Impact on inventory costs with consolidation of distribution centers

Abstract

The consolidation of Distribution Centers (DCs) is a new trend in global logistics management, with a reduction in inventory costs often being cited as one of the main benefits. This paper uses an analytical modeling approach to study the impact on facility investment and inventory costs when several DCs are consolidated into a central DC. In particular, our model suggests that consolidation leads to lower total facility investment and inventory costs if the demands are identically and independently distributed, or when they follow independent but possibly nonidentical Poisson processes. This agrees with the conclusion of the classical EOQ and newsvendor models. However, we show by an example that, for general stochastic demand processes, the total facility investment and inventory costs of a consolidated system can be infinitely worse off than that of a decentralized system. This arises mainly because the order replenishment fixed cost yields a cost component proportional to the square root of the mean value of the demand, while the demand uncertainty yields a cost component proportional to the standard deviation of the demand. Whether consolidation is cost effective or not depends on the trade-off between these two components, as indicated by an extensive numerical study. We also propose an algorithm that solves for a distribution system with the total facility investment and inventory costs within √2 of the optimal.