion model built in the software Extend by Imagine That
tion 2 provides a model formulation and description of the Inc (San Jose, CA). A difficulty with the normal demand
considered distribution system. Section 3 presents the tech- assumption is that it cannot be exactly translated into a
nical details of the proposed cost evaluation method and discrete arrival process. Thus, in the simulations we use
the associated approximations. It also contains a descrip- two other demand distributions. For the model validation
tion of the optimization method used in the numerical study and comparison between different system configurations,
found in Section 4. Conclusions are drawn in Section 5. we want to mimic normal demand in a discrete event
simulation environment as close as possible and use
appropriately chosen gamma-distributed inter-arrival
2. Problem formulation times. This approach is based on results from renewal
theory and ensures that the demand over a time period t
The considered inventory system consists of N retailers is asymptotically normally distributed as t → ∞, if the
and one support warehouse that continuously reviews and times between arrivals are independent and identically
replenishes their inventories; see Fig. 1. distributed (see, for example, Grimmett and Stirzaker
312 Axsäter et al.
(1992, p. 394)). Finally, when simulating the real data support warehouse. The assumption of continuous review
from Volvo Parts, we use a compound Poisson process (or is realistic for the case company, considering that many
gamma-distributed inter-arrival times in those cases where retailers review their stock on a daily basis. (For retailers
the variance-to-mean ratio is below one). We argue this with a non-negligible review period, the standard approach
to be a good fit for Volvo Parts’ system, where demand is of adding half of the review period to the replenishment
discrete and an arriving customer may order more than one lead time has been applied in the numerical evaluation.)
unit. It should be added that it is not possible to directly The company also expects a move to a system based on
modify our analytical model to incorporate compound real-time point-of-sale data and inventory information in
Poisson demand. This is because it is based on the exact the near future.
solution of the single-echelon model with lost sales, which We consider inventory holding costs per unit and time
remains an open question for compound Poisson demand. unit at all installations. There is also a fixed transshipment
There is no direct customer demand at the support ware- cost per unit shipped from the support warehouse to a
house. Instead, the purpose of the support warehouse is retailer. This quantifies the extra cost of acquiring a unit
to provide additional demand coverage in cases of stock- through the support warehouse, compared with that for a
outs at the retailers. More precisely, if demand at a retailer regular replenishment through the outside supplier (e.g., for
exceeds that retailer’s current amount of on-hand stock, a the extra picking, loading, transportation, and receiving ac-
transshipment to cover the additional amount needed is re- tivities involved). The retailers operate under given service
quested from the support warehouse. In concurrence with constraints. The service measure that is used at Volvo Parts
current operations at Volvo Parts, the transshipment pol- for each retailer (referred to as the combined fill rate) is the
icy is to always order from the support warehouse when fraction of demand satisfied, either directly from stock on
a stock-out occurs. This commonly used policy is easy to hand at that retailer or directly from stock on hand at the
implement and does not require an advanced inventory in- support warehouse. In other words, if a demand occurring
formation system beyond what is currently used by Volvo. at a specific retailer can be satisfied instantly at the retailer,
However, it is clear that using more advanced policies (e.g., or via immediate shipment from the support warehouse, it
incorporating the arrival times of outstanding orders) may is considered satisfactory service for the customer. As pre-
be beneficial; see, for example, Howard et al. (2012). viously mentioned, this is reasonable for the case company
We assume that the time it takes to ship units from because the overnight shipment from the support ware-
the support warehouse to a retailer is negligible; i.e., house enables the retailer to complete service of a vehicle
transshipment lead times are zero. This is a reasonable within the time stipulated in the service contract. There-
approximation for the real system at Volvo Parts because fore, from the perspective of the customer, the same service
the support warehouse provides overnight shipments, com- is received, regardless of where the part originated.
pared with the much longer lead times for regular orders Our objective is to find the integer reorder points that
from the outside supplier. Also, the customers in the real minimize the long-run expected costs for the system under
system typically leave their vehicle for service at the retailer the specified service-level constraints. Our analysis assumes
and return to pick it up the next day or later. Thus, as long that the order quantities, both at the retailers and at the sup-
as the agreed-upon pickup time is not delayed because port warehouse, are given. This is a common assumption in
of the overnight delivery, the perceived customer service the literature. Moreover, a change in the order quantities at
is the same whether the item is available at the retailer or Volvo Parts would require an analysis outside the scope of
at the support warehouse. The assumption implies that if this present work (e.g., analysis of restrictions in box or pal-
the support warehouse has sufficient stock on hand when let sizes and renegotiation of contracts with transporters).
an order from a retailer arrives, the customer demand that Although our approach does not explicitly deal with how
generated this order is satisfied instantly. However, in the to optimize the order quantities, it is worth emphasizing
event of a stock-out at the support warehouse, the demand that the computational efficiency of our method makes it
is backordered, and the customer has to wait until the possible to evaluate the impact of different order quantities
next replenishment order arrives. Alternatively, this may by simple enumeration.
be viewed as a customer demand being lost to the retailer Note that transportation costs, setup costs, and vari-
(though not lost to the system) and transferred to the ous administrative costs are not explicitly included in our
support warehouse. All demands are satisfied according to model, although these costs may be affected by our policy.
a first-come–first-served policy. All of these costs are reflected in the transshipment cost.
All installations replenish their stock using continuous Normally it is considerably more expensive to distribute
review installation stock (R, Q) policies; that is, a batch an item through the support warehouse, which means a
of size Q is ordered when the inventory position drops relatively high transshipment cost.
to or below R. For the support warehouse, the inventory We introduce the following notation:
position is defined as stock on hand + stock on order –
backorders. For the retailers, the inventory positions only N = number of retailers;
include stock on hand and stock on order, as demand is LS = lead time for an order from the support warehouse to
never backordered there but is instead transferred to the arrive from the outside supplier;
A distribution inventory model with transshipments 313
Lj = lead time for an order from retailer j (j = 1, 2, . . ., N) We determine the combined fill rate, γ j (R), at retailer j
to arrive from the outside supplier; as
QS = order quantity for an order from the support ware-
house to the outside supplier; γ j (R) = α j (Rj ) + (1 − α j (Rj ))βS (R). (1)
Qj = order quantity for an order from retailer j to the
outside supplier; If all retailers are identical, then Equation (1) is exact. How-
RS = reorder point at the support warehouse; ever, in the case of non-identical retailers the expression is
Rj = reorder point at retailer j; an approximation. The reason for this is that the actual
hS = inventory holding cost per unit and time unit at the service received from the support warehouse in these situ-
support warehouse; ations might differ between retailers.
hj = inventory holding cost per unit and time unit at retailer We now focus on how to determine Cj , α j , C S , and β S .
j;
bj = transshipment cost per unit shipped from the support 3.1.1. Determining Cj and α j
warehouse to retailer j; We restrict the analysis to cases where there can be at most
μj = mean demand per time unit at retailer j; one regular order outstanding with the outside supplier at
σ j = standard deviation of the demand per time unit at each retailer or, equivalently, Qj > Rj . This is a common as-
retailer j; sumption in models with lost sales (for a discussion of this
 j = target for the combined fill rate at retailer j. assumption, see, for example, Hadley and Whitin (1963)),
and it also accurately reflects the situation at the case com-
pany, where it is rare to have multiple orders outstand-
ing. The assumption implies that Cj can be determined
3. Methodology exactly using renewal theory (see, for example, Grimmett
and Stirzaker (1992, p. 394)). That is, we obtain Cj by de-
In this section we present the approximate cost and service riving the average cost for an order cycle (the time between
evaluation method for a given set of reorder points. We two deliveries of a batch at the retailer) and dividing this
then introduce a computationally efficient heuristic for op- by the average cycle length.
timizing the reorder points under the given fill rate targets Recall that the customer demand is assumed to be nor-
at the retailers. mally distributed and independent across disjoint time in-
tervals. Hence, the demand during the lead time also follows
3.1. Cost evaluation method a normal distribution. Define:

