1. Decentralized Multi-Echelon Supply Chains: Incentives and Information Hau Lee Seungjin Whang presented by Evren Sarınalbant

2. Contents Decentralized Systems Performance Measurement Schemes Proposed Performance Measurement Scheme Evaluation of Proposed Scheme Conclusion

3. Decentralized Systems Supply chains with multiple inventory sites are often decentralized Consist of multiple responsibility centers (RC) Own a site manager who decides order quantity & inventory level

4. Decentralized Systems Prespecified performance measurements Each maximizes own performance measurements Therefore incentive misalignments occur Performance measurement schemes are formed to reduce

5. Decentralized Systems A typical decentralized supply chain Site 2Site 1Site 3Site 0 Site 0 : End Customers Site 3 : External Source of Product Site 1,2 : Echelon Members

6. Performance Measurement Schemes Some performance measures observed in SCs are: Some functions of the actual operation cost and the fill rate achieved where the upstream managers are enforced to achieve a certain fill rate target Full site cost, which is operation costs and internal penalties where a penalty is imposed on each stock-out

7. Performance Measurement Schemes Properties of good performance schemes: Cost Conservation Property Accounting system should trace all costs to individual sites, so does not require any subsidies or taxes from HQ Incentive Compatibility Eliminating potential incentive misalignments

8. Performance Measurement Schemes Informational Decentralizability A scheme can be implemented with site information only, without using other information such as echelon inventory

9. Performance Measurement Schemes Our aim is to construct a performance scheme which has these three properties Cost Conservation Incentive Compatibility Informational Decentralizability

10. Proposed Performance Measurement Scheme Assumptions based on a multi-echelon decentralized system Site 2Site 1Site 3Site 0 Site 0 : End Customers Site 3 : External Source of Product Site 1,2 : Echelon Members Random external demand Unmet demands at site 1 are backordered

11. Proposed Performance Measurement Scheme Assumptions cont. Constant leadtime to replenish site 1 (site 2) from site 2’s (site 3’s) stock such as shipment and processing delays. Site 1 orders from site 2 and site 2 orders from site 3. After replenishing site 1, demand occurs.

12. Proposed Performance Measurement Scheme Assumptions cont. At the end of the period, inventory and shortage costs are charged and then order decisions are made. Holding cost is assumed to increase as one goes downstream Pipeline inventory belongs to the upstream The distribution of final demands are known by all site managers

13. Proposed Performance Measurement Scheme Parameters used in the analysis : Site m incurs a unit cost of c m Inventory holding cost is unique for sites, h m Shortage cost only incurred in site 1,П

14. Proposed Performance Measurement Scheme = Discount factor for costs per period = Demand in a period u m = On-hand level at site m (for site 1 negative u denotes backlog) u + denotes max(u,0) w m = Amount in transit from site m+1 to site m x m = Echelon inventory position at site m

15. Proposed Performance Measurement Scheme v m = Echelon inventory level at site m y = Inventory position of site 1 at the end of the period z = Amount ordered in a period at site 2 L m (u) = Inventory and shortage cost on site m

16. Proposed Performance Measurement Scheme Consider a decentralized inventory system where each site manager minimized his/her full site cost by using measurement scheme à which is characterized by 4 issues.

17. Proposed Performance Measurement Scheme Transfer Pricing: For each unit ordered by site 1, site 1 pays the actual variable cost, c 2

18. Proposed Performance Measurement Scheme Consignment: Site 2 pays the holding cost of its intermediate product in Echelon 2 at the rate of h 2 while site 1 pays h 1 – h 2 Inventory cost of site 2: h 2 [v 2 –v 1 + (v 1 ) + ]

19. Proposed Performance Measurement Scheme Additional Backlog Penalty at site 1: The consignment deal is void for site 1 in backlogging case, additional backlog penalty is paid to site 2 L 2 (v 2 )=h 2 [v 2 -v 1 +(v 1 ) + - h 2 (-v 1 )+ ] = h 2 v 2 L 1 (v 1 )=(h 1 -h 2 )v 1 +(h 1 + П)(-v 1 ) +

20. Proposed Performance Measurement Scheme Shortage Reimbursement: Site 2 reimburses site 1 if it fails to deliver the ordered quantity completely. Manager 2 pays G(v 2,y)= -(1- )c 1 (y-v 2 )+Ĩ 1 2 (v 2 )- Ĩ 1 2 (y) Ĩ m k (x)= k E[L m (x- (k) )]

21. Proposed Performance Measurement Scheme Under the issues stated, Manager 1 solves min C 1 (y | v 1,v 2,w 1,w 2,Ṗ 2 * ) Ṗ 2 * optimal strategy of Man 2 Manager 2 solves min {c 2 z + L 2 (v 2 ) + G(v 2, Ṗ 1 * )+ E[C 2 * (v 2 +w 2 -,z| Ṗ 1 * )]}

22. Evaluation of Proposed Scheme Under the measurement scheme Ã, the total cost of the system is fully allocated to site managers in each period

23. Evaluation of Proposed Scheme The performance measurement scheme à is incentive-compatible

24. Evaluation of Proposed Scheme Consider an informationally decentralized system in which site m orders if inventory position is less than S m * -S m-1 *, otherwise orders nothing. Deliveries are made as possible with the balance fully backlogged. Therefore, Ã is incentive-compatible and can be implemented with site specific information only.

25. Remarks Shortage reimbursement is used to motivate upstream managers to carry more inventories. Alternatives to this scheme are fill-rate targets or linear penalties The proposed scheme is informationally decentralizable for stationary demands. The model assumes a single organization. But some issues can be applied to multiple organizations.

26. Remarks Why decentralize? Local managers hold local information not available for HQ Are there any other incentive compatible schemes? Charge each site manager a fixed percentage of the total system-wide cost. Then, each manager will share the same objective.

27. Questions and Comments Thanks for listening!!!