Most inventory optimization processes are approximate in the sense that the propensity of the suppliers to face a stockout is not modeled. This approximation simplifies a lot the analysis, and as long suppliers have service levels that are substantially higher than the target service levels of the downstream retailer, distortions introduced in the inventory analysis are minimal. However, if the retailer seeks service levels higher than the ones offered by its supplier, then things get more complicated, and a lot more expensive inventory-wise too. Let’s briefly review how to mitigate supplier stockouts.
From a pure inventory control perspective, associated with the quantile forecasting insights, assuming there is only a single supplier available, the correct way to model the supplier stockouts consists of adjusting the lead time. Indeed, when the stock is not readily available on the supplier-side, the retailer needs to wait until the inventory is renewed to get its next replenishment under way. Thus, in order to account for the potential supplier stockouts, the applicable lead time is not anymore the ordering delay plus the shipping delay, but the same plus the supplier’s own lead time.
Frequently in practice however, the lead time of the supplier is much larger than the typical lead time of the retailer. Such situations happen for example when the supplier is a wholesaler importing from Asia. In such conditions, trying to achieve a service level greater or equal to the one of the supplier proves to be a costly exercise because the lead time can be increased several times to match the one of the supplier. As a result, it’s not infrequent to observe that the stock would need to be more than doubled as well as a direct consequence of this increase of lead time.
One typical way to mitigate supplier stockouts without resorting to drastic inventory increase consists of introducing some redundancy, either within the offering itself, or by diversifying the suppliers.
Redundancy in the offering happens when some goods being sold are similar enough to be considered as substitutes. The presence of substitutes, even imperfect ones, mitigate the supplier’s stockouts - as well as the retailer’s own stockouts – by reducing the damage as a certain fraction of the demand can be redirected to the substitute products when the other one is missing. One drawback of this approach is that, frequently, unless when dealing with quasi-perfect substitutes, it’s hard to assess whether two distinct products will indeed be perceived as actual substitutes by the clients. Ideally, this would require a statistical analysis of its own. Also, too many substitutes can clutter the offering, making it less appealing to the clients in the end.
Redundancy on the supplier-side typically involves secondary suppliers selling at higher prices because overall purchase volumes are smaller. Those suppliers serve as back-up if the primary suppliers cannot readily serve the products. The primary benefit of this approach is an extra available obtained for the exact product that clients seek. Then, one potential major drawbacks lie in the correlation that exists between the levels of inventory of the various suppliers. Simply put, if one supplier goes out of stock for a given item, then chances are that the market demand for the product has been surprisingly large and as a consequence most of the other suppliers will go (or have already gone) out of stock too.