Profit Contribution and Operational Risk of Inventory Policies for Intermediate Goods Sales in a Vertically Integrated Two-stage Supply Chain

This paper presents a vertically integrated two-stage supply chain in which the first stage produces intermediate goods to store as intermediate inventory, whereas the second stage produces end-product to store using intermediate goods. In addition to the internal demand from the second stage, the first stage faces external demand following a compound Poisson process. Using a Markov decision process model, we formulate the problem that controls end-product production, intermediate goods production, and inventory rationing for intermediate goods. The goal of this paper is to examine the profit contribution and operational risk of inventory policies for intermediate goods. To this end, we compare the performance of two types of inventory policies; one with pooling inventory of intermediate goods and the other with separating it into inventory for internal demand and inventory for external demand. Using a numerical experiment, we examine which type of inventory policy can be more effective for the profit enhancement and what is the operational risk in implementing each inventory policy. We also examine the impact of variable demand size and demand pattern of intermediate goods on the profitability.