Int. J.

Production Economics 145 (2013) 294–303

Contents lists available at SciVerse ScienceDirect

Int. J. Production Economics

journal homepage: www.elsevier.com/locate/ijpe

An economic lot-size model with non-linear holding cost hinging on time and
quantity
a b,n a c
Valentín Pando , Luis A. San-José , Juan García-Laguna , Joaquín Sicilia
a Departamento de Estadística e Investigación Operativa, Universidad de Valladolid, Valladolid, Spain
b IMUVA, Instituto de Matemáticas, Universidad de Valladolid, Paseo de Belén 15, 47011 Valladolid, Spain
c Departamento de Estadística, Investigación Operativa y Computación, Universidad de La Laguna, Tenerife, Spain

article info abstract

Article history: This paper develops an economic lot size inventory model where the demand rate depends on the stock level and the
Received 25 May 2012 cumulative holding cost is non-linear on both the quantity and the time they are stored. More concretely, it is supposed that the
Accepted 26 April 2013 demand rate is a concave potential function of the inventory level and the holding cost is potential on both time and quantity.
Available online 21 May 2013
Moreover, shortages are not allowed. A general procedure to determine the optimal lot size and the maximum inventory pro fit
Keywords: is developed. Also, some results about the profitability of the inventory system are presented. This work extends several
Inventory management inventory models previously considered in the literature. Finally, numerical examples, which help us to understand the
Lot-size models theoretical results, are also given.
Stock-dependent and time-dependent
holding cost
& 2013 Elsevier B.V. All rights reserved.
Stock-dependent demand rate

1. Introduction
Since Harris presented his EOQ model in 1913, many efforts have been
made to adjust their assumptions to more realistic situations in inventory
management. As is known, in order to obtain a simple mathematical model,
Harris assumed that short-age was not allowed and both demand rate and
holding costs per unit and per unit time were constant. Thus, the hypotheses
of the classic model ensured that the incomes were independent of the stock
level and, therefore, the optimal lot size was obtained by minimizing the sum
of the carrying cost and the ordering cost per unit of time. However, as is also
well-known, empirical evidence shows that these hypotheses are an excessive
simplification of reality. So, many models developed later worked with the
idea of relaxing these assumptions. In what follows, we will focus on
inventory models which maintain the assumption of not allowing shortage,
but the other hypotheses have been revised; that is, we do not consider that
both demand rate and holding cost per unit and per unit of time are constant.
Over time, some practitioners and researchers have found that an increase
in exposed merchandise may bring about increased sales of some items. So,
Wolfe (1968) presented empirical evidence of this relationship, showing that
the sales of style merchandise, such as women's dresses or sports clothes, are
proportional to the amount of displayed inventory. After this observation,
mathematical
models for inventory systems captured this idea by regarding the use of stock
level dependent demand rate in their formulation. As a starting point, Baker
and Urban (1988) defined a model in which the demand rate was supposed to
be a concave potential function of the inventory level. This new approach to
the problem brought about the loss of independence between revenues and
total inventory costs, because a larger order size results not only in higher
inventory costs but also in higher revenues. Therefore, in this situation,
besides the ordering and holding costs, it becomes necessary to consider a
third component for the inventory system: the gross profit from the sale of the
item (the difference between the selling price and the purchasing cost).
Moreover, in this case, the principal objective should be to maximize the
profit of the inventory system per unit time instead of minimizing the total
inventory cost per unit time. For this reason, Baker and Urban (1988) raised
the issue from the perspective of maximizing the profit per unit time. Since
then, many papers have appeared considering stock dependent demand rate,
but some approach the problem from the perspective of minimizing the total
inventory cost per unit time. Urban (2005) provides a detailed overview of the
related literature published up to that date. Dye and Ouyang (2005) proposed
an inventory model with a demand rate linearly depen-dent on the stock level
and shortages with a time-proportional backlogging rate, which is an
extension of the model developed by Padmanabhan and Vrat (1995). Teng
and Chang (2005) considered an EPQ model with maximizing profits where
the demand rate is simultaneously dependent on the stock level and the selling
price but with a ceiling. Also, You (2005) and Roy (2008) analyzed EOQ
models with price dependent demand.

nCorresponding author.
E-mail addresses: vpando@eio.uva.es (V. Pando), augusto@mat.uva.es
(L.A. San-José), laguna@eio.uva.es (J. García-Laguna), jsicilia@ull.es (J. Sicilia).