We seek the total expected system cost per time unit, TC(R), m j = L j μ j , mean demand during the lead time at retailer
and the combined fill rate for each retailer j, γ j (R), for j; 
given reorder points R = (RS , R1 , . . . , RN ). Note that γ j δ j = L j σ j , standard deviation of the demand during the
is a function of all reorder points in the system. This is lead time at retailer j;
because the choice of reorder point at one retailer affects φ(x) = probability density function of the standard normal
the demand stream to the support warehouse, which in distribution;
turn affects the service given to all other retailers from this (x) = cumulative distribution function of the standard
location. For a given policy R we can separate TC(R) into normal distribution;

the N + 1 components: G(x) = x (v − x)φ(v)dv = φ(x) − x(1 − (x)), the loss
function;

N
D(L j ) = stochastic lead time demand at retailer j;
TC(R) = CS(R) + C j (Rj ),
LSj = stochastic number of units lost at retailer j during
j=1
an order cycle (and satisfied by transshipments from the
where C S (R) is the expected holding cost per time unit at the support warehouse);
support warehouse, and Cj (Rj ) is the expected holding and OH j = stochastic number of units on hand just before a
transshipment cost per time unit associated with retailer j. batch arrives at retailer j;
Similarly, we define: (y)+ = max(y, 0);
(y)− = max(−y, 0).
α j (Rj ) = retailer fill rate; that is, the fraction of demand
satisfied directly from stock on hand at retailer j (inde- Analogous to Rosling (2002), we disregard the occur-
pendent of the service at the support warehouse); rence of negative demand in the analysis, and we start by
β S (R) = support warehouse fill rate, the fraction of de- determining the average number of units lost at retailer j
mand satisfied directly from stock on hand at the support during an order cycle (i.e., demand satisfied by transship-
warehouse. ments from the support warehouse), E(LSj ). The analysis
314 Axsäter et al.
is the same for all retailers. We obtain: retailer. We use the approximation:
  
N
E(LSj ) = E (Rj − D(L j ))−
 ∞  σ S2 = (1 − α j )σ j2 , (2)
1 u − mj
= (u − Rj ) φ du j =1
Rj δj δj
 which means that we regard the overflow demand at re-
Rj − m j tailer j as the share (1 − α j ) of the total retailer demand.
= δj G
δj This approximation will tend to underestimate the vari-
ance; however, our numerical tests indicate that it works
Given E(LSj ) we can then determine the expected number quite well.
of units on hand at the beginning of an order cycle (right Given μ S and σ S2 , the support warehouse can be ana-
before the batch arrives) as lyzed separately from the retailers, using standard methods
  for single-echelon systems under normal demand (see, for
E(OH j ) = E (Rj − D(L j ))+ = Rj − m j + E(LSj ).
example, Axsäter (2006)). Let:
The average time in stock for an item that just ar- m S =√LS μ S;
rived as part of a batch of size Qj is therefore given by δ S = LS σ S ;
E(OH j )/μ j + Q j /2μ j , and the resulting holding costs per IL S = inventory level at the support warehouse (stochastic
cycle are h j Q j [E(OH j ) + Q j /2]/μ j . Finally, since demand variable);
is either satisfied or lost, the average length of an order cy- FS(x) = P(IL S ≤ x); i.e., cumulative distribution function
cle is [Q j + E(LS j )]/μ j , which means that the average cost for the inventory level at the support warehouse.
per time unit is given by
h j Q j [Rj − m j + δ j G((Rj − m j )/δ j ) + (Q j /2)] + b j μ j δ j G((Rj − m j )/δ j )
Cj = .
Q j + δ j G((Rj − m j )/δ j )

Once again utilizing that the demand during an order Disregarding the occurrence of negative demand, and as-
cycle is either satisfied or lost at retailer j, determining α j is suming that the inventory position is uniformly distributed
straightforward: on the interval [R, R+Q], renders:
Qj  RS+Q S

