White Paper: Multi-Echelon Inventory Optimization

NWDCo's end customers have very high service requirements. One way NWDCo can assure that it meets these high service goals is to carry extra inventory at the DCs. At the RDCs, inventories are carried to replenish the DCs and to satisfy the RDCs' external customers. The problem is to deploy the optimal balance of inventory in the two echelons. NWDCo can use many control levers to shift the inventory balance between its RDCs and DCs. How should NWDCo set these to achieve service objectives at minimum inventory? Can slow-moving products simply be centralized at the RDCs with little or no product at the DCs? The inventory management problem is further complicated because of the high service requirements of the RDCs' external customers. The RDCs must simultaneously set aside enough inventory to satisfy external customers' demands and to provide the DCs with enough product on hand to satisfy the DCs' customers' demands.

Each RDC has its own customers that order directly from the RDC. These customers require 99% service levels. Thus, each RDC has two types of customers—external customers and internal customers represented by the DCs. Each DC orders from its RDC on a fixed schedule, but the external customers order any time they want. The lead times from the suppliers to the RDCs are generally shorter and less erratic than the lead times from the suppliers to the DCs had been before the RDCs existed. Instead of ranging from one to three weeks, the lead times are now three to 10 days. The time-definite deliveries between the RDCs and the DCs range from one to three days, depending on the DC.

NWDCo implemented a true multi-echelon inventory management system in phases, with each phase incorporating additional vendor lines. All replenishment decisions now exploit network visibility. The system models all cost implications of replenishment strategies at the DCs on the RDCs and vice versa. There are direct linkages between inventory drivers in one echelon and inventory levels in the other echelon. As an illustration, Figure 4 depicts how NWDCo sets one of the control variables, the RDC to DC service level goal, to minimize the total inventory at the RDC and DCs. As expected, the RDC inventory increases as this parameter increases. Less obvious is the effect on DC inventories. As the expected fill rate from the RDC becomes larger, the total inventory at the DCs decreases. The optimal setting for this parameter is the value that minimizes the total inventory in both echelons. Obtaining this optimal setting requires careful modeling of the interactive effects on both the RDC and DC safety stocks. NWDCo follows this optimization process for every RDC item.