The value of coordination in a two-echelon supply chain

Abstract

We study a coordination scheme in a two-echelon supply chain. It involves sharing details of replenishment rules, lead times, demand patterns and tuning the replenishment rules to exploit the supply chain's cost structure. We examine four different coordination strategies: naïve operation; local optimization; global optimization; and altruistic behavior on behalf of the retailer. We assume the retailer and the manufacturer use an order-up-to policy to determine replenishment orders and the consumer's demand is a stationary independent and identically distributed random variable. We derive the variance of the retailer's order rate and inventory levels and the variance of the manufacturer's order rate and inventory levels. We initially assume that costs in the supply chain are directly proportional to these variances (and later the standard deviations) and investigate the options available to the supply chain members for minimizing costs. Our results show that if the retailer takes responsibility for supply chain cost reduction and acts altruistically by dampening his or her order variability, then the performance enhancement is robust to both the actual costs in the supply chain and to a naïve or uncooperative manufacturer. Superior performance is achievable if firms coordinate their actions and if they can find ways to reallocate the supply chain gain.