Inventory hedging and coordination under inventory-level-dependent demand

This paper considers an inventory coordination problem in a group company where the group headquarter manages a centralized distribution center (HQ-CDC) providing inventory spaces and services for its subsidiary companies whose demands are inventory-level-dependent. To deal with uncertainty in inventory management, subsidiaries usually reserve more inventory spaces than their actual demands. This extra inventory space strategy is called “inventory hedging” in this research. As a result, subsidiaries may reserve excessive spaces which are never required for their business operations, leading to inconsistency with the lean warehousing and logistics strategy that the HQ-CDC would like to implement. This paper theoretically examine if the inventory hedging strategy is advantageous to subsidiaries, and if so how best such a strategy should be implemented. A coordination scheme with dynamic pricing is introduced here to coordinate the implementation of the inventory hedging strategy. Two types of prices are introduced. One is the basic price used for block-reserving inventory spaces. The other price is the “hedging price” which is the extra amount to the basic price in addition charged for the space more than the actual demand. Two models are developed. In one model, a Nash game is played to reach an optimal strategy for both parties. In the other model, a Stackelberg game is played in which the HQ-CDC serves as the leader. It is demonstrated that the coordination scheme through dynamic price can successfully reduce inventory hedging amount required by the subsidiaries and can increase the HQ-CDC´s profit, as compared to the decentralized decision model without considering the hedging price.