The impact of demand variability and transshipment on vendor's distribution policies under vendor managed inventory strategy

As demand variability is amplified through supply chains due to the bullwhip effect, the celebrated vendor managed inventory (VMI) strategy, in which the supplier manages the retailer's inventory, allows suppliers and retailers to significantly improve supply chain performance. Under the VMI environment, several appealing questions arise, such as how to determine vendor's optimal distribution policy with transshipment and how the variance of demand affects the optimal policy. These questions are studied in this paper. We explore a two-echelon supply chain with one supplier and two retailers in a planning horizon of two periods. The vendor of the supply chain distributes the product to the retailers at the beginning of the first period, and then adjusts retailers' inventory positions by transshipping the stocks of the retailers based on updated sales figures at the beginning of the second period. By employing transshipment in the supply chain, we prove that a unique optimal distribution policy exists for maximizing the overall expected profit of the supply chain, and that the transshipment deployment increases both retailers' and vendor's optimal expected profit and retailers' service level for customers. We also demonstrate that transshipment can reduce the mismatch between demand and supply. Furthermore, we show that demand variability and correlation among retailers play important roles on the vendor's optimal distribution policy. (C) 2011 Elsevier B.V. All rights reserved.