0925-5273/$ - see front matter & 2013 Elsevier B.V. All rights reserved.
http://dx.doi.org/10.1016/j.ijpe.2013.04.050
 V. Pando et al. / Int. J. Production Economics 145 (2013) 294–303
Another issue presented by inventory managers was that, sometimes, the
holding cost per unit of item is not proportional to the time held in stock,
and/or the holding cost per unit time is also not proportional to the amount
held in inventory. This question raised the need to consider other structures
for the holding cost in the mathematical models of inventory systems. Under
the hypothesis of a constant demand rate, Naddor (1982) proposed three
inventory models based on the holding cost function per cycle for those
situations. The first model considered that the holding cost per cycle was non-
linear with time, but linear with the quantity of items (the perishable-goods
system), the second one assumed that the holding cost per cycle was non-
linear with the quantity of items, but linear with time (the expensive-storage
system) and the third model supposed that the holding cost per cycle was non-
linear with both time and quantity of items (the general system). In this
environment, Weiss (1982) introduced a deterministic model with constant
demand rate, supposing that the holding cost per unit of product was a convex
potential function of the time in stock. This situation can occur, for example,
in the storage of perishable items such as food products. In this case, the
longer the products are kept in storage, the more sophisticated the storage
facilities and services are needed, and therefore, the higher the holding cost.
In fact, this model proved to be equivalent to the perishable-goods system
cited above, as noted by Ferguson et al. (2007). Later on, Goh (1994)
generalized this situation to the case of stock-dependent demand rate,
minimizing the total inventory cost per unit time. Alfares (2007) considered
this same situation with two types of discontinuous step functions. Urban
(2008) extended Alfares' work by using a profit maximization objective.
Recently, Pando et al. (2012a) have studied the previous model of Goh
(1994), but from the perspective of maximizing the profit.
Inventory models with holding cost rate per unit time non-linear in the
stock level are scarcer. Nevertheless, this situation can be encountered in real
inventories when the value of the item is very high and many precautionary
steps are to be taken to ensure its safety and quality. This occurs, for example,
when carrying luxury items like expensive jewelry and designer watches.
From the perspective of minimizing the total inventory cost per unit of time
and using a stock-dependent demand rate, Goh (1994) supposed that the
holding cost rate per unit of time was a convex potential function of the
quantity of items held in stock. Later on, Giri and Chaudhuri (1998) extended
this model to the case of deteriorating items with a small constant fraction of
deterioration. Berman and Perry (2006) also worked with stock-dependent
holding cost and two types of demand rate functions. Scarpello and Ritelli
(2008) gave some theoretical results for EOQ models when the holding cost
grows with the stock level. Recently, Pando et al. (2012b) have analyzed one
of the models of Goh (1994) from the perspective of maximizing the profit.
To the best of our knowledge, the work of Naddor (1982) is the only
paper dedicated to study inventory models for the situation in which the
holding cost is non-linear with both time and quantity. This structure of the
holding cost function is adequate for the representation of some real life
situations. This occurs, for example, in the storage of very expensive products
(then many precautionary steps are to be taken to ensure their safety) which
deteriorates over time (so more sophisticated storage facilities and services
are needed). However, in the work of Naddor (1982), the demand rate was
considered constant.
According to the previous comments, the objective of this paper is to
study an inventory system with stock dependent demand rate and a structure
of holding cost non-linear in both time and stock level from the perspective of
maximizing profits per unit time. Thus, the main difference between our
model and the one in Naddor (1982) is the assumption about the demand
295
rate. So, instead of a constant demand rate, we consider the case where the
demand rate is a concave potential function of the inventory level. Moreover,
we develop the necessary theory to calculate the holding cost per cycle when
it depends non-linearly on both time and stock level.
The structure of this paper is as follows. Section 2 presents the
assumptions and notation to be used throughout the paper. Section 3 deals
with the mathematical formulation of the inventory model, the procedure to
obtain the optimal policy and the main theoretical results. In Section 4, we
provide some numerical examples to illustrate the theoretical results and show
the difference between the optimal solutions for the problems of maximum
profit and minimum cost. Finally, conclusions are drawn in Section 5.
2. Assumptions and notation
The inventory system studied in this paper is developed on the basis of the
following assumptions. The inventory is continuously reviewed and the
planning horizon is infinite. The item is a single product and no shortage is
allowed. The replenishment is instan-taneous when the stock is depleted and
the lead time is zero. The demand rate is a known function of the inventory
level. The order cost is fixed, regardless of the lot size. The unit purchasing
cost and the selling price are known and constant. The cumulative holding
cost for x units of product that have been stored during t units of time is a
potential function of t and x. Thus, this function may not be linear in any of
these two variables.
Table 1 summarizes the notation used in this paper.
We suppose that the demand rate is described by the potential function of
the inventory level
β
DðtÞ ¼ λ½IðtÞ ð1Þ
with λ 40 and 0≤β o1. With this functional form, as the inventory level
decreases, so does the demand rate. Thus, at the beginning of a cycle, the
inventory level decreases rapidly because the demand is bigger at a high level
of stock. At time t¼ 0 the inventory level and the demand rate are at their
highest level. As more inventory is depleted, the rate of decrease of the stock
level slows down. The elasticity of the demand rate with respect to the stock
level β represents the relative change in demand rate with respect to the
corresponding relative change in the stock level (that is,
β ¼ ð∂DðtÞ=∂IðtÞÞ=ðDðtÞ=IðtÞÞ). Note that, if the demand is inelastic
(that is, β ¼ 0), we have DðtÞ ¼ λ and the model reverts to the well-known
inventory model with constant demand rate.
Furthermore, it is supposed that the cumulative holding cost for x items
stored during t units of time is given by the following
Table 1
List of notation.
q Order quantity or lot size per cycle ( 40, decision variable)
TLength of the inventory cycle ð 40Þ
tTime spent in inventory ð≤TÞ
I(t) Inventory level at time t ð≤qÞ
K Ordering cost per order ð 40Þ
pUnit purchasing cost ð 40Þ
sUnit selling price ð≥pÞ
Hðt; xÞ Cumulative holding cost for x items stored during t units of time ð 40Þ
hScaling constant for holding cost ð 40Þ
γ1 Elasticity of the holding cost with respect to time ð≥1Þ
γ2 Elasticity of the holding cost with respect to the stock level ð≥1Þ
D(t) Demand rate at time t
λ Scaling constant of demand rate ð 40Þ
β Elasticity of demand rate with respect to the stock level ð0≤β o1Þ
α Auxiliary parameter, α ¼ 1−β ð0oα≤1Þ
ξAuxiliary parameter, ξ ¼ αγ1 þ γ2 ð 41Þ
296 V. Pando et al. / Int. J. Production Economics 145 (2013) 294–303

potential function of t and x: equation:

