European Journal of Operational Research 145 (2003) 569584 www.elsevier.

com/locate/dsw

Production, Manufacturing and Logistics

Estimating customer service in a two-location continuous review inventory model with emergency transshipments
Kefeng Xu a, Philip T. Evers
b c

b,*

, Michael C. Fu

a College of Business, University of Texas at San Antonio, San Antonio, TX 78249-0634, USA Robert H. Smith School of Business, University of Maryland, College Park, MD 20742-1815, USA Robert H. Smith School of Business and Institute for Systems Research, University of Maryland, College Park, MD 20742-1815, USA

Received 14 March 2000; accepted 20 December 2001

Abstract In this paper, an approximate analytical two-location inventory transshipment model is developed that combines the popular order-quantity, reorder-point Q; R continuous review ordering policy with a third parameter, the hold-back amount, which limits the level of outgoing transshipments. The degree to which transshipments improve both Type I (no-stockout probability) and Type II (ll rate) customer service levels can be calculated using the model. Simulation studies conducted to test the validity of the approximations in the analytical model indicate that it performs very well over a wide range of inputs. 2002 Elsevier Science B.V. All rights reserved.
Keywords: Inventory; Emergency transshipments; Distribution; Logistics; Pooling; Continuous review policy

1. Introduction Found in both military and commercial settings, emergency lateral transshipments represent one strategy for enhancing customer service while reducing costs in a multi-location inventory system. An organization may have many service locations spread throughout a wide geographical region to satisfy numerous, dispersed customers; however, one location may have unlled demand

Corresponding author. Tel.: +1-301-405-7164; fax: +1-301405-0146. E-mail address: pevers@rhsmith.umd.edu (P.T. Evers).

due to insucient stock while another has excess stock. Here, lateral transshipment (also referred to as pooling, transfer, and redistribution) of product could be used to satisfy the unanticipated demand at one location with the surplus from another location. Although there has been a signicant amount of work studying the eects of transshipments, most of it provides no control over the degree of transshipment, with the notable exceptions of the periodic review models of Cohen et al. (1986) and Tagaras and Cohen (1992). However, like most transshipment models in the literature, both of these assume a periodic review system with no xed ordering cost, whereas we consider a set

0377-2217/03/$ - see front matter 2002 Elsevier Science B.V. All rights reserved. PII: S 0 3 7 7 - 2 2 1 7 ( 0 2 ) 0 0 1 5 8 - 3

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of independently functioning locations operating under a continuous review inventory policy that includes a xed setup cost for placing orders. Our setting is motivated by the fact that many organizations allow autonomy of operations at individual locations, and these locations are likely to use independent lot size-reorder-point ordering policies. Modeling the degree to which this ordering policy can incorporate transshipments to improve service is the major thrust of this paper. In particular, we develop a two-location inventory transshipment model that incorporates an independent continuous review three-parameter inventory control policy at each location: the usual lot size-reorder-point Q; R inventory control policy combined with an additional transshipment parameter H that controls the amount of onhand inventory held back by a location making an outgoing transshipment. An approximate analytical model is developed that can be easily solved by numerical methods. The accuracy of the model is tested against simulation for the case of Poisson demands. For key physical characteristics of the inventory system, such as the average transshipment and stockout amounts, analytical results for this model are generally within 1015% of simulated results for non-identical locations and within 35% of simulated results for identical locations. A brief review of the literature reveals that the majority of reported studies examining multilocation inventory control problems with transshipments assume a periodic review policy where at the end of each period inventories are evaluated, replenishment orders generated if appropriate, and emergency transshipments scheduled simultaneously at several locations if needed. These studies usually assume no order setup cost such that an order-up-to base-stock inventory policy is appropriate. In particular, the early pioneering works of Gross (1963) and Krishnan and Rao (1965) examine a periodic review policy in a singleechelon, single-period setting. Gross (1963) considers a multi-location system but assumes that ordering and transshipment decisions are made before the realization of demand. Das (1975) extends Gross (1963) by allowing transshipments in the middle of each period. Assuming identical cost parameters across locations, Krishnan and Rao

(1965) develop an N-location newsboy (i.e., orderup-to) model that forms the basis of many later studies. The two-location model with dierent cost parameters was analyzed by Aggarwal (1967) and Kochel (1975) for the single-period case. In particular, Kochel (1975) proves: (1) the expected oneperiod cost function is convex with respect to the inventory levels and thus a generalized order-up-to policy is optimal in the multi-location model; and (2) complete pooling is optimal under far less restrictive conditions on the cost parameters. These results are further extended to the innite horizon case by Kochel (1982, 1988) for the discounted criterion and the average criterion, respectively. Notably, Tagaras (1989) explicitly generalizes the model of Krishnan and Rao (1965) by allowing dierent unit ordering, holding, penalty, and transshipment costs across locations in a twolocation setting. Tagaras and Cohen (1992) further extend this to the case of non-zero deterministic replenishment lead time by examining, along with complete pooling, a specic partial pooling policy in which one location maintains a certain inventory level (or inventory position) after transshipping to the other location. Kochel (1990) formulates a model similar to Tagaras (1989) in a multi-location framework, though he considers a net prot objective function and (stock) selling decision at the beginning of a period. Using a model similar to those of Krishnan and Rao (1965) and Tagaras (1989), Chang and Lin (1991) examine the cost function conditions that make the case with transshipments among locations more desirable than the case without them. Kochel (1998) provides a survey of multi-location inventory models with lateral transshipments. Other authors have extended multi-location inventory models with transshipments to incorporate multi-echelon, or multi-period, aspects. However, most of their extensions were made possible by making further assumptions beyond the single-echelon, single-period case, especially regarding the unit cost of an activity across locations. Hoadley and Heyman (1977) consider a general case of two-echelon, multi-location model with a one-period order-up-to replenishment policy. Their model allows for balancing acts (purchases, dispositions, returns, normal shipments,

