A dynamic allocation heuristic for centralized safety stock

An inventory system that consists of a depot (central warehouse) and retailers (regional warehouses) is considered. The system is replenished regularly on a fixed cycle by an outside supplier. Most of the stock is direct shipped to the retailer locations but some stock is sent to the central warehouse. At the beginning of any one of the periods during the cycle, the central stock can then be completely allocated out to the retailers. In this paper we propose a heuristic method to dynamically (as retailer inventory levels change with time) determine the appropriate period in which to do the allocation. As the optimal method is not tractable, the heuristic's performance is compared against two other approaches. One presets the allocation period, while the other provides a lower bound on the expected shortages of the optimal solution, obtained by assuming that we know ahead of time all of the demands, period by period, in the cycle. The results from extensive simulation experiments show that the dynamic heuristic significantly outperforms the ‘preset’ approach and its performance is reasonably close to the lower bound. Moreover, the logic of the heuristic is appealing and the calculations, associated with using it, are easy to carry out. Sensitivities to various system parameters (such as the safety factor, coefficient of variation of demand, number of regional warehouses, external lead time, and the cycle length) are presented.