Abstract:

Two echelon inventory systems comprise of a main depot in the upper

echelon and many warehouses in the lower echelon, such systems are used
by large organizations mainly to decrease lead time. But there are some
problems associated with such system, which lies in finding the optimum
stocking levels to decrease the investment cost of the whole inventory
system, and keeping short lead times. Moreover, in case of field depots are
not owned by a single party, they may have different inventory policies
causing a decentralized control of the supply network. Because of
sustainability reasons, product take back after consumption for recycling,
create pressure on the manufacturers since returns are more unanticipated
than demands in terms of quantity, quality, and time, making inventory
control more challenging than in the case of no returns involved in the
process .

Table of Contents
Abstract:..................................................................................................................... 1
1) Introduction:........................................................................................................... 3
2) Problem Description:.............................................................................................. 4
2.1 High Capital Investment in the Inventory System.............................................4
2.2 Product Take Back due Sustainability Issues.....................................................4
2.3 Decentralized Control of the Supply Network....................................................5
3) Literature Review:.................................................................................................. 6
4) Conclusion:........................................................................................................... 10
Bibliography............................................................................................................. 11

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1) Introduction:

In this paper a two echelon inventory systems models are studied,

such inventory systems comprise of a main depot in the upper echelon and
several field storehouses in the lower echelon (Tsai & Zheng 2013). Two
echelon inventory systems are vital to large enterprises and like Wal-Mart,
and the US Navy, in order to support their operations (Al-Rifai & Rossetti
2007).
The reason behind organizations employing two echelon inventory
systems in their supply network is that product manufacturers choose to
keep the anticipated lead time to every client below a certain threshold.
Keeping short lead times is not accessible without keeping high inventory
levels; because such inventory systems, in order to be effective, require high
inventory levels.
Moreover, organizations that employ two echelon inventory systems
sell valuable and essential products, and in case of malfunctioning of critical
machines involved in the manufacturing process, a long downtime that may
incur high costs and loss of opportunity is resulted. Long downtime will lead
to a long lead time especially in after-sales customer service and service
parts, which will for sure have a major impact on sales, and may lead to
catastrophic results.
In addition to that, two echelon inventory systems may be useful if
managed properly in case there were errors in forecasting demand, or the
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demand was varying due to seasonality or completely unanticipated for any

reason in the first place. Eventually that oscillating demand will lead to the
bullwhip effect due to the demand magnification upstream of the supply
chain.

2) Problem Description:

This section of the paper will summarize from literature, problems that
might incur in a two echelon inventory systems such as the high capital
investment in the inventory system, decentralized control of the supply
network, and product take back due sustainability issues.
2.1 High Capital Investment in the Inventory System
It is essential that the producers maintain inventory levels as low as
possible at the central warehouse and field depots, since keeping high
inventory levels means that an enormous amount of capital need to be
invested (Al-Rifai & Rossetti 2007). As a result, the main objective sets in
finding the optimum stocking levels in the central store house and field
depots to decrease the investment cost of the whole inventory system.
Meanwhile, sustaining an adequate level of the estimated response time
across multiple field depots, which should be lower than the threshold level
(Tsai & Zheng 2013).

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2.2 Product Take Back due Sustainability Issues

Sustainability is a major concern nowadays, mainly because
Governments regulations in developed nations enforce organizations to take
responsibility of managing their products and packaging after being used and
thrown away by customers (Mitra 2006). In addition to that customers
awareness of the environmental contamination resulted by the landfilling
and burning of consumed products and packaging, customers now want
products manufacturers to be held accountable of recycling them (Kelle &
Silver 1989).
Some customers would buy eco-friendly or green products. Because of
these two main reasons, product take back after consumption for disposal or
recycling, create pressure on the manufacturers to take back returns of their
used products and avoid the loss of opportunity created by customers who
only buy green products. Hence reaching the fact that returns are more
unanticipated than demands in terms of quantity, quality, and time, making
inventory control more challenging than in the case of no returns involved in
the process (Mitra 2006).
2.3 Decentralized Control of the Supply Network
Product retention points in a two echelon inventory system may occur
either at the upper echelon or at the lower echelon, where the upper
echelons (main depots) supply the lower echelons. Each of these product
retention points might have different inventory policies causing a

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decentralized control of the supply network (Al-Rifai & Rossetti 2007).

Such problem
exists in a two echelon inventory system with the lower echelons not owned
by one organization , but rather owned by different individuals whom are not
keen about giving control of their inventories to the supplying organization.
Every retention point at the lower echelon may not consider interactions or
communications with other retention points at the same echelon level. This
will eventually have a great impact on the efficiency of the entire supply
network, as well as on each retention point at the lower echelon (Anderson &
Marklund 2000).

3) Literature Review:

Researchers in the area of optimizing capital investment in the

inventory system have concentrated on solving optimization problems with
cost and time constraints. (Al-Rifai & Rossetti 2007) both provided a heuristic
to minimize the total inventory holding cost while maintaining the average
total delay a teach facility be- low a pre-specified level. Their heuristic
decomposed the problem level by level, and they applied some simplifying
approximations for steady state inventory and backorder expressions. They

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then solved each depot problem by using these estimates and a Lagrangian
relaxation of the depot problem.
(Caggiano et al. 2007) considered a problem that minimize s the total
system inventory investment cost while achieving the service level
requirements, (Tsai & Zheng 2013) examined a two-echelon spare parts
inventory and distribution network with a goal of minimizing mean total
inventory capital investment in the whole network focused to restrictions on
the average annual order frequency and total average lead time at each
lower echelon because of stock out. At the lower echelons, they applied an
(R, Q) policy while at each retailer they implemented base stock model.
Scholars (Anderson & Marklund 2000) used control echelon stock
policies based on centralized information. Where decisions at each
warehouse depend on information from all lower echelons field warehouse,
meanwhile other academics showed in another models that the decision
made at each warehouse depend only on local information.
Decentralized two echelon inventory systems face the risk of the
increased overall cost of the system in terms of local costs. This is due to the
fact that the lower echelons are not owned by the same organization; hence
they have different policies regarding holding costs during transportation,
material handling at the facility, and inventory control costs than the policies
followed by the central depot at the upper echelon.

