Designing a Centralized Distribution System for Omni-Channel Retailing

Abstract

We study the optimal supply chain design for a dual-channel retailer that operates a physical and a web-based store, and traditionally, managed each one separately. However, with increased pressures from customers and decreased profits due to marked down leftover inventories in each channel, the retailer considers integrating the supply chain operations of both channels. In contrast to the existing literature, we focus on the firm's choice on the best omni-channel strategies considering demand segmentation, cost structure, and more importantly, the execution ability of the firm. We formulate our problem as a two-stage stochastic programming model and use first-order optimality conditions to study the optimal inventory replenishment decisions. Based on different omni-channel strategy decisions, we explore four supply chain design options. We identify the optimal inventory replenishment policy under each option and explicitly describe the optimality conditions on cost and demand under perfect and imperfect demand information. When the demand information is imperfect, the demand fulfillment decisions can be characterized as nested protection-level policies. First, we show that omni-channel strategies are not necessarily profitable under all settings as imposed by the market conditions. Second, we demonstrate that when the company can allocate its inventory perfectly, running omni-channel strategies may help serve not only the web-based customers but also in-store customers better. Finally, we demonstrate that, in the worst case, the imperfect demand information may result in losing all of the claimed inventory pooling benefits when running omni-channel strategies.