Understanding the Value of Fulfillment Flexibility in an Online Retailing Environment

Abstract

Problem definition: Fulfillment flexibility, the ability of distribution centers (DCs) to fulfill demand originating from other DCs, can help e-retailers reduce lost sales and improve service quality. As the cost of full flexibility is prohibitive, we seek to understand the value of partially flexible fulfillment networks under simple and effective fulfillment policies.

Academic/Practical Relevance: We propose a general method for understanding the practical value of (partial) fulfillment flexibility using a data-driven model, theoretical analysis, and numerical simulations. We then apply this method for a large e-retailer. Our method applies to e-retailers with local fulfillment constraints and customer abandonment, two features that are new to the fulfillment literature. We also introduce a new class of spillover limit fulfillment policies with attractive theoretical and practical features.

Results: We derive optimal fulfillment policies in various settings using theoretical analysis, which provides guidelines on which policies to test in numerical simulations. We then use simulations to estimate for our partner that a proposed fulfillment network with additional flexibility equates to a profit improvement on the order of tens of millions of U.S. dollars.

Managerial Implications: We provide an approach for e-retailers to understand when fulfillment flexibility is most valuable, and find it provides the most benefit for our collaborator when fulfillment costs are high, or centrally held inventory is low. Also, we identify the risks of myopic fulfillment with additional flexibility and demonstrate that an effective spillover limit policy mitigates these risks.

Methodology: Our analysis uses dynamic and stochastic optimization, applied probability, and numerical simulations.