Omega 36 (2008) 877 – 887

www.elsevier.com/locate/omega

Inventory management with variable lead-time dependent

procurement cost夡
Charu Chandraa,∗ , Jānis Grabisb
a Industrial and Manufacturing Systems Engineering, University of Michigan-Dearborn, 4901 Evergreen Road, Dearborn, MI 48128, USA
b Operations Research, Riga Technical University, Kalku 1, Riga, LV-1658, Latvia

Received 15 February 2005; accepted 28 April 2006

Available online 31 July 2006

Abstract
A reduction in the inventory replenishment lead-time allows reducing safety stock requirements and improving customer
service. However, it might be accompanied by increased procurement costs because of premium charges imposed by suppliers,
or higher transportation costs. This paper studies a single-stage variable lead-time inventory system with lead-time dependent
procurement cost. Selection of the lead-time value represents finding the trade-off between benefits of lead-time reduction and
increase in the procurement cost. A model for joint optimization of inventory and procurement costs is developed. Numerical
studies are conducted to identify conditions under which lead-time reduction is favorable compared to procuring at the lowest
cost.
䉷 2006 Elsevier Ltd. All rights reserved.

Keywords: Inventory control; Variable lead-time; Sensitivity analysis

1. Introduction making inventory replenishment decisions, which in

1.1. Problem area
Demand uncertainty coupled with inventory replen-
ishment lead-time creates the inventory carrying risk.
Lead-time reduction and application of risk reducing
inventory management policies have been shown to
improve efficiency in managing inventory. Tersine and
Hummingbird [1], Jayaram et al. [2] and Disney and
Towill [3] have demonstrated the positive impact of
physical lead-time reduction. The lead-time reduction
allows using more accurate demand information in
夡 This
manuscript was processed by Area Editor Prof. B. Lev.
∗ Corresponding author. Tel.: +1 313 593 5258;
fax: +1 313 593 3692.
E-mail address: charu@umich.edu (C. Chandra).
turn reduces safety stock requirements and improves
the customer service level. However, the lead-time re-
duction may be associated with some additional risks
and costs [4]. For instance, a shorter lead-time may
lead to higher purchasing costs and unavailability of
supplies due to the limited supplier capacity. Burnetas
and Gilbert [5] provide examples from travel indus-
try, where late orders are charged a premium price.
They also mention premium transportation charges
for short lead-time orders as a source of increasing
purchasing costs in other industries. Cachon [6] has
discussed examples from the retail industry. Retail-
ers placing late orders are not eligible for discounts
and face the possibility of insufficient supplies be-
cause suppliers give priority to early orders. Das and
Abdel-Malek [7] report that suppliers accept short
lead-time orders at a higher unit price because of