αj =   . 1 u − x − mS
Q j + δ j G Rj − m j /δ j FS(x) = 1− du
Q S RS δS

 
In this analysis we assume that Rj ≥ 0. However, if, for δS RS − x − m S RS + Q S − x − m S
= G −G .
instance, the transshipment cost is low, it might be ad- QS δS δS
vantageous for the system that a retailer always requests
a transshipment when demand occurs. This is denoted by Furthermore, we have that:
Rj = −1, which means that the retailer does not keep any CS = h S E(IL S)+ = h S(E(IL S) + E(IL S)− ). (3)
stock at all and never places any regular orders. As a con-
sequence, α j is equal to zero and the support warehouse is Determining the two terms in Equation (3) is straightfor-
used each time a demand occurs; thus, Cj = bj μj . ward (for details see Axsäter (2006)) and we obtain:


δ2 RS − m S
3.1.2. Determining CS and β S CS = h S RS + Q S/2 − m S + S H
Q δS
Demand that cannot be satisfied directly at the retailers  S
RS + Q S − m S
is transferred to the support warehouse. This means that −H .
demand at the support warehouse is the sum of N “over- δS
flow” demand (or lost sales) processes that are difficult to The function H is defined as
 ∞
characterize. Therefore, we approximate the support ware- 1 2
house demand with a normal distribution, with mean μ S H(x) = G(v)dv = (x + 1)(1 − (x)) − xφ(x) .
2
and variance σ S2 per time unit. The correct mean is given by x
Because the demand is continuous, the support ware-

N house fill rate is the probability of positive stock, given by
μS = (1 − α j )μ j .

δS RS − m S
j =1 β S = 1 − FS(0) = 1 − G
Q δS
S
Exact analysis of the variance is complicated because σ S2 RS + Q S − m S
−G .
depends on the frequency and length of stock-outs at each δS
A distribution inventory model with transshipments 315
3.2. Optimization of reorder points into the performance of the model. As an example, it is
obvious that the model will produce good results if the
In Section 3.1 we concluded that the combined fill rate at
transshipment cost is zero (all stock should then be kept at
any given retailer j is dependent on all reorder points in
the support warehouse) or very high (all stock should then
the system (via β S ). This implies that deriving an exact
be kept at the retailers), and therefore we focus on scenarios
optimization procedure is difficult (apart from a complete
with less predictable outcomes. We also purposely violate
search, which is not computationally tractable for larger
the assumption of at most one order outstanding to test
problems). Therefore, we propose a heuristic procedure.
the model’s sensitivity in these cases. In total, we consider
We wish to minimize TC(R) under the constraints
24 problems with identical retailers and 16 problems with
γ j (R) ≥  j for all j. For a given support warehouse fill
non-identical retailers for this model validation. Section
rate, β S = β̄ S, the choice of reorder point at one retailer no 4.2 investigates the value of having a support warehouse
longer affects the other retailers. Therefore, our approach in terms of cost reductions. Here, we present 32 problems
is to decompose the problem by searching over fixed values where the current structure is compared to a system without
of β S . That is, if we know the service given from the support a support warehouse, a structure also used by Volvo Parts
warehouse, each retailer’s cost function can be minimized in some markets. In Section 4.3 we compare the support
separately, with a constraint on α j given through Equation warehouse system to an alternative system structure where
(1). Conversely, if the Rj values are given (for all j), we can lateral transshipments are allowed between all retailers on a
easily determine the RS value that achieves a certain β̄ S. designated market. Finally, Section 4.4 provides simulation
The heuristic is therefore based on sequentially selecting β̄ S results based on real data from Volvo Parts.
and determining Rj for all retailers. Then, given all Rj , RS
is determined and the resulting total system cost, denoted
TC(β̄ S), is calculated. Since both C S (RS ) and β S (RS ) are 4.1. Model validation
increasing in RS it is clear that we only need to consider In total we consider 24 problems with identical retailers.
β̄ S between zero and max( 1 , . . . ,  N ). Hence, we can start First, we focus on problems 1 to 16. In these problems the
with β̄ S = 0 and increase it with some small
until we number of retailers, the demand, and the holding cost pa-
reach max( 1 , . . . ,  N ). Further details on the heuristic are rameters are given by N = 6, μj = 4, σ j = 2, and hS = hj =
available in the Online Supplement to this article. 1 (for all j). The remaining input parameters are QS = Qj =
Intuitively, the optimization procedure should produce 20 or 40, LS = Lj = 5 or 10, bj = 6 or 12, and  j = 0.92
solutions of high quality. Still, the heuristic is based on or 0.98. The 16 combinations of the low and high values
each retailer acting in its own best interest. This means constitute our problem set. For each problem, the solution
that the optimal solution for the entire system might not given by the analytical model is simulated and compared
be found in some cases. For instance, in general it may be with the solution obtained through exhaustive search by
possible for a retailer to increase its own cost in order to simulation. For computational tractability in the exhaus-
change the demand structure at the support warehouse, tive search, we impose the constraint that all retailers must
thereby enabling other retailers to decrease their costs. Our have identical reorder points. This excludes the possibility
heuristic does not consider such possibilities but, at the of asymmetric solutions but, given identical input parame-
same time, our numerical tests indicate that this does not ters, this should constitute a minor restriction. The results
affect the quality of solutions noticeably. Also, note that are presented in Table 1, which can be found in the Online
the heuristic will always produce a feasible solution, given Supplement. In the last two columns of Table 1, the rel-
all of the assumptions in Section 3.1. ative difference in total cost resulting from the simulated
The heuristic is computationally very efficient. Large analytical solution,
TC = (TC A − TC SIM )/TC SIM , and
problems from the case company with around 60 retail- the difference in combined fill rate,
γ = γ A − γ SIM , are
ers and
= 0.001 take less than a second to solve on a given (index A refers to the simulated analytical solution
standard laptop computer. and SIM to the simulation optimization). These measures
of comparison are also depicted in Fig. 2.
For all simulations in Sections 4.1 and 4.2, we utilize re-
4. Numerical study sults from renewal theory (see, for example, Grimmett and
Stirzaker (1992, p. 394)) and approximate the normally dis-
The numerical study is divided into four sections. In Section tributed customer demand with gamma-distributed times
4.1 we validate the heuristic optimization procedure and the between arrivals of single demands. In problems 1 to 20,
approximations made in the analytical model. This is done σ 2/μ = 1, and the demand in the simulation model follows
by use of a discrete event simulation model and exhaustive a Poisson process.
search. Naturally, the computation times associated with Still focusing on the first 16 problems, in Fig. 2 and Ta-
this procedure limit the number of problems that can be ble 1 (Online Supplement) the most noticeable differences
evaluated. Therefore, the aim with the problem set chosen in cost and service are found in problems 5 to 8. Here,
is to focus on the scenarios that offer the most insight total costs and combined fill rates are significantly higher
316 Axsäter et al.