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and transshipments) at the beginning of a period and emergency acts (expedited shipments from an upper echelon and emergency transshipments from the same echelon) in the case of a stockout at the end of a period. Cohen et al. (1986) extend the approach of Hoadley and Heyman (1977) even further to the multi-echelon case, with particular emphasis on low demand, high cost, high service spare parts inventory. Their model diers from most in that transshipments are not restricted only to the lowest echelon. Jonsson and Silver (1987) examine a two-echelon distribution system consisting of a cross-docking central warehouse supplying several branch warehouses and investigate the desirability of complete redistribution of all branch warehouse inventories one-period before the end of the order cycle to minimize the (approximate) total expected units backordered. Considering inventory transshipments in a multi-period problem results in a class of dynamic programming models, usually as an extension of the single-location newsboy problem, or a broad class of simulation models. Computational methods, rather than model implications and applications, are the focus of the former category, as illustrated in Karmarkar (1987), Robinson (1990), Klein (1990) and Archibald et al. (1997). Cantagalli (1987), Dorairaj (1989), Evers (1996, 1997), and Tagaras (1999) are examples in the latter category, simulating the eects of transshipment, demand, and lead time parameters on system performance. The few studies examining continuous review inventory systems, such as Lee (1987), Axsater (1990), Dada (1992), and Sherbrooke (1992), mainly focus on repairable items or spare parts inventory under one-for-one ordering policy at each location. In our setting, the xed setup cost for ordering along with the allowance for emergency transshipments makes plausible the ecacy of a three-parameter inventory control policy, and thus the basis for the form of the proposed inventory control policy. In addition to the usual continuous review lot-size and reorder-point parameters, a hold-back parameter is included to establish the amount of on-hand inventory that a location can reserve for itself prior to making an outgoing transshipment.

The paper is organized as follows. In Section 2, the approximate two-location continuous review Q; R model with lateral transshipments is developed. The accuracy of the model is tested against simulation in Section 3. Section 4 contains a summary of, and conclusions from, the work.

2. The analytical model Consider a rm with two service locations much closer in terms of transit times to each other than to their respective supply sources. Managers at each location closely watch the demand behavior and inventory level and are thus able to determine the remaining demand level near the end of an order cycle. The locations receiving the transfer request grant the transshipments based on their own reserve levels. Each location i (i 1; 2) serves the customers of its designated territory and controls its inventory level independently and continuously with an order-quantity, reorder-point Qi ; Ri policy. Once location i nds its inventory position Zi with probability density function (p.d.f.) ui  below its reorder-point Ri , it places a replenishment order of size Qi with a supplier having ample capacity to fulll all replenishment requests within a deterministic replenishment lead time Li . Location is inventory position is equal to its inventory level Yi with p.d.f. gi  and cumulative distribution function (c.d.f.) Gi  plus any replenishment orders in transit. 2.1. Model assumptions Our model adopts the usual assumptions of continuous review models (cf., Lee and Nahmias, 1993). An innite horizon problem is considered with stationary, but stochastic, demand specied by demand during lead time Di with p.d.f. fi  and c.d.f. Fi . Demands are independent over time and across locations, though demands at the two locations need not be identically distributed. With Ri P 0, stockouts occur only during the reorder lead time period. At most, only one

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replenishment order is outstanding at each location. Thus, inventory position and inventory level are dierent from each other only during the reorder period. And before the replenishment order arrives, there is a chance that demand Di will outstrip planned available stock Ri even if some safety stock is maintained. Assume location i can determine its actual demand during lead time near the end of its order cycle since most of its demand during lead time Di has already been realized and a very short time period remains to be forecasted (usually a small fraction of the replenishment lead time). This treatment is similar to those in most studies of periodic review inventory policies, such as Krishnan and Rao (1965) or Tagaras (1989), which assume transshipments occur after demand is realized but before it must be satised. If necessary then, management at location i could request an emergency transshipment during its order cycle from location j (j 6 i). Here the order cycle refers to the period between two successive order deliveries to a location. Any demand that cannot be satised either from on-hand inventory or by emergency transshipment is backordered (the inventory level becomes negative with a backorder) and satised when the next replenishment arrives. Further assume that emergency transshipment times are negligible relative to regular replenishment lead times and that there can be at most one transshipment request per cycle (typical assumptions in most transshipment studies including Tagaras and Cohen, 1992). The transshipment quantity that location i receives from j depends on location js inventory level and control policy. For example, when location j receives a transfer request from i: (A) location j could make available all of its onhand inventory; (B) location j could hold back enough of its onhand inventory to cover its reorder-point and only make available the remainder of its on-hand inventory; or (C) location j could hold back some amount of on-hand inventory beyond the zero inventory indicated in (A), but unrelated to the reorderpoint.

