Managing stochastic inventory systems with free shipping option

In many industries, customers are offered free shipping whenever an order placed exceeds a minimum quantity specified by suppliers. This allows the suppliers to achieve economies of scale in terms of production and distribution by encouraging customers to place large orders. In this paper, we consider the optimal policy of a retailer who operates a single-product inventory system under periodic review. The ordering cost of the retailer is a linear function of the ordering quantity, and the shipping cost is a fixed constant K whenever the order size is less than a given quantity – the free shipping quantity (FSQ), and it is zero whenever the order size is at least as much as the FSQ. Demands in different time periods are i.i.d. random variables. We provide the optimal inventory control policy and characterize its structural properties for the single-period model. For multi-period inventory systems, we propose and analyze a heuristic policy that has a simple structure, the (s, t,S) policy. Optimal parameters of the proposed heuristic policy are then computed. Through an extensive numerical study, we demonstrate that the heuristic policy is sufficiently accurate and close to optimal. 2008 Elsevier B.V. All rights reserved.