γ γ dIðtÞ
Hðt; xÞ ¼ ht 1 x 2 ð2Þ λIt β 0 t T 3
dt ¼−½ð Þ ; ≤ ≤ ðÞ
where h 40, γ1≥1 and γ2≥1. These three parameters can be estimated via a
non-linear regression or a multiple linear regres-sion between the logarithm of with the initial condition Ið0Þ ¼ q. The solution of (3) is
the cumulative holding cost and the logarithms of time and quantity. IðtÞ ¼ ðq −αλtÞ
α 1=α
ð4Þ
Appendix A provides a numerical example where this function is shown to be
where α ¼ 1−β. Taking into account that the replenishment is done when the
useful for evaluating the holding cost in an inventory model.
stock is depleted, we have IðTÞ ¼ 0 and, therefore, the corresponding length
of the inventory cycle T is given by
Note that h ¼ Hð1; 1Þ, that is, the holding cost of one unit held in stock
during one unit of time is the scaling parameter for the holding cost. The qα
elasticity of the holding cost with respect to time γ1 represents the relative T ¼ αλ ð5Þ
change in this cost with respect to the relative change in time (that is, γ1 ¼
Therefore, (4) can be rewritten as
ð∂H=∂t Þ=ðH=tÞ). Similarly γ2 represents the relative change in this cost
1=α
with respect to the relative change in the quantity (that is, γ2 ¼ t
ð∂H=∂xÞ=ðH=xÞ). Also, if γ1 ¼ 1 in formula IðtÞ ¼ q 1− T ð6Þ
(2), we obtain the same cumulative holding cost function considered by,
Once the mathematical expression for the inventory level is obtained, the
among others, Naddor (1982, expensive-storage system), Berman and Perry
β parameter is better understood. Specifically, the cumulative demand in the
(2006) and Pando et al. (2012b). Similarly, if γ2 ¼ 1 in (2), we have the second half of the inventory cycle is calculated as
cumulative holding cost of the model by Naddor (1982, perishable-goods
system), which was later used by Ferguson et al. (2007) and Pando et al.
(2012a). T T 1 1=ð1−βÞ

We assume the general condition ðs≥pÞ, instead of s 4p, because this Z β

T=2 λ½IðtÞ dt ¼ − Z T=2 dIðtÞ ¼ IðT=2Þ ¼ q 2
assumption allows several inventory models pre-sented by other authors to be
included in our study. We refer to some models that have been developed and the proportion of sales in this second half of the cycle with respect to the
1 1=ð1 −βÞ
from the perspective of minimizing the average cost, without considering the sales over the whole cycle is given by ρ ¼ ð 2Þ . Evidently, as 0≤β
revenues and purchasing costs. Formally, they can be obtained from the 1
o1, it is always 0oρ≤ 2 which makes sense for this type of demand with
model developed here by taking s ¼ p and, in this article, we refer to them as higher sales in the first half of the cycle. Then, the β parameter can be
inventory models of minimum cost. However, in the model studied here, our estimated as a function of ρ as
objective is to maximize the average profit and, therefore, the revenues and β ¼ 1 þ ðln 2Þ=ðln ρÞ.
purchasing costs have to be included. Hence, we will name this class of The realization of the inventory level is depicted in Fig. 1. With the
models as inventory models of maximum profit. Consequently, those assumptions given in the previous section, the total
inventory models of minimum cost which do not include revenues or profit per cycle is calculated as the difference between the revenue per cycle
purchasing costs analyze only a part of the systems associated to the models and the sum of the ordering cost, the purchasing cost and the inventory
of maximum profit; that is, those systems are subsystems of the system holding cost per cycle. Obviously, the ordering cost is K, the revenue per
considered here. In a few inventory models (for example, in the EOQ models cycle is sq and the purchase cost per cycle is pq. The holding cost per cycle
studied by Harris, 1913 and Naddor, 1982), resolving the first situation is can be calculated as (please see Appendix B)
equivalent to solving the second because the demand rate is constant, but this
does not always occur. In fact, this last case is what occurs in the model
studied here. More specifically, if we solve a model of minimum cost, as in Z T γ −1 γ
Naddor (1982), and the revenues and the purchasing costs are added later on, HCðqÞ ¼ hγ1 0 t 1 ½IðtÞ dt 2

then the profit obtained is smaller than or, eventually, equal to the profit Using (5) and (6), we have
obtained when the revenues and the purchasing costs are included in the
γ −1 γ =α
formulation of the model, that is, if we consider the model of maximum profit.
γ γ Z T t 1 1− t 2 dt
HCðqÞ ¼ hγ1q T 2 1
0 T T T
γ
γ γ 2 1
¼ hγ1q 2 T 1 B γ1; α þ
γ2 αγ ξ
hγ1B γ1; α þ1 q 1 þγ2 q 7
In this paper, as in the model of Naddor (1982, general system), a lot-size γ
inventory model with non-linear holding cost in both time and stock level is ¼ ðαλÞ 1 ¼ ðÞ
1
studied, but here we are considering the more general situation with a stock- where Bða; bÞ ¼ za−1 z b−1dz
is the well-known beta function,
0 ð1−γ Þ hγ
þ 1 . Obviously, ≥ 1
ξ αγγ and αλ 1 Bγ γ α ξ

R
level dependent demand rate and the problem is handled from the proper ¼ 1 2 ¼ðÞ= 1 ð1;ð 2= Þþ Þ þ

perspective of maximizing profit per unit time. Therefore, taking into account α41 and 40.
ξ
the previous comments, we present a model which generalizes the models Therefore, the total profit per cycle is given by ðs−pÞq−K−ðq = Þ and,
studied by Goh (1994). by (5), the profit per unit time, or gain, is GðqÞ ¼ ½ðs−pÞq− K−ðq = Þ =T,
ξ

which can be expressed as

The following section includes the mathematical formulation of the model 1−α −α αλ ξ−α
and the solution procedure to obtain the optimal policy.
GðqÞ ¼ αλðs−pÞq −αλKq − q ð8Þ
Thus, the problem consists in determining the decision variable q40 such
that the function G(q) given by (8) is maximized.
Since GðqÞ ¼ −ðαλ= ÞgðqÞ where
3. The model
ξ−α 1−α −α
gðqÞ ¼ q −ðs−pÞ q þK q ð9Þ
Considering the expression for the demand rate given in (1), it is clear that the optimal solution that minimizes g(q) is the same as the optimal solution
the stock level I(t) verifies the following differential
that maximizes G(q).
 V. Pando et al. / Int. J. Production Economics 145 (2013) 294–303 297

length of the cycle time using (5). Moreover, from (8), (9) and (11) it follows
that
αλ −α ξ
GðqnÞ ¼ − ðqnÞ ½ðqnÞ −ðs−pÞ qn þ K

αλ −α
¼− ðqnÞ ½uqn þ v−ðs−pÞ qn þ K

Substituting the values of u and v given in (12) and (13) respectively into
the previous expression, the maximum average profit is given by

G qn αλ qn −α ð1−αÞðs−pÞ s p qn αK K
ð Þ¼−ðÞ ξ−α −ð − Þ
þ ξ−α þ
n
αλ ðξ−1Þðs−pÞq −Kξ 15
Fig. 1. Behavior of the inventory level over time.
α
¼ ξ−α ðqnÞ ð Þ
Although calculating the optimal lot size q n (resolving the equation PðqÞ
¼ 0) can be easily done with any solver software, we include below a simple
Consequently, the maximum-profit problem is equivalent for solving the
algorithm to evaluate the solution using the Newton–Fourier method. It can
non-linear program be applied directly by the inventory manager without specific software.

