Inventory Allocation in the Presence of Service Level Agreements

Retailers often use service level agreements (SLAs) to evaluate their supplier's demand fulfillment performance. Based on an examination of numerous SLAs from practice we conclude that the fraction of the demand request satisfied -- the fill rate -- is a common way of measuring fulfillment performance. Furthermore, we observe that in terms of evaluating fill rate, these SLAs vary in at least two key dimensions: (1) Supplier performance can be evaluated for each demand request (single period) or over some longer horizon (multiple periods), and (2) the acceptable fill rate can be 100% or something less than 100%. For a supplier operating a periodic-review inventory system and facing multiple SLAs, we investigate the impact of inventory allocation rules on SLA compliance across these two dimensions of review horizon and fill rate target. For the single-period setting, we characterize the optimal allocation rule and rank other rules common in practice and the literature. In the multiple-period case, we characterize the optimal rule when the fill rate target is 100%. When the fill rate target is less than 100% and the performance review horizon is more than one period, we develop a simple heuristic that outperforms common allocation rules.