14.0%
10.0%
6.0%
ΔTC
2.0%
Δγ
-2.0%
-6.0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Fig. 2. Results for problems 1 to 24.

in the analytical solution. We note that the common fac- problems 19 and 20 the analytical solution is quite differ-
tor in these problems is that the order quantities are small ent, where a large amount of stock is kept at the retailer.
compared with the lead time demand. This means that the However, despite the different structures of the solutions,
assumption of at most one order outstanding at the retail- the differences in costs and service are rather small.
ers is likely to be violated. From Table 1 one can see that In problems 21 to 24 we consider lower, more volatile
the analytical solution does, in fact, render retailer reorder demand. Here, the input data are identical to problems
points around twice the size of Q in these problems. It is 1 to 4 except for the mean demand, which is reduced by
also interesting to note that, even though the analytical so- 50% to μj = 2. We see in Fig. 2 and Table 1 that the an-
lutions render higher costs and service, the retailer reorder alytical solutions are just below the target service levels in
points in problems 5, 6, and 8 are identical to the ones these cases. This is not surprising since the probability of
found by simulation optimization and only off by three negative demand under the normal demand assumption
units in problem 7. The main difference is instead found at is increased, a factor that is disregarded in the analytical
the support warehouse, where the analytical method ren- model.
ders higher reorder points than needed. To explain this We also consider 16 problems with non-identical retail-
behavior we compare the analytical results with the sim- ers. Here, the input data are given by N = 2, LS = L1 = L2
ulated analytical solution in Table 2, which can be found = 4, hS = h1 = h2 = 1, and QS = 10 in all problems. The
in the Online Supplement. For problems 5 to 8 where the values of the remaining input parameters differ between
assumption of at most one order outstanding is violated, the two retailers. That is, μ1 = 2 or 4, σ 1 = 1 or 2, b1 =
the analytical model underestimates the average stock on 2 or 10, Q1 = 15 or 25, and  1 = 0.92 or 0.98, where re-
hand at the retailers. Consequently, holding costs and fill tailer 2 is given the opposite value of retailer 1 (if μ1 = 2
rates are underestimated (by around 12–13% and two to then μ2 = 4, etc.). Given five parameters to vary, and be-
five percentage points, respectively), while transshipment cause retailer numbers are interchangeable, this results in 16
costs are overestimated (58–68%). However, for the retailer unique problems. A detailed comparison between the sim-
costs, these under- and overestimations seem to balance ulated analytical solution and the simulation optimization
out and the total retailer costs are close to the simulated is given in Table 3 and Table 4, which can be found in the
values (slight underestimations of around 3–4%). The an- Online Supplement. Analogous to the problems with iden-
alytical models’ fairly accurate approximations of total re- tical retailers, the differences in total costs and combined
tailer costs explains the similarity of the retailer reorder fill rate are depicted in Fig. 3. Note that, because the target
points (see Table 1) compared to the simulation optimiza- service level differs between the retailers, the comparison
tion. Furthermore, the underestimation of retailer fill rates of service levels is given separately for each retailer.
in the analytical model implies an overestimation of the From Fig. 3 we can conclude that the maximum devi-
overflow demand, which explains why the stock on hand ation in total costs is 4% and the maximum deviation in
at the support warehouse is overestimated in problems 5, combined fill rate is two percentage points. Moreover, in
6, and 8. Note that the same effect of having R ≥ Q at the many problems the solutions given by the analytical model
retailers can also be seen in problems 1, 4, and 16, although are much closer than that, rendering small differences in
less apparent in these cases. costs and service. The service assumption, Equation (1),
In problems 17 to 20 we make it more attractive to utilize used for calculating γ j in the analytical model also appears
the support warehouse by lowering the transshipment cost to be accurate. For all problems in Table 3 and Table 4,
to bj = 4 (the input data are otherwise identical to problems the average difference between the analytical values of γ 1
11 to 14). Here we see from Table 1 that, in all four problems, and γ 2 (not included in the tables) and the simulated values
all stock should be kept at the support warehouse, accord- of γ 1 and γ 2 is merely 0.2 percentage points, with a maxi-
ing to the simulation optimization. The analytical method mum of two percentage points. This means that the support
finds the exact same solution in problems 17 and 18. In warehouse provides the retailers with essentially the same
A distribution inventory model with transshipments 317

4.0%
2.0% ΔTC
0.0%
Δγ1
-2.0%
-4.0% Δγ2
25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40

Fig. 3. Results for problems 25 to 40.

