Evaluating the costs of Centralization vs Decentralization of Inventory: A case study of a retail company

Abstract

Efficient inventory management is crucial for successful supply chain management with it attributing up to 30% of an organization’s supply chain costs. A key strategic decision in inventory management remains whether to centralize or decentralize inventory with both decisions having their advantages and disadvantages. Most studies highlight the importance of an organizations supply chain network in determining the suitable inventory system and have focused their results on costs, service levels, and flexibility. As such, this thesis will study The Retailer’s current supply chain network and evaluate the costs associated with centralization vs decentralization of inventory. Moreover, it will also explore the business impact of centralization which is a factor not discussed in previous studies.

Problem Description
The Retailer is evaluating whether they should centralize their inventory through a 3PL to gain greater control over their inventory, enhance their competitive advantage, and generate a new stream of sales.

Purpose:
The purpose of this study is to evaluate the costs associated with centralizing versus decentralizing of inventory, investigate the impact of the new stream of sales and to provide The Retailer with a quantitative basis to support their decision-making process.

Research Questions:
1. What are the total cost implications of centralization versus decentralization?
2. What is the impact of the new stream of sales on the decision-making process?

Methodology:
This thesis follows an operations research framework and started by collecting relative quantitative and qualitative data. Then, the data was analysed and a representative selection of products for analysis was determined, followed by developing and selecting suitable analytical and simulation models. Lastly, these models were tested and used to generate the necessary output needed to conduct the evaluation.

Conclusion/ Findings:
The findings of this thesis address the two posed research questions and the results are specific to the case company. The first set of findings relates to the evaluation of costs associated with centralization versus decentralization. The analysis indicates that centralization would lead to a 1.3% increase in inventory costs and a 7.1% increase in total costs, primarily due to 3PL and transportation costs. However, it would contribute to enhancing material flow and operational efficiency across the retail stores. The second set of findings examines the impact of a new stream of sales. Five scenarios were evaluated, revealing that The Retailer could break even on the costs of centralization with an upstream demand of 21% of total sales. Additionally, once upstream demand exceeds 40% of total sales, The Retailer would surpass the gross margin return on investment achieved under the current setup.

Popular Abstract

A - Should The Retailer centralize its inventory or not?
B - Well, it depends!
A - But the cost implications clearly point to a particular direction
B - Then again…it depends!

The choice between centralization and decentralization represents a trade-off problem where researchers have long argued their advantages and disadvantages in terms of costs, flexibility, and service levels. Yet, supply chain context remains crucial. This study explores the unique supply chain setup of a major Swedish retailer of building materials, referred to as The Retailer, and evaluates not only the costs but also the broader business implications of centralization.

The Retailer’s current decentralized set-up, that sees hundreds of suppliers delivering products to their 65 stores, has served them well across the past years. However, with an evolving market and increasing competition, The Retailer is evaluating whether to centralize their inventory through third-party logistics (3PL) to increase their competitive advantage, gain control over their inventory, and enable next-day delivery to a new customer segment.

This thesis analysed the costs and benefits of both inventory systems using a combination of analytical and simulation models, and evaluated the impact of the new stream of sales from the central warehouse. Data from these models were used to determine the inventory, warehousing, and transportation costs used as part of the evaluation. The focus of this study was on one product category, the light building materials, comprising around 10,000 items from which a representative sample of 17 products was selected for detailed analysis.

The results? Here they come. Upon centralization, inventory costs increased by 1.3% and total costs by 7.1%, mainly due to added warehousing and transportation expenses. However, centralization also offered operational benefits, such as more efficient deliveries and reduced workload at stores. On paper, and based solely on the first set of results, centralization doesn’t look ideal. But there’s more to the story.

A key insight emerged when evaluating the potential for a new sales stream i.e. direct deliveries from the central warehouse to customers. Simulations and calculations of five different demand scenarios showed that if this new channel accounts for at least 21% of total sales, it could offset the added costs of centralization. Beyond 40%, it would even outperform the current setup in terms of profitability.

The study also highlighted that not all products are similar, and some might be more favourable to centralise over the others. High value, fast moving, and high variability products are better suited for centralization compared to slow moving and low value products. This provides The Retailer with a balanced solution to consider a hybrid approach where they centralize the most favourable products to centralize.

A - So, what should The Retailer do?!
B - You guessed it: it depends!

Yes, the results offer a clear indication of the cost implications of centralizing inventory and the impact of the new stream of sales. Yet, The Retailer’s decision hinges on several other factors. The 7.1% increase in costs provide The Retailer with an indication of how much savings they ought to negotiate from their suppliers. With a central warehouse, The Retailer is taking the responsibility of inventory from the suppliers by buying in bulk and allowing them to deliver to one location instead of 65. Additionally, a proper evaluation of the potential new stream of sales must be done. If the prognosis is anything close to the break-even point or if The Retailer can negotiate price reductions exceeding 7.1%, then by all means yes, centralization is the way forward!

• author: El Khodari, Samir
• supervisor: Peter Berling
• organization: Department of Mechanical Engineering Sciences; Production Management
• course: MIOM01 20251
• year: 2025
• type: H2 - Master's Degree (Two Years)
• subject: Technology and Engineering
• keywords: Centralization, Decentralization, Inventory Control, Simulation, Costs, Single-echelon, Multi-echelon, Upstream Demand
• other publication id: 25/5321
• language: English
• id: 9199537
• date added to LUP: 2025-06-18 12:32:08
• date last changed: 2025-06-18 12:32:08