Multiple in-cycle transshipments with positive delivery times

We study a centralized inventory sharing system of two retailers that are replenished periodically. Between two replenishments, a unit can be transshipped to a stocked-out retailer from the other. It arrives a transshipment time later, during which the stocked-out retailer incurs backorder cost. Without transshipment, backorder cost is incurred until the next replenishment. Since the transshipment time is shorter than the time between two replenishments, transshipments can reduce the backorder cost at the stocked-out retailer and the holding costs at the other retailer. The system is directed by a centralized inventory manager, who minimizes the long-run average cost consisting of replenishment, holding, backorder, and transshipment costs. The transshipment policy is characterized by hold-back inventory levels, which are nonincreasing in the remaining time until the next replenishment. The transshipment policy differs from those in the literature because we allow for multiple transshipments between replenishments, positive transshipment times, and backorder costs. We also discuss the challenges associated with positive replenishment time and develop upper and lower bounds of average cost in this case. Bounds are numerically shown to have an average gap of 1.1%. A heuristic solution is based on the upper bound and differs from the optimal cost by at most this gap. © 2011 Production and Operations Management Society.