service in the cases considered, which is the key assumption we will investigate the cost reductions that can be achieved
used in Equation (1). by utilizing the support warehouse system, compared with
Summarizing the insights gained in this section, the ana- the decentralized solution.
lytical model appears to be accurate, in cases of both iden- In the decentralized system, demand is backordered at
tical and non-identical retailers, given that the assumption each retailer in cases of stock-outs, as opposed to being
of R < Q at the retailers holds. In the 25 problems (out transferred to a support warehouse. Consequently, the tar-
of a total of 40) where this assumption holds, the aver- get fill rate  j must be achieved at each retailer j individually,
age
TC is merely −0.4%, with a maximum of 2.6% and and the only cost incurred at the retailers is the inventory
minimum of −4.8%. The corresponding average for
γ is holding cost. The demand distribution, ordering policies,
−0.4 percentage points, with maximum 0.6 and minimum and lead times in the decentralized system are otherwise
−1.8 percentage points, where
γ for problems with non- identical to the ones for the support warehouse system.
identical retailers is the demand weighted average of
γ 1 The aim is to compare the total cost for achieving target
and
γ 2 . However, when the retailers have more than one service levels in the decentralized system, denoted TC DC ,
order outstanding the performance is slightly worse. Here, with the corresponding cost, TC SW , for the support ware-
the average
TC over these 15 problems is 2.5%, with max- house system. Note that TC DC is the sum of inventory
imum 13.2% and minimum −4.0%. In these cases, the av- holding costs at each retailer, whereas TC SW is the com-
erage
γ is 1.0 percentage points, with maximum 5.9 and bined holding and transshipment costs at both the support
minimum −0.4 percentage points. In general, the analytical warehouse and the retailers. For the decentralized system,
model tends to overestimate the amount of stock needed in the reorder point at each retailer is easily optimized using
the system when R ≥ Q at the retailers. Conversely, due to single-echelon methods (we apply the same method that
the normal demand assumption and the associated issues of was used for the support warehouse in Section 3.1). In the
negative demand realizations, the amount of stock needed support warehouse system, reorder points are optimized
is underestimated when the variance of the customer de- using our analytical method. In order to make perfor-
mand is high compared to the mean. Still, it is interesting mance measures comparable, both systems are simulated
to note that the total cost increases with the combined fill with gamma-distributed times between demand arrivals.
rate in most cases studied. That is, an increase in costs gives We define the value of having a support warehouse as
V =
an increase in service as well and vice versa. From a prac- (TC DC − TC SW )/TC DC . The interpretation of
V is the
tical perspective, this means that if you are paying more relative cost reductions that can be achieved by introduc-
in terms of stock, you are, as expected, receiving higher ing a support warehouse in the decentralized system. Note
customer satisfaction as a result. Thus, it is ambiguous to that the comparison assumes that the service to end cus-
say that a solution with lower costs is better. This explains tomers given from the support warehouse is comparable to
why the analytical solution for several problems in Figs. 2 the service given from the retailers, as discussed in Section
and 3 renders lower costs than the solution obtained by 2. Furthermore, the focus is purely on savings in inven-
simulation search. In all of these instances the lower cost is tory costs; additional costs of operating and maintaining a
associated with lower fill rates. support warehouse are not included in the comparison.
The numerical study encompasses 32 problems. For ease
of exposition we only consider problems with identical re-
4.2. The value of a support warehouse tailers. Input data shared by the two systems considered
The support warehouse structure studied in this work is one are N = 6 or 60, Lj = 5 or 20, σ j = 1 or 2,  = 90% or
of two main inventory control structures that are currently 99%, Qj = 1.5 μj Lj or 3 μj Lj , hj = 1, and μj = 2. Here, the
used at Volvo Parts. The other type of system, which we retailer order quantities are functions of the lead time de-
refer to as the decentralized system, does not include a sup- mand. This is to ensure that the assumption of at most one
port warehouse and consists only of N retailers that operate order outstanding is not violated. The holding cost rates
independently of each other. Clearly, an interesting ques- and replenishment lead times are the same for the support
tion here is: what value does a support warehouse actually warehouse and the retailers; i.e., hS = hj = 1 and LS = Lj .
bring to these types of systems? Therefore, in this section To facilitate straightforward comparison between different
318 Axsäter et al.

ΔV ΔV
100% 100%
N=6, σ=1 L=5, Γ=90% N=6, σ=2 L=5, Γ=90%
90% 90%
L=5, Γ=99% L=5, Γ=99%
80% 80%
L=20, Γ=90% L=20, Γ=90%
70% L=20, Γ=99% 70%
L=20, Γ=99%
60% 60%
50% 50%
40% 40%
30% 30%
20% 20%
10% 10%
b b
0% 0%
(a) 0 5 10 15 20 25 30 35 40 45 50 (b) 0 5 10 15 20 25 30 35 40 45 50
ΔV ΔV
100% 100%
N=60, σ=1 L=5, Γ=90% N=60, σ=2 L=5, Γ=90%
90% 90%
L=5, Γ=99% L=5, Γ=99%
80% 80%
L=20, Γ=90% L=20, Γ=90%
70% L=20, Γ=99% 70% L=20, Γ=99%
60% 60%
50% 50%
40% 40%
30% 30%
20% 20%
10% b 10% b
0% 0%
(c) 0 5 10 15 20 25 30 35 40 45 50 (d) 0 5 10 15 20 25 30 35 40 45 50

Fig. 4.
V , as a function of the transshipment cost b, when Qj = 1.5 μj Lj .

