Distribution channel coordination by damping the ordering variability

The paper studies a stochastic inventory problem from viewpoint of minimizing the distribution system cost. Firstly, we establish the dynamic programming equation for the problem by implementing the premium mechanism to retailer, and then we prove the existence of an optimal policy and characterize the dynamic programming equation both in finite and infinite horizon. Finally, an example is provided, and computational results indicate that the premium mechanism can lead to significant savings in total expected distribution system cost.