MinimizefgðqÞ : q 40g ð10Þ

Solution algorithm. Obtaining the optimal policy and the optimal profit
in the model.
3.1. Solution procedure γ
Step 1. Calculate ¼ ðαλÞ 1 =hγ1Bðγ1; ðγ2=αÞ þ 1Þ, ξ ¼ αγ1 þ
The first two derivatives of the function g(q) are g′ðqÞ ¼ γ2,
ξ−α−1 −α −α−1
u ¼ ð1−αÞðs−pÞ =ðξ−αÞ and v ¼ αK =ðξ−αÞ.
ðξ−αÞq −ð1−αÞðs−pÞ q −αK q 1=ξ
Step 2. If u ¼ 0 then the optimal lot-size is qn ¼ v . Go to Step5.
ξ−α ξ ð1−αÞðs−pÞ αK Step 3. If u þ v ¼ 1 then the optimal lot size is qn ¼ 1. Go to Step5.
q q 1=ξ 1=ðξ−1Þ
¼ Step 4. Calculate qo ¼ maxfðu þ vÞ ; ðu þ vÞ g and r¼
q αþ1 − ξ−α − ξ−α ðu=ξÞ1=ðξ−1Þ.
and (a) Select a positive tolerance value, say TOL 40, with
0oTOL or.
ξ−α−2 −α−1 ξ ξ − 1
g″ðqÞ ¼ ðξ−αÞðξ−α−1Þq þ αð1−αÞðs−pÞ q þ αð1 þ αÞK (b) Calculate qi ¼ ððξ−1Þq i−1 þ vÞ=ðξq i− 1 −uÞ
q
−α−2 for
i ¼ 1; 2; 3; …; until Pðqi−TOLÞ o0.
Since g″ðqÞ 40 for q 40, it follows that g(q) is a strictly convex function;
(c) Take as optimal lot-size the value qn ¼ qi.
moreover, limq↓0 gðqÞ ¼ limq-∞ g ðqÞ ¼ ∞. Therefore, the function g′ðqÞ α
Step 5. Compute the optimal inventory cycle Tn ¼ ðqnÞ =αλ and the maximum
has only one positive root which is the value q n where g(q) attains the global
α
minimum, that is, the solution for the problem. Obviously, the equation g′ðqÞ profit GðqnÞ ¼ ðαλ=ðξ−αÞÞ½ððξ−1Þðs−pÞqn−KξÞ=ðqnÞ
¼ 0 is equivalent to this other
Remark. In order to understand the previous algorithm and its criterion of
ξ stop, it is convenient to see the proof of Theorem 1 in Appendix C. Thus we
PðqÞ ¼ q −uq−v ¼ 0 ð11Þ have: (i) the function P(q) attains its minimum at point r; (ii) PðqÞ o0 if and
where
only if q∈ð0; qnÞ; (iii) the succession qi is strictly decreasing and r oqn oqi
u ð1−αÞðs−pÞ 0 12 for all i ¼ 0; 1; 2; …; and (iv) as the tolerance TOL belongs to the interval
¼ ξ−α ≥ ð Þ ð0; rÞ, it follows that qi−TOL 40 for all i ¼ 0; 1; 2; …. Then, when the
condition P ðqi−TOLÞ o0 is satisfied, it follows qi−TOL oqn, that is, qi−qn
αK
oTOL. This allows us to conclude that Pðqi−TOLÞ o0 is a suitable stopping
v ¼ ξ−α 40 ð13Þ
rule.
It is clear that if u ¼ 0 (that is, α ¼ 1 or s¼ p) the solution is
3.2. Meaning and discussion of optimal policy
αK 1=ξ
qn ¼ v1=ξ ¼ ξ−α ð14Þ An interesting question for inventory managers is to establish conditions
Therefore, it is only necessary to solve Eq. (11) when u 40 (that is, 0oα to ensure that the inventory system will generate profits. If this happens using
o1 and s 4p). The following result answers this question the optimal lot size qn, then GðqnÞ 40 and it is called a profitable inventory
ξ system. However, if GðqnÞ o0, we say that it is a non-profitable inventory
Theorem 1. Let the function PðqÞ ¼ q −uq−v, with ξ 41, u 40, v 40 and q system, because, even using the optimal lot size, it generates losses. Finally, if
1=ξ 1=ðξ−1Þ
40. Write qo ¼ maxfðu þ vÞ ; ðu þ vÞ g. For i ¼ 1; 2; 3; …,
GðqnÞ ¼ 0 then, for the optimal situation, it matches costs and revenues and
"consider the sequence
it is called a break-even inventory system. With these definitions, the
ξ ξ − 1 inventory managers are interested in characterizing the system as profitable,
qi ¼ qi−1−ðPðqi−1Þ=P′ðqi−1ÞÞ ¼ ððξ−1Þnqi −1 þ v Þ=ðξqi − 1 −uÞ.
Then P(q) has a unique" positive root q
∞
which is the limit of the
non-profitable or break-even without calculating the optimal lot size qn and
sequence fqig i¼ 0.
the max-imum profit GðqnÞ. Obviously, if s ¼ p then GðqnÞ o0 and the
Proof. Please see Appendix C. □ system is non-profitable. The following result gives a character-ization for the
type of inventory system as a function of the input parameters when s 4p.
Using this theorem, we can numerically calculate the optimal lot-size q n
with the desired precision and evaluate the optimal
298 V. Pando et al. / Int. J. Production Economics 145 (2013) 294–303

