Designing replenishment rules in a two-echelon supply chain with a flexible or an inflexible capacity strategy

We consider a two-echelon supply chain where a single retailer holds an inventory of finished goods to satisfy an i.i.d. customer demand, and a single manufacturer produces the retailer's replenishment orders on a make-to-order basis. The objective of this paper is to analyse the impact of the retailer's replenishment policy on total supply chain performance. We consider two strategies with regard to the production capacity. In a flexible capacity strategy, the manufacturer invests in excess capacity to guarantee constant lead times in order to keep inventories low. The amount of investment depends on the retailer's order pattern. In an inflexible capacity strategy, the capacity is limited and independent of the retailer's replenishment decision. This results in stochastic lead times, thereby inflating the retailer's inventory requirements. We treat the variability of the order rate of the retailer as the primary decision variable to minimise total supply chain costs. The objective is to find the value of the replenishment parameter β (parameter to tune the order variability) that minimises total supply chain costs in a flexible and inflexible capacity scenario.