A coordination mechanism with fair cost allocation for divergent multi-echelon inventory systems

This paper is concerned with the coordination of inventory control in divergent multiechelon inventory systems under periodic review and decentralized control. All the installations track echelon inventories. Under decentralized control the installations will decide upon replenishment policies that minimize their individual inventory costs. In general these policies do not coincide with the optimal policies of the system under centralized control. Hence, the total cost under decentralized control is larger than under centralized control. To remove this cost inefficiency, a simple coordination mechanism is presented that is initiated by the most downstream installations. The upstream installation increases its base stock level while the downstream installation compensates the upstream one for increased costs and provides it with additional side payments. We show that this mechanism coordinates the system; the global optimal policy of the system is the unique Nash equilibrium of the corresponding strategic game. Furthermore, the mechanism results in a fair allocation of the costs; all installations enjoy cost savings