Ship-Pack Optimization in a Two-Echelon Distribution System with Product Obsolescence

Abstract

Distribution centers (DCs) replenish stores with size-specific ship-packs. The ship-packs may be eaches (i.e. individual units), inners (a group of individual units), or cases (a group of inners). The problem that we consider is to determine the ship-pack to use for each stock-keeping-unit. The retailer faces a cost trade-off when choosing the appropriate ship-pack size: shipping in cases may incur lower handling costs in the DC but higher labor and inventory costs at the store. In addition, a larger ship-pack increases the likelihood of product obsolescence especially for products with a short life-cycle. Conversely, shipping in inners and eaches could result in higher labor and handling costs at the DC but lower store costs. We develop a cost model to find the optimal trade-off among these various costs. Our model assumes a two-echelon distribution system that captures the cost elements as functions of the ship-pack size. Next, we implement our cost model for our research partner, a US-based retailer which we call Gamma. We show that optimizing the ship-pack size can reduce Gamma’s ship-pack related costs by 9%. Furthermore, we find that for our test samples if Gamma were to renegotiate the ship-pack configurations with its vendors (i.e., the unit quantities for each inner and case), it could achieve a total cost saving of 17% compared to the original ship-pack sizes. This paper extends the literature on ship-pack optimization by developing a practical and integrable model that accounts for the costs associated with product obsolescence. Our cost model provides managers with a ship-pack recommendation system that finds the optimum balance between DC and store costs. Furthermore, our model lends managers a decision tool when negotiating with the retailer’s vendors on ship-pack size.