Investing in ordering cost reduction for integrated inventory systems

In this paper, we investigate an integrated inventory system where a single vendor purchases and processes raw materials in order to deliver finished items to multiple buyers. The vendor and all buyers jointly invest in reducing the ordering cost (e.g., establishing electronic data interchange based ordering systems) to decrease their joint total cost. The amount of investment determines the planned ordering cost and hence affects their inventory replenishment decisions. An analytical model is developed to decide the optimal investment amount and lot sizes for both vendor and buyers. In addition, we apply an exponential ordering cost function to our general model to provide interesting insights of the model. Numerical results show that the integrated inventory system can benefit substantially from this ordering cost reduction investment.