Policy (A) corresponds to the complete pooling policy used by many authors in the periodic review case (cf., Krishnan and Rao, 1965; Tagaras and Cohen, 1992). Complete pooling is preferred in those studies since replenishment orders are often assumed to arrive at every location after the maximally possible transfer amounts are used to reduce system shortages to a minimum. However, in a continuous review system, such a transshipment may result in another shortage situation quickly arising at the supplying location. Policy (B) tries to minimize each locations own risk of stockout resulting from making an emergency transshipment by assuring location j a certain degree of protection from shortage after transferring out some of its inventory. Consequently, managers at each location may favor policy (B) to protect their own interests. Nevertheless, one weakness of (B) is that it is conservative and potentially myopic since it is possible that location j could transfer stock to i now and then request an emergency transfer later if necessary, hoping that by then location i will be in a surplus situation. While (A) and (B) represent two convenient policy options, our model captures the range of transshipment options implied by (C) through incorporation of an additional control parameter Hj that represents the amount of on-hand inventory held back before an outgoing transshipment is authorized. Subject to stability considerations, there are no theoretical limits for the choice of Hj , though commonly Hj P 0. For instance, Hj > Rj could be used if management feels a locations xed order cost is too high and/or needs to reduce the order frequency caused by transshipments (another reason for Hj > Rj could be the existence of a transshipment setup cost). The transshipment quantity from location j to location i, given that the demand during lead time at i is x and the inventory level at j is y, is dened by: Xji x; y minfx Ri ; y Hj g:

Thus, a transshipment only takes place if the realized demand during lead time exceeds the reorder-point at the receiving location and there is excess inventory above the held-back point available at the sending location. The notation Xji Xji Di ; Yj is used to dene the corresponding

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random variable. Using the hold-back quantity H to control transshipments by each location is appealing here because of its simplicity and ease of implementation. This reserve parameter controls the window of opportunities to transship and can be determined a priori. As pointed out earlier, the only papers identied as providing some control over the hold-back quantity are those periodic review models of Cohen et al. (1986) and Tagaras and Cohen (1992). Cohen et al. use a single sharing rate for all locations in total to control the fraction of excess supply at surplus locations used to satisfy excess demand elsewhere. Our design is more exible as each location sets its own hold-back amount. And, while similar in essence to ours, the model of Tagaras and Cohen is more complicated due to an additional control parameter: a threshold inventory level that a location would like to reach but not exceed after receipt of the transshipment. In order to obtain an analytically tractable model for the performance of such a transshipment system, we require the following assumptions, which are exact for systems without transshipments in general settings:  1=Qj for Rj < z 6 Rj Qj A1 uj z 2 0 otherwise for all j: A2 Di and Yj are independent for all i 6 j: A3 Yj t Lj Zj t Dj for all j: 3 (A1) means the steady-state inventory position Zj , which we will assume to exist (true for appropriate values of Q; R; H ), is uniformly distributed on Rj ; Rj Qj and is independent of the lead time demand Dj . This assumption is used by Zheng (1992) in a general treatment of the Q; R policy. According to Browne and Zipkin (1991), in the case of continuous demand (A1) holds when the cumulative demand can be modeled by a nondecreasing stochastic process with stationary increments and continuous sample paths. When the demand is discrete and unitized and forms a stationary point process, these conditions are justied if demand can be modeled as a Poisson process (Hadley and Whitin, 1963). In this case, the re-

plenishment order is placed as soon as the inventory position hits Rj exactly. (A2) says that the demand during lead time at one location is independent of the on-hand inventory level at the other. Since Di and Yi are perfectly correlated during the reorder period, this implies that Yi and Yj are independent at the end of each locations order cycle. (A3) is a well-known fundamental relationship for an ordinary single-location facility relating the inventory level at time t Lj , the inventory position at time t, and the demand during a xed lead time (cf., Zipkin, 1986), stating that everything on order at time t will have arrived in the system by time t Lj , whereas new orders placed after t will not have arrived by time t Lj . Thus, the onhand inventory level Yj t Lj contains on-hand inventory at time t and all orders in-transit on or before time t but is reduced by the demand during the lead time. In the stationary case t ! 1, the time dependence can be dropped, so Yj Zj Dj . Thus the c.d.f. for Yj is given by Gj y P Yj 6 y Z Rj Qj Z
Rj

uj zfj x dx dz 4

z y

Rj Qj

uj z1 Fj z y dz:

Rj

Once transshipments are introduced, these assumptions do not hold precisely. For instance, based on (A1) and (A3) it is assumed that the inventory position at a location is aected by its own demand process but not by the transshipment process, even though transfers into and out of a location actually do aect the on-hand inventory level and, consequently, the inventory position. Likewise, (A2) could be violated if a large demand Di at one location results in a large inbound transshipment Xji which, in turn, decreases the inventory level Yj at the other location. Violations of these assumptions, however, pose few problems as simulation experiments reported later indicate that the quality of the resulting analytical performance measures is quite good in many settings.