0305-0483/$ - see front matter 䉷 2006 Elsevier Ltd. All rights reserved.
doi:10.1016/j.omega.2006.04.009
878 C. Chandra, J. Grabis / Omega 36 (2008) 877 – 887
their disruptive impact on suppliers’ operations. These
observations lead to the problem of finding the trade-
off between lead-time reduction and additional procure-
ment costs. The trade-off between purchasing cost and
delivery lead-time from the manufacturing point is dis-
cussed by Elhafsi [8] and Slotnick and Sobel [9] among
others. These authors show that manufacturers are inter-
ested in providing flexible pricing in response to more
attractive delivery time conditions.
1.2. Literature review
Ouyang and Wu [10] and Lan et al. [11] consider a
continuous review re-order point policy with variable
lead-time. Costs associated with lead-time reduction are
represented by the lead-time crashing cost, which is in-
dependent of the order size. They consider the random
demand. The above-mentioned papers focus on compu-
tation of the optimal policies. Hariga and Ben-Daya [12]
propose similar variable lead-time periodic review and
base stock policies. Similarly, lead-time crashing has
been investigated in two stage systems involving buyer
and supplier [13]. The integrated inventory model with
controllable lead-time is used in demonstrating that the
buyer–suppliers system as a whole benefits from the
lead-time reduction while gains for individual partners
are not distributed uniformly.
Burnetas and Gilbert [5] have analyzed the trade-off
between higher procurement costs against the benefit of
making ordering decisions using better demand related
information. The authors develop an optimal ordering
policy for a short life-cycle product. The procurement
cost increases along the product life cycle, while a pa-
rameter of the demand process (modeled as a Bernoulli
process) is continuously updated as more accurate in-
formation becomes available. The authors demonstrate
that ordering pattern depends upon characteristics of the
procurement cost function.
There have been numerous investigations on early
commitment policies, which are closely related to vari-
able lead-time inventory policies in the supply chain en-
vironment (e.g., [6,14]). Under these policies, a supplier
offers a discount, if an internal supply chain customer
places orders in advance. The customer increases its in-
ventory carrying risk by committing early (i.e. using the
longer lead-time) or loses an opportunity to procure at
the lower cost. The primary objective of early commit-
ment policies is finding a discount level optimizing the
supply chain performance.
Early commitment policies under evolving forecast-
ing accuracy are investigated by Ferguson [15]. He
analyzes negotiation of an exchange price between a
supplier and a manufacturer depending upon the supply
chain power structure and the frame of commitment.
Information about the external demand has two lev-
els of accuracy (not necessarily no information and
completely accurate information). This level of accu-
racy depends upon a choice between using either early
commitment or delayed commitment. In the case of
balance of power in the supply chain and, if accuracy
of demand information improves quickly, the delayed
commitment is preferable. However, if improvement
of forecasting accuracy is small, the early commitment
is preferable. The author also provides an excellent
summary of literature related to early commitment. His
main observations are that existing models usually con-
sider short planning horizons, two levels of information
accuracy or two procurement cost levels.
Buyer–supplier interactions are also analyzed using
dual sourcing models (for instance, [16–18]), where the
buyer allocates orders between suppliers with different
characteristics including lead-time. The dual sourcing
models are directed towards minimizing risk of suppli-
ers’ non-performance while this paper focuses on set-
ting the supply lead-time in the long-term collaboration
framework.
1.3. Contribution
In this paper, a single stage, long horizon, reorder
point inventory system is studied; wherein the pro-
curement cost increases with decreasing lead-time. An
instance of such inventory problems is routine procure-
ment of a product for which there are multiple modes
of transportation at different cost levels. The objective
of this paper is to find the lead-time value representing
the trade-off between benefits of lead-time reduction
and increase in the procurement cost. The lead-time
reduction is expected to reduce the inventory cost be-
cause of more accurate demand information and lower
safety stock requirements. Yet, it increases the procure-
ment cost because the supplier sets a higher price for
short lead-time orders, limited supplies force to seek
more costly alternative products or a more expensive
shipping mode is used to ensure the shorter lead-time.
In order to describe this trade-off, a model for joint
optimization of inventory and procurement costs with
respect to the lead-time is developed. It is based on
the traditional continuous review re-order point model.
Demand is modeled as an autoregressive process. This
model differs from the traditional model by inclu-
sion of the lead-time dependent procurement cost. A
procurement cost function is used to describe the de-
pendence of the procurement cost upon the lead-time.
 C. Chandra, J. Grabis / Omega 36 (2008) 877 – 887 879