system configurations and avoid the issue of optimizing comparing graph (a) with graph (c) and (b) with (d) shows
QS , we assume QS = 1 in all problems. This implies that that
V increases when N = 60, compared with N = 6. The
we are looking at best-case scenarios, allowing for maxi- interpretation here is that the benefits of being able to pool
mum flexibility at the support warehouse. When it comes demand to a single location are increased with the number
to the transshipment cost, it is obvious that the value of of retailers.
having a support warehouse is directly related to the size of As for the effect of increased variability in customer de-
bj . Therefore, for each of the 32 problems we consider, we mand, the results point in two different directions. Clearly,
present
V as a function of bj , where bj starts at zero and the value of pooling demand to the support warehouse is
is increased one unit at a time until
V reaches zero. increased when σ = 2, compared with σ = 1. However,
For the problems considered, the differences in end- the choice of order quantities also affects system perfor-
customer service between the two systems are very small mance. Because we assume that Qj is given, and therefore
(average absolute difference over all problems and bj is less ignore ordering costs, increasing Qj will increase total costs.
than one percentage point) and, therefore, we focus solely Generally, large values of Qj will have less of an impact on
on costs. The results for the 16 problems where the retailer total costs when the variance is higher (see Federgruen and
order quantities are set to their lower value, Qj = 1.5 μj Lj , Zheng (1992) for joint optimization of R and Q in the
are depicted in Fig. 4. backorder case or Rosling (2002) for the lost sales case).
The results show that for low values of bj all stock is Therefore, the value of using the support warehouse and
kept at the support warehouse, as indicated by the linear thereby also making use of the smaller order quantity at
slope of the functions. We also see that the cost reductions this location is not necessarily increased when σ is higher.
that can be achieved with the support warehouse structure We now turn to the problems where the retailer order
are highly dependent on the system configuration. Figure 4 quantities are larger; i.e., Qj = 3 μj Lj . Because the results
shows that longer lead times increase the value of the sup- regarding other input parameters match those from the
port warehouse. Intuitively, as regular replenishments take previous problems, we refrain from presenting all 16 prob-
a longer time, the option of using quick transshipments to lems. Instead, we focus solely on the effects of larger order
satisfy demand should become more attractive. Further- quantities and present the four problems where N = 60 and
more, the results indicate that the support warehouse is σ = 2 in Fig. 5.
more valuable when the target service levels are high. This We see in Fig. 5 that the changes in the linear slopes
is also reasonable because the marginal costs for achiev- appear later when Qj are increased, meaning that there
ing targets at the retailers, without the help of the support is a greater benefit in keeping all stock at the support
warehouse, increase with the target service level. Moreover, warehouse. Moreover, in general, the value of the support
A distribution inventory model with transshipments 319

ΔV demand first occurred. This backordered demand will then


100% wait in anticipation of the next incoming regular replen-
N=60, σ=2 L=5, Γ=90%
90%
80%
L=5, Γ=99% ishment order from the central warehouse to the retailer
L=20, Γ=90% in question. As in the support warehouse system, we as-
70% L=20, Γ=99%
60% sume negligible transshipment times and a fixed cost b̂ j per
50% unit transshipped to retailer j. Other system features are
40% identical to those in the previous sections.
30% We wish to investigate the potential cost savings in using
20%
complete pooling instead of a support warehouse structure.
10%
0%
b We use the results obtained through simulation optimiza-
0 5 10 15 20 25 30 35 40 45 50 tion for the support warehouse system in problems 1 to 16
(Table 1 in the Online Supplement) as a base for our com-
Fig. 5.
V , as a function of the transshipment cost b, when Qj = parison. Recall that all retailers are identical and initially
3 μj Lj . we also assume that the transshipment costs are the same
in both systems (i.e., b̂ j = b j for all j). Let TC CP be the
lowest total cost per time unit (found by simulation search)
warehouse is higher. However, as can be seen in the prob- that achieves target service levels in the complete pooling
lem with L = 5 and  = 99% (solid gray line), compared system. Define
CP = (TC SW − TC CP ) / TC SW as the rela-
to the same problem in Fig. 4 (graph (d)), the larger order tive cost savings that can be achieved by using the complete
quantities do not benefit the support warehouse structure pooling structure instead of the support warehouse struc-
for all bj . A plausible explanation is that, in these situations, ture. Furthermore, define
γ = γ CP – γ SW as the increase
we are forced to keep either a large amount of stock at the in end-customer service. These performance measures and
retailers, or nothing at all. Consequently, the allocation of the best reorder points found in the complete pooling sys-
stock between the support warehouse and the retailers is tem for problems 1 to 16 are provided in Table 5, which can
affected by the order quantity. be found in the Online Supplement. Consider the first four
Concluding this section, our numerical tests indicate that columns. We see that there is an obvious benefit in com-
for items with long regular replenishment lead times and plete pooling if we assume the same transshipment costs.
high target service levels, the support warehouse structure The average relative cost decrease is 9.9% and the average
can hold a significant advantage over a decentralized struc- improvement in service is 2.4 percentage points. Clearly,
ture. Our tests show that utilizing a support warehouse having a multitude of transshipment providers from which
can make sense for a wide range of transshipment costs. to choose provides opportunities to achieve high service
For items with shorter lead times and lower target service levels at low costs. However, the potential downside is that
levels, utilizing a support warehouse is mainly reasonable it may be difficult to implement complete pooling in prac-
when the transshipment cost is low. tice. As previously mentioned, one of the main reasons why
Volvo Parts uses a support warehouse as the sole provider
of transshipments is that it makes the inventory distribu-
4.3. The value of complete pooling
tion easier to manage. For instance, routines for ordering,
The cost benefits of the support warehouse structure il- handling, and shipping can be standardized at the support
lustrated in Section 4.2 are due to the increased oppor- warehouse. This results in lower transshipment costs than
tunities for inventory pooling. Using the nomenclature of would be the case in a complete pooling system, where the
Kranenburg and Van Houtum (2009), the support ware- IT and logistics systems must be able to handle shipments
house offers means to partial pooling of safety stocks. An between the retailers. Therefore, in Table 5 we also include
alternative way of achieving these inventory pooling effects scenarios where a lateral transshipment between two retail-
is, of course, for the retailers to share stock with each other ers is twice (columns 5 to 7) and four times (columns 8 to
by use of lateral transshipments. In this section we compare 10) as expensive as a transshipment from the support ware-
the support warehouse system to a single-echelon system house. In these new scenarios the support warehouse sys-
where all retailers can provide lateral transshipments to all tem renders lower expected costs than the complete pooling
other retailers. Again using the nomenclature of Kranen- system in almost all cases (average
CP being −4.2% and
burg and Van Houtum (2009), we refer to this as a system −15.7%, respectively). This indicates that complete pooling
with complete pooling. is only a reasonable option if such a system can be imple-
In the complete pooling system, a retailer facing a stock- mented without large increases in the transshipment costs.
out requests a lateral transshipment from the retailer that
currently has the most stock on hand. In the case of a tie,
4.4. Numerical results from the case company
one of the retailers with the most stock on hand is chosen
randomly. In the event that all retailers have zero stock on We conclude the numerical study with some results from
hand, the demand is backordered at the retailer where the our case company. At the moment, Volvo Parts determines
320 Axsäter et al.

