Optimal capacity in a coordinated supply chain

Xiuli Chao, Sridhar Seshadri, Michael Pinedo

Research output: Contribution to journalArticlepeer-review


We consider a supply chain in which a retailer faces a stochastic demand, incurs backorder and inventory holding costs and uses a periodic review system to place orders from a manufacturer. The manufacturer must fill the entire order. The manufacturer incurs costs of overtime and undertime if the order deviates from the planned production capacity. We determine the optimal capacity for the manufacturer in case there is no coordination with the retailer as well as in case there is full coordination with the retailer. When there is no coordination the optimal capacity for the manufacturer is found by solving a newsvendor problem. When there is coordination, we present a dynamic programming formulation and establish that the optimal ordering policy for the retailer is characterized by two parameters. The optimal coordinated capacity for the manufacturer can then be obtained by solving a nonlinear programming problem. We present an efficient exact algorithm and a heuristic algorithm for computing the manufacturer's capacity. We discuss the impact of coordination on the supply chain cost as well as on the manufacturer's capacity. We also identify the situations in which coordination is most beneficial.

Original languageEnglish (US)
Pages (from-to)130-141
Number of pages12
JournalNaval Research Logistics
Issue number2
StatePublished - Mar 2008
Externally publishedYes


  • Coordination
  • Dynamic programming
  • Inventory systems
  • Optimal capacity
  • Supply chain

ASJC Scopus subject areas

  • Modeling and Simulation
  • Ocean Engineering
  • Management Science and Operations Research


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