It is assumed that the lead-time is deterministic and the 2. Model

procurement cost for different values of the lead-time
is known in advance. Burnetas and Gilbert [5] have 2.1. Notation
also used the assumption of the known procurement
cost. 2.1.1. Parameters
The model developed is compared with the tradi- A fixed cost per order placed
tional constant lead-time model by means of ANOVA D expected yearly demand
analysis. The analysis is aimed at identifying values b0 base procurement cost, which does not
of parameters of the demand process and the inven- depend upon the lead-time
tory system under which the lead-time reduction is v added value to the purchased product
favorable compared to procuring at the lowest cost. Pa- B2 fractional charge per unit short
rameters considered for the inventory system are added r inventory carrying charge per year
value, backlogging penalty cost, fixed ordering cost  average weekly demand
and a procurement cost function according to the lead- 2 demand process noise variance
time. Parameters considered for the demand process 
yt weekly demand such that D = 52 t=1 yt
are strength of autocorrelation and the signal-to-noise
 coefficient of the autoregressive demand
ratio.
process
The model developed in this paper differs from mod-
els using the lead-time crashing approach by explic- 2.1.2. Variables
itly specifying the source of the lead-time reduction
cost (i.e., increasing procurement cost), which allows Q order size
for analyzing the impact between lead-time reduction L lead-time in weeks, Lopt is used to
and buyer–supplier interactions. This paper differs from refer to the lead-time value giving
other published papers on early commitment policies by the lowest total cost and
concurrently considering long planning horizon, multi- Lmax is used to refer to the largest
ple levels of procurement cost and continuously evolv- lead-time value considered
ing demand information. The distinguishing feature of k safety factor
this paper from other papers dealing with the impact 2L lead-time demand variance
of lead-time reduction on buyer–supplier interactions is c(L) lead-time dependent procurement
that it addresses the problem solely from the buyer’s cost per unit
perspective and no information about the supply side ex- v  = v + c(L) unit variable cost of the product
cept the procurement cost function is required. Serially pu  (k) probability that a unit normal vari-
correlated demand is used instead of traditionally con- able is equal or larger than k
sidered independent random demand. While the paper Gu (k) a special function of the unit
focuses on first order autoregressive processes, results normal variable [19, p. 255]
can be generalized to any autoregressive demand pro- Other notations are introduced as necessary.
cess. The model developed enables buyers to balance
2.2. Model assumptions
their procurement preferences regarding cost and deliv-
ery lead-time with inventory management decisions in
The following assumptions are used:
the case of routine replenishments over a relatively long
time period. Another main contribution of the paper to
1. Inventory is managed using the continuous review
the existing body of literature is analysis of factors in-
variable re-order point policy [20] with the reorder
fluencing the trade-off between procuring at a lower
point st and the fixed order size Q.
cost and using more accurate demand information. This
2. The lead-time is a deterministic decision variable.
analysis highlights situations when buyers are highly
3. Shortages are small with respect to the total lead-
motivated to negotiate for lead-time reduction.
time demand.
The rest of the paper is organized as follows.
4. Shortages are backordered.
Section 2 describes the model for simultaneous opti-
5. Shortages incur a penalty cost per item short.
mization of inventory cost and procurement cost. An
6. External demand is a first order autoregressive pro-
example and numerical evaluation of the model are pre-
cess of the form:
sented in Section 3. Section 4 offers general conclusion
on the analyzed problem. yt =  + yt−1 + t , (1)
880 C. Chandra, J. Grabis / Omega 36 (2008) 877 – 887

where  = (1 − ) and the noise process t ∼ is the last observed demand value. The variance of the
N(0,  ). lead-time demand is obtained as 2L = (2 /(1 − )2 )
L i 2
i=1 (1 −  ) (see [22]). This expression is trans-
7. The procurement cost is a decreasing function of the
lead-time. It is calculated per unit purchased (Ca- formed to a form without summation for use in further
chon [6] also determines the procurement cost for computations
orders with a shorter lead-time on per unit purchased
basis. Lan et al. [11] calculate the lead-time crashing  
2 L − 1 2
2L
−1
cost on per order basis, while the lead-time crash- 2L = L − 2 + 2 .
ing cost has both order cycle and per item specific (1 − )2 −1  −1
components according to Pan et al. [21]).
The total cost function uses widely used approximation
In this paper, the time unit is one year divided in weeks. for determining average inventory just before inventory
A week represents the period between consecutive up- replenishment and the number of backlogged orders.
dates of demand forecasts. The base measurement unit This approach does not explore impact of short-term de-
for the lead-time is also a week. Other time units can mand fluctuations characteristic to autoregressive pro-
be used, if necessary. cesses. Urban [20] has shown that by using the variable
re-order point, the average number of backlogged units
2.3. Model formulation under autoregressive demand is controlled in the same
way as under random demand. Therefore, accuracy of
The inventory management cost over the unit time the approximation is comparable in both situations. In
interval is comprised of ordering, holding and shortage order to assess the impact of short-term fluctuations on
costs. This traditional cost structure is augmented to in- the inventory level just before the replenishment arrives,
clude the purchasing cost expressed as a multiple of the a more elaborate expression for determining the inven-
lead-time dependent procurement cost c(L) and D units tory holding cost (IC) is
purchased over the unit time interval. The unit variable
cost is expressed as a sum of the variable procurement Q Q   ∞
int(D/Q)
IC = v  r + v  r (st − YtL )f dYtL
cost and the added value v  = v + c(L) because the 2 D 0
i=1
variable procurement cost has substantial impact on the
shelf value of the product (see [19, p. 44]). Q  Q   ∞
int(D/Q)

The total inventory and procurement cost is expressed = v r + vr (ŶtL + kL − YtL )
2 D 0
as i=1

TC(L, Q, k) = ordering cost + holding cost × f (YtL ) dYtL , (3)

