Enhancing Customer-Supplier Coordination Through Inventory Decision Rights Transfer

Abstract

This paper analyzes alternative customer-supplier relationships based on agreements governing material flow and ordering decision rights, as well as the sharing of inventory and shortage costs. Material flow in a supply chain typically is determined by the orders placed by a "customer" to its immediate upstream "supplier." The consequences of poor customer service and high inventory costs, however, affect both parties involved; thus, there are many cases where nonstandard customer-supplier arrangements have been adopted.

We introduce a model that captures both decentralized and centralized ordering, as well as variants based on the allocation of decision rights to either the upstream supplier, i.e., supplier-managed inventory (SMI), or to the downstream customer, i.e., customer-managed inventory (CMI). We develop optimal inventory stocking polices for both parties involved and derive necessary and sufficient conditions for adopting one of the relationships. Our model includes parameters that capture modifications to the incentive structure based on cost sharing mechanisms, which impact the ultimate relationship choice.

We then apply the model to analyze four well-known industry examples, Barilla, Saturn, Boeing, and Hewlett Packard, where either SMI or CMI was adopted. The parameterization of the model can capture the different aspects of each company’s supply chain in a realistic manner. We illustrate how the modified incentive structure can generate benefits for the customer, the supplier, and the end consumers (i.e., "win-win-win"), and determine the gap for achieving the first-best performance. This paper concludes with a discussion of managerial implications and opportunities for incorporating additional consequences of the relationship choice.