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2.2. Model development Beginning with the expected amount of transshipment across locations during a typical order cycle, given by EXji in (1), various model performance measures can be derived. Xji depends on Di and Yj , which under (A2) can be treated as independent. While the explicit derivation will only be shown for the case where the demand process and all decision parameters Q; R; H are continuous, the discrete case can be obtained in a similar, straightforward manner. Dierentiating and using assumption (A1) for the p.d.f. of Zj , the corresponding p.d.f. is Z Rj Qj gj y G0j y uj zfj z y dz
Rj

Rj Qj . EXji depends on the relative magnitudes of Hj and Rj . To demonstrate the exibility of our analytical model to capture a wide range of scenarios, we evaluate both Hj 6 Rj and Hj P Rj . If H j P Rj : Z Rj Qj 1 Fj Rj Qj y EXji Qj Hj Z Ri y Hj 1 Fi x dx dy : 7
Ri

Otherwise Hj 6 Rj : "Z Rj Qj 1 EXji Fj Rj Qj y Qj Hj

Z Z
Ri y Hj

1 Fi x dx dy
Ri Ri y Hj Ri

Rj

Fj Rj y
Hj

Fj Rj Qj y Fj Rj y =Qj 8 Fj Rj Qj y Fj Rj y =Qj > > < if y 6 Rj ; Fj Rj Qj y =Qj > > : if y P Rj :

# 1 Fi x dx dy : 8

Note Fj 0 0 under non-negative, continuous demand as assumed in our case here. Integrating over the joint density, the expected amount of transshipment Xji during a typical cycle of location i is calculated as Z 1 Z Rj Qj EXji Xji x; y gj y fi x dy dx
Ri Hj

Ri Rj Qj Hj

Rj Qj

x Ri

Ri

Hj xRi

gj y fi x dy dx Z Rj Qj Z 1 y Hj gj y fi x dx dy Z
Hj Ri y Hj Ri Rj Qj Hj

1 Fi x 6

Ri

1 Gj Hj x Ri dx;

where (1) is used in the second equality to rst divide the region of integration into two parts. Then, a change in order of integration plus some algebraic manipulations leads to the last line of (6) for details, see Xu (1997). Note that Gj Rj Qj 1 (i.e., the inventory level does not exceed

In the case of Hj 6 Rj (and especially in the extreme case of Qj Hj < Rj ), it is conceivable that (8) is merely approximate since the inventory position after an outbound transshipment could drop so low that a second replenishment order would be needed. If so, then the conventional Q; R model assumption of, at most, only one outstanding replenishment is violated and model accuracy could deteriorate. This issue is investigated in detail later. The partial derivatives (shown in Appendix A) have clear implications as to the eects of changing decision parameters on expected transshipments. A higher reorder-point at location i makes transshipments less likely since a higher safety stock is maintained by i. The expected average transshipment from j to i is not aected by location is order size since i needs an emergency transshipment during its reorder period, nor is it related to location is own held-back amount since the latter only aects transfers to location j. On the other hand, a higher reorder-point and order-quantity at location j lead to higher on-hand inventory at location j and thus increase the expected average transshipment quantity from j to i. Finally, a higher Hj results in location j curbing the outow transfer to location i. Later, these observations will be tested using simulation.

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The second important performance measure considered is the expected amount of stockout during a cycle. In the typical independent Qi ; Ri inventory system, the expected amount of stockout per order cycle of i is given by: Z 1 ni Ri EDi Ri x Ri fi x dx 0 Z 1 1 Fi x dx: 9
Ri

PiBP no-stockout probability at location i before pooling Fi Ri , PiAP no-stockout probability at location i after pooling, bBP i demand ll rate at location i before pooling 1 ni Ri =Qi , bAP i demand ll rate at location i after pooling. When measuring service levels, consider the original transshipment Xji dened in (1) as the stochastic addition to the total inventory availability Ri during an order cycle at i. That is, with transshipments a stockout occurs if Di > Ri Xji :
PiAP P Di 6 Ri Xji (Z 1 Z Hj 1 gj y fi x dy dx
Ri 1

Allowing for transfers between two locations at the same echelon, the inventory availability at location i during its reorder lead time is no longer Ri , but Ri Xji . According to the transshipment policy dened by (1), the transshipment quantity Xji is always less than or equal to the requested amount Di Ri . Therefore, the expected amount of stockout at location i per order cycle with transshipments is:
EDi Ri Xji Z 1 Z Rj Qj x Ri Xji x; y gj y fi x dy dx 1 0 Z 1 Z Rj Qj x Ri Xji x; y gj y fi x dy dx
Ri 1

1 Z

Z Z

Rj Qj

) gj y fi x dx dy

Hj 1

Ri y Hj

fi x dx 1 Gj Hj x Ri fi x dx Z
Ri Rj Qj Hj

Ri Ri Rj Qj Hj

Ri

ni Ri EXji :