Theorem 2. Assuming that s 4p, we have

1. The inventory is profitable if and only if

ξ−1 1=ξ
s−p4ðξ=ðξ−1ÞÞððξ−1ÞK = Þ .
2. The inventory is a break-even system if and only if s−p ¼
ξ−1 1=ξ
ðξ=ðξ−1ÞÞððξ−1ÞK = Þ .
3. The inventory is non-profitable if and only if s−p
ξ−1 1=ξ
oðξ=ðξ−1ÞÞððξ−1ÞK =Þ .
n
Proof. From (15) it is clear that Gq and only if
n ð Þ 40 if
q 4Kξ=ððξ−1Þðs−pÞÞ. Thus, by the properties of the function P(q)
(please see Appendix C), this last inequality is equivalent to

P½Kξ=ððξ−1Þðs−pÞÞ o0. Now, as

ξ

P Kξ Kξ K ξð1−αÞ α
−
ðξ−1Þðs−pÞ ¼ ðξ−1Þðs−pÞ ξ−α ξ−1 þ
ξ
Kξ K

¼ ðξ−1Þðs−pÞ − ξ−1
Fig. 2. Optimal policy for profit maximizing.

we deduce that the inventory is profitable if and only if ½Kξ=ððξ−1Þðs−pÞÞ

ξ ξ−1 1=ξ
oK =ðξ−1Þ, that is, s−p 4ðξ=ðξ−1ÞÞððξ−1ÞK = Þ , which is assertion 1.
The same reasoning applied to break-even and non-profitable systems proves 3.3. Particular models
assertions 2 and 3. □

As a consequence of this theorem, it is clear that s ¼ p þ Next, let us deduce that several lot size models studied by other authors
ξ−1 1=ξ turn out to be particular cases of the model developed in this paper.
ðξ=ðξ−1ÞÞððξ−1ÞK = Þ is the minimum selling price that the
inventory manager should overcome to obtain a profitable system.
Another interesting issue for practitioners is to have a rule to know if a
replenishment policy is the optimal one. For this purpose, the following 1. When β ¼ 0 (that is, α ¼ 1) and choosing the notation h ¼ c1,
theorem allows us to characterize the optimal policy for the model under γ 1 ¼ n, γ2 ¼ m, K ¼ c3 and λ ¼ r, we obtain the general system
consideration. developed by Naddor (1982). Thus, putting a ¼ γ1Bðγ1; γ2 þ 1Þ, we
n
have u¼ 0 and v ¼ c3r =ac1ðm þ n−1Þ. Applying Solution
Theorem 3. Let the functions Ψ ðqÞ ¼ ðs−pÞq (gross profit per cycle with n 1=ðmþnÞ
Algorithm, we obtain qn ¼ ½c3r =ðac1ðm þ n−1ÞÞ which
ξ
lot size q) and HCðqÞ ¼ q = (holding cost per cycle with lot size q). Then, coincides with the optimal policy shown by Naddor. Substituting
the lot size q is optimal if and only if this value into (15), we see that the maximum average profit is GðqnÞ ¼
m mþ n−1 1=ðmþnÞ
rðs−p Þ−ðm þ nÞ½ac1r ðc 3=ðm þ n−1ÞÞ . Of course,
ðξ−αÞHCðqÞ ¼ αK þ ð1−αÞΨ ðqÞ ð16Þ
qn), from (7), (11), (12) and (13), we the last term in GðqnÞ is the minimum cost given by Naddor (1982, p.
q optimal (that is, q
108). Note that this model admits the following ones as particular cases:
Proof. If is n nξ ¼ n
HC q α ξα α ξ α α (i) If γ1 ¼ 1 (that is, the holding cost per cycle is non-linear in quantity of
ð
have n Þ ¼ ðq Þ = ¼ ðð1− Þðs−pÞ=ð − ÞÞqn þ K=ð − Þ ¼ ðð1−n Þ items but linear in time), we obtain the model studied by Naddor (1982,
=ðξ−αÞÞΨ ðq Þ þ ðα=ðξ−αÞÞK. That is, ðξ−αÞHCðq Þ ¼ αK þ ð1−αÞΨ ðq Þ.
fi αK α Ψ ðqÞ, sub- expensive-storage system) and (ii) if γ2 ¼ 1 (that is, the holding cost per
On the other hand, if q veri es ðξ−αÞHC ð qÞ ¼ þ ð1−n Þ cycle is non-linear in time but linear in quantity of items), then we revert
tracting this equation from the other one with q , we have
ξ ξ
ðξ−αÞ½ðqnÞ = Þ−ðq = Þ ¼ ð 1−αÞðs−pÞðqn−qÞ; or, equivalently, from to the model analyzed by Naddor (1982, perishable-goods system) which
ξ ξ has also been studied by Weiss (1982).
(12), ½ðqnÞ −q uðqn−qÞ. Now, as qn is the solution of Eq. (11), we
ξ ξ
have ðqnÞ ¼ uqn þ v and thus q −uq−v ¼ 0. Hence q ¼ qn because P 2. If we suppose that γ2 ¼ 1, we revert to the model developed by Pando et
(q) has a unique positive root. □ al. (2012a). Let us remember that, in this case, various particular models
It is possible to obtain an interpretation of the above result if we consider can be deduced: (i) If we set s¼ p, we obtain the model developed by Goh
the gross profit per unit time instead of the gross profit per cycle. Thus, (1994, model A) and (ii) if we suppose that s 4p and γ1 ¼ γ2 ¼ 1, we
dividing both sides of the equality (16) by the optimal cycle time Tn, we have revert to the model proposed by Baker and Urban (1988) when the order
point is zero.

