On measuring supplier performance under vendor-managed-inventory programs in capacitated supply chains

As widely accepted performance measures in supply chain management practice, frequency-based service levels such as fill rate and stockout rate are often considered in supply contracts under vendor-managed-inventory (VMI) programs. Using a decentralized two-party capacitated supply chain model consisting of one manufacturer and one supplier in a VMI environment, we demonstrate that supplier's service level is in general insufficient for the manufacturer to warrant the desired servive level at the customer end. The method by which the supplier achieves her service level to the manufacturer also affects customer service level. By developing bounds on the customer service level, we show that the expected backorders at the supplier should also be taken into account. We suggest a supply contract that offers a menu of different combinations of supplier's service level and expected backorders according to a linear function. Under this contract, the manufacturer can control the end customer service regardless of how the supplier manages her inventory. The supplier has complete flexibility on which combination of the two quantities on the menu to choose according to her own cost functions. Because it does not require any detailed information on supplier's operational characteristics nor her costs, this kind of control is expected to be easily implementable. In addition, we derive an estimate of the customer service level in terms of the new measures. Our findings have direct implications to supply chain metrics in general: The local service levels are insufficient measures to guarantee the system wide performance. Alternative local measures and/or coordination mechanisms should be employed to achieve desired system performance. Our analysis illustrates a possible way to explore such alternative measures.