10

PiBP

1 Gj Hj x Ri fi x dx:
Ri

It is clear from (10) that, compared with the expected stockout in an independent system, the expected stockout in the transshipment system is reduced by the expected amount of transshipment into the location per cycle. The partial derivatives of EDi Ri Xji with respect to the control parameters (shown in Appendix A) indicate that by raising its own reorder-point or the other locations reorder-point level or replenishment order size, or by reducing the others held-back amount, a location could reduce its own expected stockout amount. For the same reasons that EXji is not related to Qi and Hi ; EDi Ri Xji is not related to Qi and Hi . One of most important reasons for holding inventory is to ensure customer service. Here, the levels for a given set of (not necessarily optimal) operating parameter values Qi ; Ri ; Hi with and without emergency transshipments are computed. Following Tagaras (1989), Type I and Type II service measures are dened as follows:

11

Thus PiAP > PiBP for Hj < Rj Qj , according to (11). A convenient way of writing (11) is
oEXji PiAP PiBP oRi   oEXji where 6 0 from 15 in Appendix A : oRi 12

Eq. (11) indicates that emergency transshipments do indeed improve each locations no-stockout probability, though only complete satisfaction of the transfer request (i.e., full transshipment) can prevent any stockout. Thus, the increase in the nostockout probability reects the likelihood that the location requested to make a transshipment has enough extra stock to fulll any emergency needs at the requesting location under all scenarios of demand during the replenishment lead time.

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Dened as the ratio of satised to total customer demand at a location (where a locations total customer demand during its cycle is Qi ), the ll rate in the independent case is given by the following: bBP i 1 ni Ri = Q i Z 1 1 x Ri fi x dx=Qi
0

1 EDi Ri =Qi :

13

During an average cycle, a location i is expected to receive a replenishment order of size Qi from its supplier and an inbound transshipment amount of EXji from the other location j to fulll its demand, but would also transfer outbound amounts of EXij Ti =Tj to the other location. Here Ti and Tj are the average order cycle lengths of locations i and j, respectively. Note that outbound transshipment amounts should not be counted as cycle demand at location i since they are not direct customer demands from location i. Therefore, the expected value of cycle demand can be approximated as: Ecycle customer demand at i Qi EXji EXij Ti =Tj : This expression implies that outbound transshipments shorten the cycle length in the same way that inbound transshipments extend it. This is conrmed by our simulation studies later. The shorter the cycle length Tj is relative to Ti , the more frequent the transshipment request is from j. Since both EXji and EXij are small relative to Qi and tend to cancel each other out, partially if not completely, we can approximate the cycle customer demand as Qi . The ll rate with transshipments is approximately: 1 EDi Ri Xji bAP i =Qi EXji EXij Ti =Tj % 1 ni Ri EXji =Qi bBP i EXji =Qi : 14

base stock in a two-location (periodic review) newsboy model. In general then, emergency transshipments represent an eective approach for improving service levels as measured by no-stockout probabilities and demand ll rates. This is achieved for any level of the operating parameters Qi ; Ri ; Hi as long as Hi is specied in a way that allows transshipments. Under the no-transshipment system, increasing service levels requires raising Ri , or more precisely the safety stock, thus resulting in higher total costs. However, as long as the savings in shortage and holding costs outweigh the costs of making emergency transshipments, an inventory system with transshipments should result in lower total costs than a system without transshipments having the same operating parameters Qi and Ri .

3. Model validation To examine the accuracy of the analytical model, simulation is used. In contrast with the analytical model (where only the distribution of demand over lead time is needed), complete specication of the demand process is required for simulation. In order to make the simulation specication readily correspond to the aggregate information required for the analytical model, we consider a Poisson demand process, which leads to a Poisson distribution of demand during lead time (average demand during lead time is denoted as DDLT). Here, replenishment lead time is equal to 4 days. Three levels of demand inter-arrival time (0.3333, 0.1667, and 0.1 days to represent low, medium, and high demand, respectively) are simulated, resulting in three levels of DDLT: low of 12; medium of 24; and high of 40. Additional experiments having even lower or higher DDLT are also conducted but not reported here, since comparable results are obtained. Shown in Table 1, 15 dierent levels of the inventory control parameters Q; R; H are considered as well. A total of 270 runs (3 demand levels, 3 control parameters, 15 control parameter levels, and identical and nonidentical locations), each of 1,000,000 days in simulation run length, are tested. In the case of identical locations, each location has the same

The results in (12) and (14) resemble those of Tagaras (1989), who derived the partial derivatives of expected transshipments with respect to the

K. Xu et al. / European Journal of Operational Research 145 (2003) 569584 Table 1 Inventory control parameters DDLT Low (12) Medium (24) High (40) Q 16; 18; 20; . . . ; 44 30; 32; 34; . . . ; 58 50; 54; 58; . . . ; 106 R 12; 14; 16; . . . ; 40 24; 26; 28; . . . ; 52 36; 38; 40; . . . ; 64 H 0; 2; 4; . . . ; 28 0; 3; 6; . . . ; 42 0; 5; 10; . . . ; 70