2 Average inventory
levels, current
1 soluon
Average inventory
0 levels, proposed
SW R2 R4 R6 R8 R10 R12 R14 R16 R18 R20 R22 R24 R26 soluon

Fig. 6. Average inventory levels for Article A at retailer Rj .

reorder points (and order quantities) at each inventory lo- 96%, implying that the cost reductions can be made without
cation separately using tables based on price and forecasted compromising the target service levels set by management.
demand. Depending on their size (small, medium, or large) For the articles we consider, there are two main reasons
the retailers use different tables, and the support warehouse for the superior cost performance of the analytical model,
also uses separate tables. These tables were constructed on compared with the approach currently used. First, coor-
the basis of achieving target service levels, which also vary dinating all reorder points in the entire system obviously
between retailers, depending on price and frequency of de- means that the right amount of stock is kept where it is
mand. However, there is no coordination between the sup- most cost-effective. Hence, service levels can be retained,
port warehouse and the retailers when determining reorder or even increased, at a lower cost. Second, for some arti-
points. We present simulation results from 50 articles sold cles the model brings service levels closer to their target.
on the Spanish market. This market includes 63 retailers, Simulating Volvo Parts’ current solutions results in an av-
but not all articles are sold at all locations; this means that N erage service level of 5.5 percentage points above target
is between 7 and 63 for the articles considered. Lead times (compared with two percentage points in our solutions),
are LS = 2.5 days and Lj is between 5 and 15 days, depend- implying a costly overinvestment in stock. In order to il-
ing on the retailer (including half of the review period that lustrate these two typical situations we present two articles,
ranges between 1 and 6 days). The longer transportation referred to as Article A and Article B. Article A can be
times are associated with retailers on the Spanish islands. characterized as a high-price low-demand item, with a to-
Customer demand (μj ) varies significantly between retail- tal market demand of 113 units per year. The item is sold at
ers and articles, ranging from the extreme case of one per 27 retailers, with a total market target service level (target
year to around seven per day. The 50 articles chosen in- at each retailer weighted with that retailer’s average de-
clude both high- and low-price items, with target service mand) of 78%. For this kind of low-demand item, Volvo
levels between 75 and 97%. For more information on the Parts’ current strategy is to have RS = Rj = 0 and QS =
determination of parameters and the current system setup Qj = 1 for all j, with the exception of two larger retailers
at Volvo Parts, see Borowiec and Liedberg (2009). where Rj = 1. This results in a total market service level of
For each of the 50 articles, the reorder points and or- 88%. The average inventory level at each location is given in
der quantities that are currently used at Volvo Parts were Fig. 6.
obtained using the existing tables. Keeping the order quan- Figure 6 illustrates that the solution proposed by the
tities fixed, this current solution is compared, through simu- analytical method results in more stock at the support
lation, with the reorder points obtained from our presented warehouse and implies that the majority of retailers should
analytical model. Currently, the company stores demand always order directly from the support warehouse (zero in-
data on a monthly basis only. This makes it difficult to ventory) when a demand occurs. In effect, RS is increased
use statistical analysis in order to find a suitable demand by only two units while Rj is decreased by 24 units in to-
process for the simulation model. However, through discus- tal. This results in 58% savings in total costs and actually
sions with Volvo Parts, it was decided to use a compound increases the total service level to 92%.
Poisson process with a geometric compounding distribu- Article B is a less expensive, high-demand item with a
tion in cases where σ j 2/μj > 1 (see Axsäter (2006)). For total market demand of 17 700 units per year. The item is
other variance-to-mean ratios we use gamma-distributed sold at all 63 retailers and the weighted target service level
times between customer arrivals to mimic normally dis- is 96%. In this case, Volvo Parts’ current solution results
tributed lead time demand. in very high inventory levels with a total market service
Results show that applying the proposed model can lead level of close to 100%. As depicted in Fig. 7, the solution
to large cost savings. The reduction in total costs for all 50 from the analytical method is to lower all reorder points,
articles is 29% (the holding costs and transshipment costs resulting in lower average inventory levels, and thus there
are both reduced). Looking purely at the inventory level, is no need to utilize the support warehouse to achieve the
its average value decreases by 43%. The demand-weighted target service levels. This gives a cost decrease of 25% and
average target service level over all 63 retailers and 50 arti- a total market service level of 98%; that is, slightly above
cles is 94%. Our model renders an average service level of target in this case.
A distribution inventory model with transshipments 321
80
60 Average inventory
levels, current
40 soluon
Average inventory
20
levels, proposed
0 soluon
SW R5 R10 R15 R20 R25 R30 R35 R40 R45 R50 R55 R60

Fig. 7. Average inventory levels for Article B at retailer Rj .

