Impact on inventory costs with consolidation of distribution centers

The consolidation of Distribution Centers (DCs) is a new trend in global lo gistics management, with a reduction in inventory costs often being cited a s one of the main benefits. This paper uses an analytical modeling approach to study the impact on facility investment and inventory costs when severa l DCs are consolidated into a central DC. In particular, our model suggests that consolidation leads to lower total facility investment and inventory costs if the demands are identically and independently distributed, or when they follow independent but possibly nonidentical Poisson processes. This agrees with the conclusion of the classical EOQ and newsvendor models. Howe ver, we show by an example that, for general stochastic demand processes, t he total facility investment and inventory costs of a consolidated system c an be infinitely worse off than that of a decentralized system. This arises mainly because the order replenishment fixed cost yields a cost component proportional to the square root of the mean value of the demand, while the demand uncertainty yields a cost component proportional to the standard dev iation of the demand. Whether consolidation is cost effective or not depend s on the trade-off between these two components, as indicated by an extensi ve numerical study. We also propose an algorithm that solves for a distribu tion system with the total facility investment and inventory costs within r oot2 of the optimal.