Policy mechanisms for supply chain coordination

The problem is to determine a review period and stocking policy that are mutually bene®cial to a producer and a retailer. In our model, the retailer uses a periodic review, base stock policy for ordering the item from the producer's Distribution Center (DC). Excess customer demand is assumed to be lost. A make-to-order production system supplies to the DC. We show that given a review period, unless the manufacturer agrees to share the cost of carrying a fraction of the safety stocks at the retailer, the two will not agree upon the level of stocks to be carried in the store. We prove that there is an equilibrium value for this fraction, such that the retailer and the manufacturer are always in agreement with regard to the stocking level. We then show that complete coordination on the stocking level as well as the review period can be achieved solely through carrying out negotiations on credit terms. These theoretical results are used to construct an algorithm for calculating the optimal policy parameters for a supply chain. As part of the analysis we suggest a modi®cation of the base stock policy for the positive lag lost sales case of periodic review inventory models that consistently outperforms the base stock policy in our numerical studies.