Inventory Pooling Under Heavy-Tailed Demand

Risk pooling has been studied extensively in the operations management literature as the basic driver behind strategies such as transshipment, manufacturing flexibility, component commonality, and drop-shipping. This paper explores the benefit of risk pooling in the context of inventory management using the canonical model first studied in Eppen (1979). Specifically, we consider a single-period multi-location newsvendor model, where n different locations face independent and identically distributed demands and linear holding and backorder costs. We show that Eppen’s celebrated result, i.e., that the expected cost savings from centralized inventory management scale with the square root of the number of locations, depends critically on the “light-tailed” nature of the demand uncertainty. In particular, we establish that the benefit from pooling relative to the decentralized case, in terms of both expected cost and safety stock, is equal to n α−1 α