Approximate dynamic programming for lateral transshipment problems in multi-location inventory systems

Companies commonly allocate their inventories across multiple locations based on their historical sales rates. However, random fluctuations in customer purchases, such as those caused by weather conditions and other external factors, might cause significant deviations from expected demand, leading to excess stock in some locations and stockouts in others. To fix this mismatch, companies often turn to lateral transshipments, e.g., the movement of stock between locations of the same echelon. In this paper, we examine multi-location inventory systems under periodic review with multiple opportunities for proactive transshipments within one order cycle. If stockouts occur, demand is lost with no opportunity to backorder. The objective of our model is to find an optimal policy that indicates the sources and the destinations of transshipments as well as the number of units, to maximise the profit of the network. We create a dynamic program that can, in principal, be solved to optimality using Bellman’s equation. However, the size of the state and decision spaces makes it impossible to find the optimal policy for real-world sized problem instances. Thereby, we use forward approximate dynamic programming to find a near-optimal transshipment policy. Finally, we conduct an extensive numerical study to gauge the performance of our transshipment policy. For small size instances, we compare our policy to the optimal one. For larger scale instances, we consider other practically oriented heuristics. Our numerical experiments show that our proposed algorithm performs very well compared to state-of-the-art methods in the literature.