A (Q,R) inventory model with a drop-shipping option for e-business

Drop shipping is used by online as well as traditional retailers as an order fulfillment strategy. A retailer simply forwards customers' orders to the manufacturer or a distributor who fills the orders directly to the customers and is paid a predetermined price by the retailer. For the retailer, advantages of drop shipping include lower holding, handling, and shortage costs. Disadvantages include increased per-unit cost, fragmented order delivery when a single customer order involves products from different manufacturers, longer delivery times, and increased order processing cost. In this paper, we develop two (Q,R) inventory models that allow a retailer to use the drop-shipping option in case of a shortage during lead-time. In the first model, the units short are backordered whereas in the second model sales are lost. We provide closed-form results for exponential and uniform demand distributions. We perform numerical sensitivity analysis and illustrate the results with numerical examples.