n n
ξ α HCðq Þ α K 1 α Ψ ðq Þ 17 3. If γ1 ¼ 1, then the problem is equivalent to the one studied by Pando et al.
ð− Þ T
n n
¼ T þð − Þ T
n
ð Þ (2012b). Thus, our optimal policy qn is equal to the one shown by them.
where HCðqnÞ=Tn, K=Tn and Ψ ðqnÞ=Tn are the optimal holding cost, Also, if we further assume that s ¼ p, we obtain the model analyzed by
Goh (1994, model B).
ordering cost and gross profit per unit time, respectively. There-fore, the
function G(q) attains its maximum at the cut point of the functions
ðξ−αÞðHC ðqÞ=TÞ and α ðK=TÞ þ ð1−αÞðΨ ðqÞ=TÞ. Fig. 2 illus-trates
this idea by plotting the three functions. 4. Computational results
Note that this interpretation is an extension of a well-known result
associated to the classical lot size model: “for the optimal order quantity, the To illustrate the proposed model and its associated optimal policies, in
holding cost happens to be exactly equal to the ordering cost” (see, for this section, some numerical examples are presented. We consider the same
instance, Axsäter, 2000, p. 32), but adapted here to the model under numerical example proposed by Pando et al. (2012a), but adding values for
consideration. Specifically, if α ¼ γ1 ¼ γ2 ¼ 1, Eq. (17) leads to the parameter which were not considered in their model. Therefore, we
HCðqnÞ=Tn ¼ K=Tn which is the result previously cited. assume the following input parameters for the inventory system: λ ¼ 1, K¼
10, h¼ 0.5,
 V. Pando et al. / Int. J. Production Economics 145 (2013) 294–303 299

s¼ 62, p¼ 50 and β∈f0; 0:1; 0:3; 0:5; 0:7; 0:9g. Moreover, to observe the
effects of the parameters γ1 and γ2 on the optimal lot-size and the maximum
profit, we suppose that both parameters belong to f1; 1:5; 2; 2:5g. The
computed results are reported in Table 2.
Note that, in all considered cases, the inventory system we obtain is
profitable. Moreover, we find that, in these numerical examples, the smaller
optimal profit is obtained when β ¼ 0:9,
γ 1 ¼ 1 and γ2 ¼ 2:5. In this case, we have s−p ¼ 12; which is
ξ−1 1=ξ
greater than ðξ=ðξ−1ÞÞððξ−1ÞK = Þ ¼ 4:260; as GðqnÞ ¼ 3:60, the
inven-tory system is profitable, which agrees with part 1 of Theorem 2. Also,
note that when γ2 4γ1 we obtain a smaller optimal lot size and maximum
average profit than if we exchange the values of the
parameters γ1 and γ2. This is due to the fact that, in the first case, a bigger
holding cost is generated.
Moreover, in Fig. 3, we plot the variation of the optimal lot size and the
maximum profit as functions of γ1 and γ2 when β ¼ 0:3. From these graphs,
we can extract the following conclusions:
1. Fixed γ2, if the value of γ1 is increasing, then three cases are possible
(please see Fig. 3(1) and (2): (a) the optimal lot size q n and the optimal
profit GðqnÞ are strictly decreasing (this occurs, for example, when γ2 ¼
2), (b) the optimal profit and the optimal lot size are firstly strictly
increasing and, later on, they decrease slightly (this occurs, e.g., when γ2
¼ 10) and (c) the

Table 2
Optimal values qn and Gðqn Þ ¼ Gn for different parameters β, γ1 and γ2 respectively.

β 0 0.1 0.3 0.5 0.7 0.9

γ1 γ2 qn Gn qn Gn qn Gn qn Gn qn Gn qn Gn
4 13 11
1 1 6.32 8.84 10.0 10.1 38.4 16.6 326 53.7 3 10 1440 6 10 3 10
1 1.5 4.07 7.90 5.02 8.48 8.47 10.5 16.8 14.8 43.2 25.6 187 52.5
1 2 3.11 7.17 3.52 7.43 4.68 8.13 6.59 9.11 10.0 10.0 17.2 7.73
1 2.5 2.59 6.60 2.81 6.67 3.37 6.82 4.16 6.84 5.29 6.29 7.05 3.60
9 6
1.5 1 4.07 7.90 5.21 8.56 10.7 11.3 37.6 20.9 591 122 3 10 7 10
1.5 1.5 3.24 7.37 3.77 7.72 5.58 8.89 9.77 11.3 23.3 17.4 114 35.1
1.5 2 2.76 6.93 3.07 7.10 3.95 7.59 5.48 8.31 8.53 9.09 16.3 7.48
1.5 2.5 2.45 6.56 2.65 6.62 3.17 6.74 3.94 6.77 5.19 6.35 7.44 3.88
5 4
2 1 3.11 7.17 3.65 7.51 5.75 8.78 12.8 12.4 76.6 33.6 4 10 2 10
2 1.5 2.76 6.93 3.10 7.13 4.20 7.78 6.59 9.11 13.9 12.3 64.0 21.5
2 2 2.51 6.70 2.75 6.79 3.42 7.08 4.61 7.51 7.09 7.98 14.1 6.61
2 2.5 2.33 6.48 2.50 6.50 2.96 6.55 3.67 6.53 4.88 6.13 7.33 3.86
2.5 1 2.59 6.60 2.90 6.72 3.94 7.22 6.68 8.59 21.4 14.5 5038 560
2.5 1.5 2.45 6.56 2.69 6.64 3.41 6.92 4.87 7.52 8.98 8.93 34.8 12.5
2.5 2 2.33 6.48 2.51 6.51 3.04 6.61 3.94 6.77 5.85 6.87 11.5 5.48
2.5 2.5 2.22 6.38 2.37 6.36 2.77 6.32 3.39 3.68 4.49 5.74 6.86 3.63

Fig. 3. Optimal lot size and maximum profit curves in function of γ1 and γ2 for β ¼ 0:3.
300 V. Pando et al. / Int. J. Production Economics 145 (2013) 294–303

optimal lot size and the maximum profit are strictly increasing Finally, in Fig. 5, we plot the variation of the optimal lot size and the
simultaneously (if γ2 ¼ 30, this is what happens). maximum profit as functions of β and γ2 when γ1 ¼ 2. From these graphs we
2. The same comments as before can be made about the optimal lot size and can extract the following conclusions:

the optimal average profit when γ1 is fixed (please see Fig. 3(3) and (4)).
1. With γ2 fixed, if the value of β is increasing, then the optimal order
quantity is strictly increasing, but this increase is very slight when γ2≥4
Fig. 4 depict the curves of the optimal lot size and the maxi-mum average (please see Fig. 5(1)).
profit when γ2 ¼ 2. We can now establish the following comments about 2. Fixed γ2 and regarding the maximum profit, we have the following cases
if the value of β is increasing: (a) it grows to
these results. ~

infinity when γ2 ¼ 1, (b) there is a point, say β, such that the optimal average profit
~
GðqnÞ increases as β increases into ½0; β Þ
1. Given γ1≤4, as the parameter β increases, the optimal lot size increases. ~

