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To see how decisions at one part of a supply chain effect the overall performance of a system, we ran a simulation called the beer game. The supply chain consists of a retailer who orders from a distributor who orders from a wholesaler who orders from a factory. At the beginning of each period, each stage of the chain orders upstream and receives the order shipped out to them two periods ago (the order they placed 4 periods ago) unless the next stage upstream is backlogged. All orders are eventually filled when inventory becomes available. The holding cost specified for each location are (in $/keg.period): factory: 0.25, distribution center: 0.50, warehouse: 0.75, and factory: 1.00. Additionally, the penalty cost for a shortage is zero for all stages except the retail stores where the penalty cost is estimated to be $10.00 per keg/period.
After trying many different strategies, the best policy I was able to come up with had a total cost of $122.00. This was achieved using choice 4, the base-stock policy. This policy re-orders a specified amount, less inventory on hand and pipeline inventory. The player specifies the base stock quantity for the retailer, warehouse, distributor, and factory. When this policy was used at each point in the supply chain, the lowest cost strategy was achieved.
Location Base Stock Amount Cost
Retail 300 101.55
Warehouse 210 10.21
Distributor 210 7.70
Factory 150 3.41
Because the retail store encounters such a high penalty for shortages, it is best to keep them well stocked. They also have the highest holding “overage”cost, but at $1.00 it is only 1/10 of the shortage “underage”cost. If the “overage” and “underage” costs were equal it would make sense to always order enough to anticipate having the mean (50) on hand. This policy is not optimal however, when it costs the retailer more for a shortage than for excess.
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The distributor and warehouse are better off with lower bases-tock numbers, mainly because they don’t incur any penalty cost for shortages. However, when they are short, the retailer is more likely to become short and incur the huge penalty fee for shortage. This will effect the chain in a negative way and so it necessary to balance the cost of the distributor and the warehouse paying holding fees and the retailer paying shortage penalties.
The factory is very similar to the distributor and the warehouse, except that it has a shorter lead-time and lowest holding cost. I found the optimal policy when the factory used a base stock quantity of 150. The shorter lead-time from the factory to its supplier enables them to respond better to changes in demand and reduced the chance of a stock-out.