5. Summary and concluding remarks support warehouse. Another possible modification, in or-
der to quantify the difference in service, is to introduce a
In this article we present an inventory model for approx- factor θ j when calculating the combined fill rate. That is,
imate cost evaluation and joint optimization of reorder let γ j (R) = α j (Rj ) + (1 − α j (Rj ))β(R)θ j , where 0 ≤ θ j ≤ 1.
points across N retailers and a support warehouse. The Here, θ j can be interpreted as the proportion of customers
model is underpinned by our experiences with Volvo Parts, that recognize shipments from the support warehouse as
which is a global spare parts supplier with headquarters satisfactory service.
in Sweden. The proposed method is computationally effi-
cient and is designed to be directly applicable in practice. References
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tive structure with complete pooling through lateral trans- NY.
shipments between all retailers illustrates an anticipated Axsäter, S. (2007) A heuristic for triggering emergency orders in an
cost advantage of the latter when transshipment costs are inventory system. European Journal of Operational Research, 176,
880–891.
equal. Arguably, the support warehouse structure has the Axsäter, S. (2011) When is it feasible to model low discrete de-
potential for lower transshipment costs, in which case our mand by a normal distribution? OR Spectrum (to appear). DOI:
study illustrates that this structure may offer lower expected 10.1007/s00291-011-0278-8
costs than complete pooling. Finally, we demonstrate the Borowiec, P. and Liedberg, C.J. (2009) Benefits and challenges with co-
model’s practical usefulness by applying it to real data from ordinated inventory control at Volvo Parts. M.S. thesis, Lund Uni-
versity, Sweden.
Volvo Parts. Here, simulation results for 50 representative Cohen, M.A., Kleindorfer, P.R. and Lee, H.L. (1986) Optimal stocking
products, showing average cost reductions of 29% without policies for low usage items in multi-echelon inventory systems.
compromising the target service levels, indicate that ap- Naval Research Logistics, 33, 17–38.
plying our model can result in considerable reductions in Federgruen, A. and Zheng, Y.S. (1992) An efficient algorithm for com-
inventory holding and transshipment costs. puting an optimal (R,Q) policy in continuous review stochastic in-
ventory systems. Operations Research, 40, 808–813.
In closing, one of the key assumptions in the model is Grahovac, J. and Chakravarty, A. (2001) Sharing and lateral transship-
that service from the support warehouse is comparable to ment of inventory in a supply chain with expensive low-demand
service from the retailers. As discussed previously, this is items. Management Science, 47, 579–594.
reasonable for our industrial partner. However, for some Grimmet, G.R. and Stirzaker, D.R. (1992) Probability and Random Pro-
companies it might be more realistic to assume that the cesses, second edition, Oxford University Press, New York, NY.
Gross, D. (1963) Centralized inventory control in multilocation supply
customer is more pleased if the products are readily avail- systems, in Multistage Inventory Models and Techniques, Scarf, E.,
able at the retailer. One way of dealing with these situ- Gilford, D.M. and Shelly, M.W. (eds), Stanford University Press,
ations, within the current model structure, is to add an Stanford, CA, pp. 47–84.
extra cost per unit shipped from the support warehouse or, Hadley, G. and Whitin, T.M. (1963) Analysis of Inventory Systems,
equivalently, to increase the transshipment cost, thereby Prentice-Hall, Englewood Cliffs, NJ.
Howard, C., Reijnen, I., Marklund, J. and Tarkan, T. (2012) Using
quantifying the difference in service perceived by the cus- pipeline information in a multi-echelon spare parts inventory sys-
tomer. This extra cost can, for instance, be based on the tem. Working paper, Lund University, Sweden, and Eindhoven Uni-
time the customer has to wait for a shipment from the versity of Technology, The Netherlands.
322 Axsäter et al.
Johansen, S.G. and Thorstenson, A. (1998) An inventory model with Song, J.S. and Zipkin, P. (2009) Inventories with multiple supply sources
Poisson demands and emergency orders. International Journal of and networks of queues with overflow bypasses. Management Sci-
Production Economics, 56–57, 275–289. ence, 55, 362–372.
Kranenburg, A.A. and Van Houtum, G.J. (2009) A new partial pooling Wong, H., Van Houtum, G.J., Cattrysse, D. and Van Oudheusden, D.
structure for spare parts networks. European Journal of Operational (2006) Multi-item spare parts systems with lateral transshipments
Research, 199, 908–921. and waiting time constraints. European Journal of Operational Re-
Kukreja, A., Schmidt, C.P. and Miller, D.M. (2001) Stocking decisions for search, 171, 1071–1093.
low-usage items in a multilocation inventory system. Management
Science, 47, 1371–1383. Biographies
Lee, H.L. (1987) A multi-echelon inventory model for repairable items
with emergency lateral transshipments. Management Science, 33,
1302–1316. Sven Axsäter has been a Professor of Production Management at Lund
Minner, S. (2003) Multiple-supplier inventory models in supply chain University since 1993. The main focus of his research has concerned
management: a review. International Journal of Production Eco- production and inventory control. Past and current interests include hi-
nomics, 81-82, 265–279. erarchical production planning, lot sizing, and multi-echelon inventory
Moinzadeh, K. and Nahmias, S. (1988) A continuous review model for systems. He has published numerous papers in the leading journals in his
an inventory system with two supply modes. Management Science, research area.
34, 761–773.
Moinzadeh, K. and Schmidt, C.P. (1991) An (S-1,S) inventory Christian Howard is a Ph.D. candidate in the Division of Produc-
system with emergency orders. Operations Research, 39, 308– tion Management at Lund University, Sweden. He holds degrees from
321. Linköping University (M.Sc.) and Lund University (Tekn. Lic.). His
Olsson, F. (2010) An inventory model with unidirectional lateral trans- research interests include supply chain management, inventory theory,
shipments. European Journal of Operational Research, 200, 725– and optimization theory. His current research is focused on stochastic
732. multi-echelon inventory systems.
Paterson, C., Kiesmüller, G., Teunter, R. and Glazebrook, K. (2011)
Inventory models with lateral transshipments: a review. European Johan Marklund is a Professor of Production Management at Lund
Journal of Operational Research, 210, 125–136. University, Sweden. Previously, he held positions at the Leeds School of
Rijk, P.J. (2007) Multi-item, multi-location stock control with capacity Business, University of Colorado, Boulder, and the Boston Consulting
constraints for the fieldstock of service parts at Océ. M.S. thesis, Group. He holds degrees from Linköping University (M.Sc.), and Lund
Technische Universiteit Eindhoven, The Netherlands. University (B.Sc. and Ph.D.). His research interests include inventory
Rosling, K. (2002) The (r,Q) inventory model with lost sales. Working theory, supply chain management, and logistics, with a special focus on
paper, Växjö University, Sweden. stochastic multi-echelon inventory problems.