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

In this paper we study the coordination of inventory control in divergent multi-echelon inventory systems under periodic review and decentralized control. Under decentralized control the installations 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. We present a simple coordination mechanism that removes this cost inefficiency. The upstream installations increases its base stock level while the downstream installations compensate their supplier for increased costs and provide 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.