+ backordering penalty
where YtL is the actual lead-time demand and f (YtL )
+ procurement cost is the distribution density function of the lead-time de-
or mand. The summation is made over all ordering cy-
  cles assuming they coincide with the unit time inter-
AD Q
TC(L, Q, k) = + + kL v  r val. The difference between the estimated lead-time de-
Q 2 mand and the
D  actual lead-time demand can be found as
L−i
+ B2 v  L Gu (k) ∗ + D ∗ c(L). (2) ŶtL − YtL = L i=1 j =0 j t+i (see [22]). Thus, expres-
Q sion (3) can be rewritten as
The modeling objective is to select k, Q and L in order

int(D/Q)  ∞
to minimize the total inventory and procurement cost. Q  Q
IC = v r + vr w f (YtL ) dYtL ,
Minimization of the total cost describes a trade-off be- 2 D 0
i=1
tween the inventory cost and the procurement cost.
The total cost expression is stated assuming that the  L−i
where w = kL + L i=1 j =0 j t+i . This expression
variable re-order point is expressed as
can be solved by means of simulation by generat-
st = ŶtL + kL . ing realizations of the noise process t . In numerical
studies reported in Section 3, the difference between
The expected lead-time demand is obtained as ŶtL = using the inventory cost approximation as in (2) and
L + (yt − )((1 − L )/1 − ) (see [20]), where yt using expression (3) is found insignificant. Therefore,
 C. Chandra, J. Grabis / Omega 36 (2008) 877 – 887 881

the computationally more attractive approximation is Step 5: Repeat steps 3 and 4 until values of k, Q
used in further presentation. and L do not change, similar to using the simultaneous
procedure for finding k and Q only (see [19, p. 325]).
2.4. Model solving Step 6: Calculate the optimal total cost using expres-
sion (2).
In order to minimize the total cost, the total cost
function is differentiated with respect to each decision 2.5. Procurement cost function
variable. Partial derivatives obtained are set to zero, re-
sulting in following expressions used in finding optimal Solving model (2) requires knowing the procurement
values of decision variables cost function, which should be provided by a supplier.
In practice, suppliers are more likely to provide a few
rQ
pu  (k) = , (4) discrete values of the procurement cost for specific lead-
B2 D times. Existing research is restricted mainly to using
just two levels of the procurement cost [6,14]. How-
2[AD + B2 v  L Gu (k)]
Q= , (5) ever, it is plausible to have more than two levels, espe-
vr
cially if the procurement cost depends upon the mode of
and transportation used. One could use these discrete values


