Acme : Risk Pooling

Risk Pooling: ACME

The case study of ACME compares centralized and de-centralized inventory and lists the factors and the trade-off between the same. The comparison brought out the following

1. Warehouse centralization reduces both the safety stock and the average inventory in the system.

2. The correlation between the market areas of each of the warehouse acts as an important factor in the risk pooling process.

3. The reduction in safety stock by risk pooling is directly correlated with the coefficient of variation.

The concept of risk pooling triggers the centralization of warehouses rather than the traditional separate warehouses for different regions. The trade-off is done between the average cost of holding and the transportation cost of each product.

The concept is supported with negative correlation between the two regions, as the concept of risk pooling is that when the demand of one region rises it is equalized by the decrease in demand of the other region and the items in the warehouse that where originally allocated for one market place can be reallocated to the other. The process of reallocating the inventory is not generally practiced and can be considered when the transportation cost is actually low. Thus transportation cost can be of significant importance when centralizing the system as higher the transportation cost for each delivery then decentralization can be more sensible to carry on as the transportation cost may outweigh the cost of holding of the goods.

The higher the coefficient of variation the greater the benefit obtained from the centralized system. This is because the average inventory consists of two parts the average and the standard deviation. Since the reduction in the average inventory mainly depends on the reduction in the safety inventory. The higher the coefficient of variation the more probable the reduction in safety stock will be.

The centralization of the warehouse in the case study can bring about two changes. The same service level with a lower amount of inventory and even higher service level with the same amount of inventory. The overhead cost is greater in the decentralized system than the centralized system because of the economies of scale. The lead time is shorter in decentralized system as the warehouses are closer to the delivery points.