577

control parameters and average demand level. In the non-identical case, the locations have the same average demand level, but one dierent control parameter (simulations not presented here verify that transshipment behavior is similar even when demands are dierent for two locations). A 1000day period is taken as one batch, leading to 1000 batches for each run-example. Batch means are computed for the performance measures of interest, resulting in a suciently high degree of precision in the estimates (standard error to mean ratios of under 1% in almost all cases), so the condence intervals are neither reported nor displayed in the results here. With respect to the validation, one parameter at a single-location (either Qi ; Ri , or Hi ) is varied and plotted while all other parameters at both locations are xed. The xed Q; R values are obtained through independent (no-transshipment) optimal conditions (cf., Nahmias, 1989) and by setting H R. In order to consider a reasonable range of the parameters, the following costs are used: unit holding cost $10 per unit per year, penalty cost $1 per unit, and order setup cost $5 per order. Thus, without transshipments, the optimal Q; R values are 36; 14, 51; 27, and 65; 46 for low, medium, and high demand levels, respectively. 3.1. Results The performance measures compared are the expected amounts of transshipments and stockout per order cycle. The complete set of results is contained in Xu (1997), the vast majority of which strongly support the model. Due to space limitations, we present in gures here only a small subset of cases, concentrating mainly on those where the discrepancies between the analytical model and the simulation results are most pronounced. A de-

scription of the particular experiment setting accompanies each gure. According to the analytical model properties (A.2) and (A.4), from the perspective of location i, increasing order size Qi should not have any eect on inbound transshipments EXji but should increase outbound transshipments EXij . From

Fig. 1. Non-identical locations; low DDLT (Ri Rj Hi Hj 14; Qj 36). (a) Comparison of transshipment quantities across order quantities. (b) Comparison of stockout amounts across order quantities.

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Fig. 1(a), such predictions are generally conrmed as the simulated average transshipment per order cycle conforms to these general trends. In particular, the eects of Qi on Xij are relatively well predicted under all three demand scenarios. However, according to the simulation results, changing ones own order size does have some minor impact on Xji , especially with low or medium demand and a low Qi . Similar in degree to that of expected transshipments, the expected amount of stockout also conforms to its simulation counterpart. Such conformance is better under lower Qi , as illustrated in Fig. 1(b), though it is unclear why some deviation (maximum 1020%) occurs in the mid-range of Qi under the low to medium demand scenarios. According to the gure, the theoretical properties (A.7) and (A.9), predicting that location is stockout amount is not aected by its own order size but decreases with the other locations rising order size, are generally conrmed. Unlike Fig. 1, which is based on low demand, the analytically determined amounts of transshipments and stockouts strongly conform to the simulation averages in the case of high demand (see Xu, 1997 for details). This suggests that as demand discreteness and the coecient of variation decline due to higher demand, the analytical model better predicts the simulation results. Recall (A.1) and (A.3) raising ones own reorder-point Ri reduces inbound transshipments EXji , whereas raising the other locations reorder-point Rj increases EXji . Such properties are clearly conrmed by the simulation results in Fig. 2(a). Moreover, the theoretical curves of Xji and Xij versus Ri match their simulation counterparts very well, generally with less than 23% discrepancy. An exception arises when Ri is less than or equal to its DDLTi (where roughly a 1020% discrepancy between simulation and analytical results arise for Xji ), but since Ri < DDLTi usually implies stockouts of 50% or more, it can be argued that such a low reorder-point is not reasonable. Likewise, the expected stockout amount at the receiving location is closely matched by the simulation results (see Fig. 2(b)). For reasonable ranges of Ri ( P DDLTi ), the predicted stockout level at each location is, in general, within less than 35% of the

Fig. 2. Non-identical locations; medium DDLT (Qi Qj 51; Rj Hi Hj 27). (a) Comparison of transshipment quantities across reorder points. (b) Comparison of stockout amounts across reorder points.

simulated level. The gure provides evidence that the model is well-behaved in relation to one locations reorder-point. In Fig. 3, the eects of one locations transshipment control parameter, the held-back point Hi , is shown. In all demand scenarios, the simulated average outbound transshipment and stockout amounts as a function of Hi are extremely accurately predicted by the analytical model (less than 2% discrepancy). However, the model prediction that inbound transshipments would not be aected by the locations own held-back point is not supported near the lower limit of Hi (especially when close to 0) where a gap of roughly 3040% is

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amounts increase less than 20% when Hi decreases from 40 ( DDLTi ) to 0 (the lower limit). To summarize, under two non-identical locations most of the theoretical properties are conrmed and the levels of physical quantities approximately predicted, though the errors tend to be larger when one of the inventory control parameters (Qi ; Ri , or Hi ) approaches its lower limit. A number of possible sources for the discrepancies between the analytical and simulation models may exist. These are briey examined below. 3.2. Possible causes of discrepancies and examination of model assumptions In the analytical model, the expected inbound transshipment amount was shown in (A.2) not to vary with Qi . However, when Qi is small relative to DDLTi but the random realization of demand during lead time at location i far exceeds DDLTi , it is more likely that an inbound transshipment request will be made in the next cycle since an arriving replenishment Qi may not be enough to bring the inventory level above Ri . The analytical model assumes that location i will have inventory position Ri to properly handle the random realization of demand during lead time at the time of reordering. Since the simulation is not limited by this restrictive assumption, the actual inventory position at the time of reordering could be lower than Ri . In this case, the analytical model fails to identify the higher need for inbound transshipments, which is captured by the simulation model. Thus, a very low Qi relative to DDLTi represents one instance where the analytical model cannot be very accurately applied. When Ri is less than DDLTi , there is a signicant chance of stockout and/or a signicant amount of stockout, leading to relatively large inbound transshipments and making the assumption of uniform inventory position at the other location tenuous. Thus, when Ri is low, the analytical model is less applicable because of its assumptions. In this situation, the accuracy of predictions for inbound transshipments decreases, though estimates of other performance characteristics from the analytical model tend to maintain their validity.

