The value of early order commitment in a two-level supply chain

Abstract

One approach to supply chain coordination is early order commitment, whereby a retailer commits to purchase a fixed-order quantity at a fixed delivery time before demand uncertainty is resolved. In this paper, we develop an analytical model to quantify the cost savings of an early order commitment in a two-level supply chain where demand is serially correlated. A decision rule is derived to determine whether early order commitment will benefit the supply chain, and accordingly to determine the optimal timing for early commitment. Our results indicate that the supply chain would experience greater savings from early order commitment when – (a) the inventory item receives less value-added activities at the retailer site; (b) the manufacturing lead time is short; (c) demand correlation over time is positive but weak; or (d) the delivery lead time is long (if a condition exists). We also propose a rebate scheme for the supply chain partners to share the gains of practicing early order commitment.