Pooling Risks: Is Transshipment More Cost-Effective Than Hubs?

In a study published in the journal IISE TransactionsYale T. Herer at the Technion-Israel Institute of Technology and I assessed and compared the costs of various pooling approaches as the number of stocking locations grows. Our analysis, which differs from other studies by factoring in certain costs associated with physical pooling, shows that as long as transshipment costs are no more than five times the physical pooling costs, information pooling is more attractive.

Mistaken assumptions?

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It’s frustrating for customers to be told that a coveted mobile phone is out of stock, or worse, be bumped off an overbooked flight. Disgruntled consumers could turn to rival products or hurt the business’s reputation with negative reviews. But holding excess stock to avoid disappointing customers isn’t a solution because it also incurs costs in the form of storage, spoilage, or working capital requirements.

Information pooling, on the other hand, doesn’t incur additional per-location costs. It also helps offset the costs of holding too much or too little stock across locations. Our analysis shows that, as the number of locations increases, information pooling trumps physical pooling whenever transshipment cost per item is less than five times the cost of shipping it from a central hub.

Although physical pooling has been widely adopted by companies to reduce costs and improve customer service, merging stock locations can be expensive upfront. Besides building a centralized and more technologically sophisticated facility, the company also must close existing warehouses, transfer existing stocks, implement a new workflow, and even relocate workers. These are known collectively as additional per-location costs.

Published: Thursday, September 14, 2023 – 12:02

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Meanwhile, we also investigated the problem of dividing a set of locations into pooling groups of given sizes. We found that locations should be divided based on demand variability. In other words, locations that experience high demand volatility should be pooled with other locations of high demand volatility to achieve lower expected total cost.

A viable alternative

Managers in supply chain and inventory management now have more tools at their disposal. Our findings could help managers get the most out of these tools by sizing up the various costs associated with different pooling approaches in the context of a business with a rising number of locations.

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Pooling Risks: Is Transshipment More Cost-Effective Than Hubs?

Drones, self-driving vehicles, and other technologies have made shipping stock between locations a viable alternative

Our goal is to generate insights into both pooling approaches by characterizing their total expected costs in the context of a growing number of locations. By reexamining some classical information-pooling results and accounting for all cost drivers for both types of pooling, we show that physical pooling is not always superior. In fact, if the expected per-location costs are large, then managing a centralized inventory location can be more expensive than managing independent locations, i.e., no pooling.

Photo credit: Kazem Hussein on Unsplash

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Published on Aug. 7, 2023, by INSEAD.