Fig. 3. Non-identical locations; low DDLT (Qi Qj 36; Ri Rj Hj 14). (a) Comparison of transshipment quantities across held-back points. (b) Comparison of stockout amounts across held-back points.

present. We recognize that when Hi < Ri there is a chance (though usually not large) that outbound transshipments diminish the protection provided by Ri during the replenishment lead time. This is not accounted for in our model, making it only approximately true when Hi approaches 0. Again, the relative extent of discrepancy is less severe in the high demand scenarios. All stockout quantities at both locations in relation to ones held-back point are reasonably predicted by the model in all demand scenarios. Model property (A.7) predicts that the stockout amount is unchanged with Hi but is only marginally supported (though the actual magnitude of change is not large). For instance, in the worst scenario where demand is high, simulated stockout

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Low levels of Hi (less than DDLTi and approaching 0) reect another area where some of the critical assumptions in the model only partially hold. For instance, it is assumed in (A1) that the inventory position at a location is aected by its own demand process but not by the transshipment process. This is fairly acceptable if the extent of transshipment is not large, such as when Hi is close to or above DDLTi . However, an extremely low Hi induces high outbound transshipments, resulting in pronounced consumption of is on-hand inventory, even during its own replenishment period. Thus, even larger inbound transshipments are inevitably needed to avoid potential stockouts. Since the analytical model assumes only one outstanding order and, implicitly, the existence of a steady-state, long-run stability could be a concern when Hi Qi < Ri and the inventory of location i drops to Hi after a transshipment. If a steady-state does not exist, then there will likely be some discrepancies between the analytical results and the simulation results. This is addressed by prohibiting more than one outstanding replenishment in the simulation model, too. In the experiments examined here, stability was never an issue; however, there is at least some chance that this could be a problem when Hi Qi is pushed to the lower extreme. Another source of discrepancy is the actual realization of Gi  (the distribution of Yi ). To obtain (5), Eq. (3) was used, which is exactly true in the independent (no-transshipment) case but only approximately so when transshipments are allowed since transshipments into and out of a location also aect on-hand inventory. Unfortunately, an exact analysis is dicult to perform. Suce it to say, however, that a low Qi , Ri , or Hi intensies the disparity and that, if two identical locations engaging in transshipments are considered, the eects of transshipments into and out of a location should largely cancel each other out, resulting in more precise model predictions relative to those in the two-non-identical location case. Other possible causes are violations of critical assumptions of the analytical model. One assumption is that the inventory position at a location is uniformly distributed. Again, transshipments into and out of a location distort this.

However, after experimenting with a reasonable range of Q; R; H values, such distortion from the uniform distribution was found not to be excessive for modest transshipment amounts and frequency, at least in comparison with the inventory distribution of a typical, single-location Q; R model. A second assumption is that the random realization of demand during lead time at location i and the on-hand inventory level Yj at location j are independent. If instead they are positively correlated, then there will be more actual transshipments than when the two are independent. However, experiments indicate that the correlation is generally less than 0.1. A nal assumption is that a location has no more than one outstanding order at any one time. This is violated only occasionally in most experiments, less than 0.2% of the cycles may need more than one order, though a second order before the arrival of the outstanding one is not allowed in our simulation. Thus it appears that breaches of the underlying assumptions are not a signicant factor (for details, see Xu, 1997). 3.3. The case of identical locations While examining discrepancies, we hypothesized that the analytical model would match the simulation results more closely if the locations were identical. This notion is examined below with a number of experiments under all demand scenarios. Since low demand usually resulted in more inaccuracies in the case of non-identical locations, only results from low demand scenarios are presented in the discussion of identical locations. Since the locations are identical, only one locations results need to be graphed. Along the Xaxis of the identical location graphs, the same parameters at both sites are changed simultaneously, in order to maintain the denition of identical locations. Thus, application of equations such as (A.1)(A.5) requires the use of the chain rule. For instance, the eect of varying Qi and Qj simultaneously in the same magnitude on is inbound transshipments would be equal to the sum of their individual eects, represented by (A.2) and (A.4), respectively. (The end result is that increasing the order size of both locations will raise

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order sizes (Qi and Qj ) are considerably more accurate in the case of identical locations. The discrepancy between the analytical and simulation results is barely 23%, for both transshipments per cycle (Fig. 4(a)) and stockouts per cycle (not shown). Similarly, when the order sizes and heldback points are xed at both locations while the reorder points at both locations are altered, as in Fig. 4(b), the analytical model follows the simulation fairly precisely, except at the point where Ri DDLTi 12. The possible cause of such discrepancy has been previously explained. Also in the case of identical locations, the dierences between the analytical and simulation results under changing held-back points at both locations are greatly reduced (compare Fig. 4(c) with Fig. 3(a)). Moreover, reasonable approximations (less than 15% discrepancy) of inbound transshipments per cycle have been obtained for the lower limit of Hi (i.e., larger transshipments), which are hardly achievable in the cases of non-identical locations. The plots for two identical locations conrm the hypothesis that identical locations lead to signicantly better model accuracy. In particular, for some of the most problematic regions of Qi and Hi , the maximum discrepancies between the analytical and simulation results dropped from 20% (with respect to low Qi ) and 40% (with respect to low Hi ) in the case of non-identical locations to 3% and 15% in the case of identical locations, respectively.

