Inventory rationing · Emergency transshipment · Multi-echelon system

Abstract We consider the inventory rationing problem in a multi-echelon system for spare parts with multiple demand classes at warehouses in the highest echelon. The service provider has two types of contracts for its spares supply service: the performance-based contracts(PBCs) and the traditional transactional contracts. In PBCs, the service provider is heavily penalized for stock-out events and obliged to procure emergency supply from lower echelons to meet the customer demand. On the other hand, for the transactional con-tracts, the cost of stock-out events is much less and emergency transshipment from lower echelon is not a cost-effective option for the service provider. We propose an inventory rationing policy that is based on customer critical levels and uses the aggregate on-hand inventory level at the local warehouses to make rationing decisions. We model the multi-echelon system using continuous-time Markov chains and perform numerical experiments to analyze the cost sav-ings of the proposed policy under different demand and cost structures. The results suggest that inventory rationing can significantly reduce the total cost, especially when the holding and transportation costs are high