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At the main facility in the upper echelon local costs include holding
costs during transportation, and material handling cost from the main
supplier to central depot, while the holding costs during transportation and
material handling from central depot to warehouses at the lower echelon
level are considered as the local cost of the warehouses at the lower
echelon.
Such difference in local cost policies followed will eventually increase
the total capital invested in the decentralized two echelon inventory system,
and that was the motivation behind (Axsater 2001) to develop a cost
structure which its main purpose is to minimize the local cost at each facility
in the system. (Axsater 2001) suggested that the warehouses at the entire
lower echelon level play a Stackelberg game with the central depot leading
it at the upper echelon.
The suggested cost structure, decreases the total systems cost by
making the central depot in addition to the its local cost, pay a penalty cost
to the affected facility at the lower echelon. Where this delay penalty is a
nonlinear function to the period of delay, but should be paid in the
occurrence of delay, that is until the system reaches a stable state, where all
echelon levels implement it, and in case of a change in the cost structure it is
changed accordingly in all levels at all points, and that is a favorable state of
Nash Equilibrium.
In order to ensure that the cost structure doesnt always mean that the
upper echelon is always paying a penalty fee on every delay, a modified cost
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structure is used, which is a step toward optimizing the solution of

decentralized two echelon inventory systems. The modified cost structure
states that after each time the penalty is paid the central depot modifies the
implemented initial cost policy and optimizes it, and signals all the facilities
at the lower echelon to optimize the costs accordingly (Axsater 2001).
The state of Nash Equilibrium is attained only after iterating the
procedure of modified cost structure, at each interface between the facilities
of a two echelon inventory system. This state of Nash Equilibrium does not
replace the optimum solution of a completely centralized supply network
operating under a central policy and governed by the main depot at the
upper echelon level.
Eventually because of the iteration of the modified cost structure
process, it is considered as one of two qualities of the modified cost structure
method, is that the modified local cost should be equal to the total local cost
at all echelon levels, this is because of the payment fee made by the central
warehouse to the lower echelon facilities.
And the other quality is that the local costs of the warehouses at the
lower echelon applying their own policies is not affected; that is according to
the satisfaction of the rationality constraint discussed by (Axsater 2001), the
initial local cost governed by the warehouses applied policy at the lower
echelon is equal to the local cost, without any increase. The reason behind
keeping the facilitys initial cost equal to its total cost is that the
compensation of the delay paid as a cost by the supplying upper echelon.
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According to (Mitra 2006) inventory systems with returns keep track,

and deal with units of three types: returned units, recovered units and
manufactured units. It is extremely challenging to determine the suitable
holding cost rates for returned and recycled units, if the holding cost rates
are different for recycled and manufactured units, then a stock depletion rule
has implemented in case the recovered units and the manufactured units are
present at the same time at all lower echelons warehouses.
Academics as (Kelle & Silver 1989) developed mathematical models,
for a multi-echelon system with returns in order to solve the issues related to
inventory levels of products and packaging after being used and thrown
away, so to decrease the total estimated backorders while maintaining a
budget restriction.

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4) Conclusion:

Two echelon inventory systems are vital to large enterprises in order to

support their operations, in case of malfunctioning of critical machines
involved in the manufacturing process, a long downtime is expected, which
will incur high costs and losses of opportunity. The main challenge faced
when employing a two echelon inventory systems models is in determining
the optimal inventory levels in the whole system to reduce the investment
cost of the whole inventory system while keeping short lead times. Product
retention points in a two echelon inventory system may occur either at the
upper echelon or at the lower echelon. These retention points might have
different inventory policies causing a decentralized control of the supply
network. Such problem exists if the lower echelons are not owned by one
organization. Sustainability is a concern of a significant importance, and
global awareness of the environmental contamination due to disposal of used
products has increased. This made manufacturers to be held responsible of
recycling. Returns are more unanticipated than demands in terms of
quantity, quality, and time, making inventory control more challenging than
in the case of no returns involved in the process.

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Bibliography
Al-Rifai, M & Rossetti, M 2007, 'An efficient heuristic optimization algorithm
for a two-echelon (R, Q) inventory system', Int. J. Production Economics, pp.
195-213.
Anderson, J & Marklund, J, 2000, 'Decentralized inventory control in a twolevel distribution system control in a two-level distribution system', European
Journal of Operational Research, pp. 483506.
Axsater, S 2001, 'A framework for decentralized multi-echelon inventory', IIE
Transaction, pp. 91-97.
Caggiano, KE, Jackson, PL, Muckstadt, JA & Rappold, JA, 2007, 'Optimizing
service parts inventory in amulti-echelon,multi-item supply chain with timebased customer service level agreements.', Operations Research, pp. 303
318.
Kelle, P & Silver, E 1989, 'Forecasting the returns of reusable containers',
Journal of Operations Management, pp. 17-35.
Mitra, S 2006, 'Analysis of a two-echelon inventory system with returns',
International Journal of Management Science, pp. 106-115.
Tsai , SC & Zheng, Y-X 2013, 'A simulation optimization approach for atwoechelon inventory system with service level constraints', European Journ
alofOperational Research, pp. 346-374.

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