4. Conclusions and further research This research presents an approximate analytical model of a two-location inventory system with emergency transshipments. It adds to the existing literature in several ways. First, it includes a commonly used continuous review order-quantity, reorder-point Q; R inventory policy at individual locations, whereas past studies focused on a periodic review inventory control policy or a oneforone ordering policy in the case of continuous review. Second, it incorporates a hold-back quantity H, which allows each location to control its extent of inventory sharing. A Q; R; H policy is potentially attractive because it is a direct extension of the Q; R policy often employed at

Fig. 4. Identical locations; low DDLT. Comparison of transshipment quantities across: (a) order sizes (Ri Rj Hi Hj 14); (b) reorder points (Qi Qj 36; Hi Hj 14); (c) held-back points (Qi Qj 36, Ri Rj 14).

each locations inbound transshipments while reducing stockout amounts.) Comparing Fig. 4(a) with Fig. 1(a) shows that the analytical model predictions under changing

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autonomous locations. Third, many interesting properties of lateral transshipments can be investigated easily using the analytical model. For example, transshipments are shown to always improve every locations customer service; furthermore, given a cost structure on performance measures, it would be easy to identify the appropriate inventory control parameters to adjust and straightforward to predict their costs. Since analytical tractability of the model required various approximations, simulation was used to test the accuracy of the model. From these results, the analytical model appears to work especially well (1) with medium to high demand ranges, (2) with medium to high levels of each inventory control parameter (relative to expected demand during lead time), or (3) when all locations are identical. Immediate future research in this area should focus on utilizing the current model to explore other issues not considered in this research. For instance, how well does this model predict system performance if some knowledge about the distribution of demand during lead time exists but information regarding the details is unavailable? More specically, suppose that the only information available for the demand process are the mean and standard deviation of demand during lead time; will its approximation with, say, a normal distribution be sucient to analyze such a transshipment system? The sensitivity of the performance estimates to the actual form of the demand process could then be evaluated. It would also be desirable to collect the necessary demand and cost information from a rm and conduct an empirical analysis on the applicability of the model. In this paper, a xed hold-back amount Hj was considered. Whether a constant Hj or a dynamic Hj (one that varies during a cycle) should be employed raises some interesting issues. Ideally, a dynamic Hj should provide more control over inventory and allow managers to make betterinformed decisions regarding the appropriateness of transshipments and their timing in cases of long order cycle times. A exible hold-back parameter, however, is signicantly more complex to implement and dicult to analyze mathematically (for example, the timing within a cycle for the location

receiving the transshipment request is now stochastic). Nevertheless, a dynamic Hj presents numerous issues for future exploration. Relaxation of some of the major assumptions of the analytical model, such as stochastic or relatively long transshipment lead time, imperfect information regarding demand during transshipment lead time, or more than one inbound transshipment per order cycle, may make exact mathematical analysis dicult. However, it would be useful to investigate how well the analytical model and its modication can approximate more complex situations. In addition, the analytical model could be extended to incorporate more than two locations.

Appendix A The partial derivatives of EXji with respect to the control parameters are as follows: Z Ri Rj Qj Hj oEXji 1 fi x oR i Ri 1 Gj Hj x Ri dx 6 0; oEXji oEXji 0; oQ i oH i
oEXji o Rj Z
Ri Rj Qj Hj

A:1 A:2

1 Fi xgj Hj x Ri dx oEXji oR i A : 3
Ri Rj Qj Hj

Ri

1 Fi Ri 1 Gj Hj P 0;

oEXji oQj

fFj Rj Qj Hj x
Ri

Ri 1=Qj Gj Hj x Ri =Qj g 1 Fi x dx Z Ri Rj Qj Hj F j Rj Q j H j x Ri
Ri

1 Fi x=Qj dx EXji =Qj P 0; A:4

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oEXji oHj

Rj Qj

1 Fi Ri y Hj gj y dy
Hj

oEXji o Rj 6 0: A:5 The partial derivatives of EDi Ri Xji with respect to the control parameters are as follows: oEDi Ri Xji o Ri Z 1 Fi Ri

Ri Rj Qj Hj

fi x A:6

Ri

1 Gj Hj x Ri dx 6 0;

oEDi Ri Xji oEDi Ri Xji 0; oQ i oHi A:7 oEDi Ri Xji o Rj Z Ri Rj Qj Hj 1 1 Fi xgj Hj x Ri dx

Ri

6 0;

A:8

oEDi Ri Xji oQj Z Ri Rj Qj Hj 1 fFj Rj Qj Hj x Ri

Ri

1=Qj Gj Hj x Ri =Qj g1 Fi x dx 6 0; A:9 oEDi Ri Xji oH j Z Rj Qj 1 Fi Ri y Hj gj y dy

Hj

P 0:

A:10

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