An integrated guaranteed- and stochastic-service approach to inventory optimization in supply chains

• We integrate the stochastic- and guaranteed-service inventory optimization models.
• The new hybrid-service (HS) approach exploits the benefits of both pure approaches.
• We develop an optimization procedure for serial supply chains.
• The HS approach performs at least as well as the better of the two pure approaches.
• In many settings of our numerical study it delivers additional cost savings.

Multi-echelon inventory optimization literature distinguishes stochastic- (SS) and guaranteed-service (GS) approaches as mutually exclusive frameworks. While the GS approach considers flexibility measures at the stages to deal with stockouts, the SS approach only relies on safety stock. Within a supply chain, flexibility levels might differ between stages rendering them appropriate candidates for one approach or the other. The existing approaches, however, require the selection of a single framework for the entire supply chain instead of a stage-wise choice. We develop an integrated hybrid-service (HS) approach which endogenously determines the overall cost-optimal approach for each stage and computes the required inventory levels. We present a dynamic programming optimization algorithm for serial supply chains that partitions the entire system into subchains of different types. From a numerical study we find that, besides implicitly choosing the better of the two pure frameworks, whose cost differences can be considerable, the HS approach enables additional pipeline and on-hand stock cost savings. We further identify drivers for the preferability of the HS approach.