For fixed γ1 44, the optimal order quantity is a slightly decreasing and it decreases as β increases into ðβ; 1Þ (this occurs when 1 oγ2 o4)
function of β (please see Fig. 4(1)). and (c) the maximum profit is strictly decreasing (this occurs, for example,
2. Fixed γ1 and regarding the maximum profit, three cases can occur if the when γ2≥4). Moreover, we see that, if γ2 41, the maximum profit
value of the elasticity of demand rate is increasing: converges to zero when β goes to
~ 1 (please see Fig. 5(2)).
(a) there is a point, say β , such that the optimal average profit
~

GðqnÞ increases as β increases into ½0; βÞ and it decreases as β 3. Lastly, with β fixed, if the value of γ2 is increasing, Fig. 5(3) and
~ (4) show that the optimal lot size and the maximum average profit
increases into ðβ ; 1Þ (this occurs, for example, when γ1 o4),
decrease (but is always positive, i.e., all the systems are profitable).
(b) the maximum profit is strictly decreasing (this occurs, for example,
^
when γ1 ¼ 4) and (c) there is a point, say β , such that the optimal
^
average profit GðqnÞ decreases as β increases into ½0; β Þ and it
^ 4.1. Differences between the optimal solutions for maximum profit and
increases as β increases into ðβ ; 1Þ (this occurs, for example, when γ1 minimum cost
44). We also observe that, in all these cases, the maximum profit
converges to zero when β goes to 1 (please see Fig. 4(2)).
To end this section, we illustrate graphically the difference between the
3. For fixed β, as the parameter γ1 increases, the optimal lot size and the optimal solution for the problem of maximum profit and the optimal solution
maximum average profit decrease (please see Fig. 4
for the problem of minimum cost. Obviously, the total cost of the inventory
(3) and (4). Moreover, we see that, contrary to what happened in Table 2,
system per unit time may be calculated by considering only the opposite of
the system can be non-profitable for certain values of the parameters β and
the two negative terms in (8) and it is given by the expression CðqÞ ¼
γ1 (this occurs, for example, when β ¼ 0:7 and γ1 ¼ 13). −α ξ−α
αλKq þ ðαλ= Þq . It is clear

Fig. 4. Optimal lot size and maximum profit curves in function of β and γ1 for γ2 ¼ 2.
 V. Pando et al. / Int. J. Production Economics 145 (2013) 294–303 301

Fig. 5. Optimal lot size and maximum profit curves in function of β and γ2 for γ1 ¼ 2.

that this function can be minimized by taking s¼ p in problem (10) and,

consequently, using Solution Algorithm with u¼ 0. Thus, the optimal lot size
1=ξ
is qnmin ¼ v .
Now, supposing that γ1 ¼ γ2 ¼ 1:5 and β ¼ 0:3 (that is, α ¼ 0:7 and ξ ¼
αγ1 þ γ2 ¼ 2:55), while the other parameter values remain as at the beginning
of this section, in Fig. 6, we plot the functions G(q), C(q), ðξ−αÞHCðqÞ=T,
ðαK þ ð1−αÞΨ ðqÞÞ=T and αK=T. Note that:

1. In the problem of maximum profit, the optimal lot size occurs when the
function ðξ−αÞHCðqÞ=T intersects the function ðαK þ ð1−αÞΨ
ðqÞÞ=T, as follows from (17). In this case, we see that the optimal lot
size is qn ¼ 5:58 and the maximum profit is GðqnÞ ¼ 8:89.

2. In the same way, for the problem of minimum cost, the optimal lot size
that minimizes the total inventory cost per unit time, C(q), is obtained
when the function ðξ−αÞHCðqÞ=T intersects the function αK=T. In this
case, we obtain qnmin ¼ 3:28 as the optimal lot size with CðqnminÞ ¼
4:20 as the minimum total inventory cost per unit time.
Fig. 6. Optimal solutions for maximum profit and minimum cost with γ1 ¼ γ2 ¼ 1:5
n n and β ¼ 0:3.
3. Also, we observe that q ¼ 5:58 is greater than q min ¼ 3:28.
4. In addition, if after solving the problem of minimum cost we add the
revenues and the purchasing costs, then the profit obtained is GðqnminÞ ¼
time, or that they are linear in time, but non-linear in quantity of items.
7:80, which is lower than the optimal profit per unit time GðqnÞ ¼ 8:89.
However, there are very few papers on the subject with holding costs
Therefore, when the max-imum profit policy is achieved, a 14%
improvement in the profit would be obtained with the minimum cost simultaneously non-linear in time and stock level.
solution. To further explore this issue, a general inventory system is developed
including the above cases and, moreover, assuming that the demand depends
on the inventory level. This last assumption forces us to distinguish between
5. Conclusions the problems of minimizing costs and the problems of maximizing profits.
Usually, the first include in their costs only the sum of the ordering costs and
Most of the works on inventory control presented in the literature consider the holding costs, while in the second, it is necessary to add, at least, the costs
that the holding costs are linear in both time and quantity of items held in associated with the purchase of the items and the income from the sale. Both
stock. Also, some works assume that the holding costs are linear in the stock problems may arise in the practical life of companies.
level, but non-linear in
302 V. Pando et al. / Int. J. Production Economics 145 (2013) 294–303

In this work, we study the problems of maximizing profit when the Table 4
demand rate is a concave potential function of the inventory level and the Cumulative holding cost Hðt; xÞ.
holding cost is a potential function depending on both the quantity of items
t x
and the time they are stored. The problems of minimizing costs may be
considered the particular cases of the corresponding problem of maximizing 25 50 100 200
profit if we assume that the unit purchasing cost equals the unit selling price.
1 12.5 25 50 110
Taking into account the above assumptions, we develop a general procedure
2 25 50 130 280
to determine the optimal lot size and the maximum inventory profit. 3 47.5 95 210 460
4 70 140 310 670
5 92.5 185 410 890
Moreover, an important question for inventory managers is to establish 6 115 240 520 1120
conditions to ensure that the inventory system will generate profits. Thus, in
this paper, some properties about the profitability of the inventory system are
given. As a consequence of these properties, we present a rule to check if a We assume that the regular storage cost is 0.1 currency units per item and
replenishment policy is the optimal one. This rule is given considering a per unit time. Thus, for example, if x ¼ 100 and t¼ 4, the cumulative holding
certain balance between the three components of the system: ordering cost, cost is the sum of the regular storage cost plus the insurance cost, that is (0.1)
holding cost and gross profit, and may be interpreted as an extension of the (4)(100)+270¼ 310 currency units. In a similar way, the cumulative holding
well known result associated to the classical lot size model: the economic costs given in Table 4 are obtained.
order quantity happens when the holding cost is exactly equal to the ordering
cost. The parameters h, γ1 and γ2 can be estimated with the values in Table 4
using a non-linear regression. Thus, the values h ¼ 0.31, γ1 ¼ 1:28 and γ2 ¼
Numerical examples show that, if the demand rate depends potentially on 2
1:12 are obtained with a determination coeffi-cient R ¼ 0:998. Hence, the
the inventory level, maximizing the profit is not equivalent to minimizing the
1:28 1: 12
total inventory cost, and the improve-ment in profits with respect to the function Hðt; xÞ ¼ 0:31t x can adequately represent the cumulative
solution of the minimum cost can be important. holding cost for this inven-tory system.

The proposed model can be extended in several ways. For example, it

may seem interesting to consider the existence of a reorder point before the
stock is depleted, which could improve the profit due to the increased demand
caused by a higher level of stock. Another way would be the incorporation of
changes in selling price, variations in demand rate, discounts in purchasing
cost, deteriorating items, etc. Also, we might consider other bivariate
mathematical functions for the cumulative holding cost and extend the
deterministic demand function to stochastic fluctuating demand patterns.
Acknowledgment
Appendix B
This appendix shows the evaluation of the holding cost per inventory
cycle in a situation where it is simultaneously non-linear in time and stock
level.
γ γ
Let Hðt; xÞ ¼ ht 1 x 2 be the cumulative holding cost for x units that have
been stored during t units of time and x ¼ IðtÞ the decreasing inventory level
curve with Ið0Þ ¼ q and IðTÞ ¼ 0. Further-more, let: (i) A be the region of
the plane enclosed by the curve x ¼ IðtÞ and the coordinate axes; (ii) P ¼ fto;
t1; …; tng be the partition of the interval ½0; T into n equal pieces with t i ¼
iðT=nÞ and (iii) A(P) be the staggered region defined by the union of
rectangles Ai ¼ ½ti−1; ti 0; I ðtiÞ , for 1≤i≤n−1. It is clear that A is the limit

This work is partly supported by the Spanish Ministry of Science and of the regions A(P) as n tends to infinity and the holding cost δi for each
Innovation through the research project MTM2010-18591. rectangle Ai, with i ¼ 1; …; n−1, can be evaluated as:

γ γ γ2
Appendix A δi ¼ Hðti; IðtiÞÞ−Hðti−1; IðtiÞÞ ¼ hðt i1 −t i−11Þ½IðtiÞ
γ −1 γ
¼ hγ1θ i1 ðti−ti−1Þ½IðtiÞ 2
This appendix provides an example, which shows the utility of the
γ γ
function Hðt; xÞ ¼ ht 1 x 2 to evaluate the holding cost in an inventory model
with ti−1 oθi oti by the Mean Value Theorem of differential calculus applied
and how the parameters h, γ1 and γ2 can be estimated. We consider an γ γ
inventory system for luxury items (such as expensive jewelry or designer in the factor ðt i1 −t i−11Þ.
watches) which needs to be insured while remaining stored. Table 3 gives the Therefore, the holding cost associated with the region A(P) is
cumulative insurance cost for various units of time and quantity, showing that n −1 n −1 γ −1 γ
∑ i¼ 1δi ¼ hγ1∑ i¼ 1θ i1 ½IðtiÞ 2 ðti−ti−1Þ
it is not linear in both, time and quantity.
n −1 γ 1 −1 γ
¼ hγ1∑ i¼ 1t i ½IðtiÞ 2 ðti−ti−1Þ
n−1 γ1−1 γ1−1 γ2
−hγ ∑ ðt t
Table 3 1ðti −θii¼1 Þ½IðtiÞ i− i−1 Þ ð18Þ
Cumulative insurance cost. Again, using the Mean Value Theorem of differential calculus in factor
γ −1 γ −1
t x
ðt i1 −θ i1 Þ, the second term in this expression can be rewritten as

25 50 100 200 n−1

γ1 −2 γ2
hγ1ðγ1−1Þ ∑ ηi ½IðtiÞ ðti−θiÞðti−ti−1Þ ð19Þ
1 10 20 40 90 i¼1
2 20 40 110 240
with ti−1 oθi oηi oti. Taking into account that ηi oT, IðtiÞ oq,
3 40 80 180 400
4 60 120 270 590 ti−θi oti−ti−1 and ti−ti−1 ¼ T=n, it follows that (19) is bounded above by
5 80 160 360 790 γ γ 2
hγ1ðγ1−1ÞT 1 q 2 ðn−1Þ=n . Then, it converges to zero as n tends to infinity.
6 100 210 460 1000
Finally, taking the limit of the first term in (18) as n tends to infinity, we find
that the holding cost for region A, that
 V. Pando et al. / Int. J. Production Economics 145 (2013) 294–303 303

On the other hand, if u þ v ¼ 1; we have qo ¼ 1 and P ðqoÞ ¼ 0. That is,

qn ¼ 1 is the unique positive root of PðqÞ ¼ 0. Note that, in this case, the
∞
sequence fqig i¼ 0 is constantly equal to q n, because qi ¼ qi−1 for i ¼ 1; 2;
…. □

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