 to conduct optimization by enumeration of alternatives.
Qr jc(L) B2 Gu (k)D
+D ∗ + kr+ h = 0, (6) Alternatively, the procurement cost function can be fit-
2 jL Q ted using the values provided. This approach is appeal-
where ing because the retailer can find any lead-time value to
be optimal from the range of plausible lead-time val-
jL jc(L) jL
h=v + L + c(L) . ues. Even though the supplier probably does not quote
jL jL jL this lead-time value, the retailer can attempt to agree
For purposes of further derivations, Qr/2+D is denoted with the supplier on providing it at the corresponding
by  and kr + B2 Gu (k)D/Q is denoted by . purchasing cost level. Such situations occur if products
Evaluation of jc(L)/jL depends upon the choice of are purchased directly from manufacturers with limited
PCF. The partial derivative of L is found as capacity. Manufacturers often have options to alternate
 their manufacturing schedules to balance manufactur-
jL 1 2 ing costs and delivery lead-time requirements.
=  For example, the supplier offers L = 2, c(L) = 9 and
jL 2 2 (1 − )2
 L=5, c(L)=7.5. The retailer finds the optimal lead-time
2L+1 ln() L
× 1− 1− .
−1 +1
The following procedure is used to find values of the
decision variables if demand is a first order autoregres-
sive process:
Step 1: Identify a range of lead-time values.
Step 2: Initialize values of L and Q by setting L = 1
and Q to economic order quantity.
Step 3: Calculate k using expression (4). Update Q
using expression (5).
Step 4: Numerically solve expression (6). If it has no
solutions, calculate the total cost using lead-time values
defined by endpoints of the range of lead-time values
and select the lead-time value yielding the lowest total
cost. The endpoints of interval are analyzed to find the
optimal lead-time in cases when the total cost is not a
convex function of the lead-time or expression (6) has
no solution within the specified lead-time range (Section
2.6 discusses properties of the total cost function).
equal to 1 with the corresponding purchasing cost equal
to 9.5 per item. Both sides can attempt to settle on L=1.
In this paper two types of PCF are considered:
1. linear PCF c(L) = b0 − b1 L;
2. nonlinear PCF c(L) = b0 + b1 La .
The linear PCF implies a controlled growth of the pro-
curement cost while the nonlinear PCF implies an un-
controlled growth. The coefficient b1 determines the
speed of growth of the procurement cost. Coefficients
b1 and a should be selected in a way to obtain a declin-
ing function in the case of nonlinear PCF. That occurs
if b1 > 0 and a < 0 or b1 < 0 and a > 0. For the latter
case, a = 1 yields linear PCF and a > 1 yields concave
PCF, which is less likely to occur in practice. Burnetas
and Gilbert [5] have used linear and step-wise purchas-
ing cost functions. Ray and Jewkes [23] in their paper
on dependence of external customer demand upon the
lead-time also express the product price as a linear de-
creasing function of the lead-time.
882 C. Chandra, J. Grabis / Omega 36 (2008) 877 – 887
2.6. Model analysis
In order to gain preliminary insights into the influence
of lead-time on the total inventory and procurement
cost and to predict performance of the proposed solu-
tion procedure, dependence of the total cost function
upon the lead-time is analyzed. The impact of autocor-
relation on the lead-time demand variability is ignored
to avoid too cumbersome derivations. Despite omitting
the impact of autocorrelation, the lead-time demand
variance is still a monotonically increasing function of
the lead-time. The linear and nonlinear procurement
cost functions as defined in the previous section are
analyzed.
Given that the linear PCF is just a special case of the
nonlinear power PCF, the model analysis is conducted
for the general case at first. The first partial derivative
is found for analysis of extreme points of the total cost
function, and the second partial derivative is found to
analyze convexity properties of the total cost function.
The first partial derivative of the total cost according
to the lead-time is ab1 La−1 +  b1 (a + 21 )La−1/2 +
√
(b0 + v)  /2 L. The second partial derivative of the
total cost according to the lead-time subsequently mul-
tiplied by L−3/2 is a(a − 1)b1 La−1/2 +  b1 (a − 41 )2
La − (b0 + v)  /4.
In the case of linear PCF a = 1, the second partial
derivative is clearly negative (after accounting for the
sign change). Therefore, TC is the concave function
with respect to the lead-time. Subsequently, the optimal
lead-time is either the shortest one or the longest one.
This effect can be perceived as dominance of either the
inventory cost or the procurement cost in the decision
making process.
The situation is more complex in the case of non-
linear PCF. The convexity properties of the total cost
function strongly depend upon the values of parameters
of inventory system and demand. In the general case,
the total cost function is neither convex nor concave. If
b1 > 0 and a < 0, TC is convex for small values of L
and it becomes concave as L increases due to rapid de-
cline of the power function. Location of inflection point
strongly depends upon the parameter v (its large val-
ues causes inflection at smaller L). The inflection point
is also a global minimum of TC for the given range
of lead-time values because the first derivative found
above is composed of monotonic functions. It can be
perceived as a point of trade-off between the inventory
cost and the procurement cost.
If b1 < 0 and a > 0, TC is likely to be concave. It
is certainly concave for b1 < 0 and a > 1 . If TC is a
concave function, the minimum TC occurs at the end-
points of the lead-time range, similarly as for the linear
PCF.
3. Numerical results
3.1. Experimental design
Numerical studies are conducted to test the accuracy
of approximations used, to evaluate the proposed model
and to identify parameters of the inventory system and
properties of the demand process having the most pro-
found impact on the trade-off between the inventory cost
and the procurement cost. The demand process is de-
scribed using expression (1). Factors characterizing the
inventory system included in the experimental design
are fixed ordering cost, added value and backlogging
penalty. Factors characterizing the demand process are
the coefficient of the autoregressive demand process 
and the signal-to-noise ratio. The signal-to-noise ratio,
which describes variability of the demand process, is
defined as the average demand  divided by the demand
standard deviation . Values of the considered experi-
mental factors are given in Table 1. Values of other pa-
rameters are set to D = 5000 (a relatively fast moving
product) and r = 0.25. These values are chosen similar
to those often considered in the published literature. The
values of the demand properties are chosen to cover both
strongly and weakly correlated processes. The base pro-
curement cost b0 is set to obtain equal values of c(Lmax )
for all PCFs considered. The parameter a for the non-
linear PCF is set equal to −1. The range of lead-time
values is 1 to 12. TC(Lopt , Q, k) and TC(Lmax , Q, k)
are calculated separately, for all 108 experimental cells
for three PCFs. The difference between these two quan-
tities TC = TC(Lmax , Q, k) − TC(Lopt , Q, k) is used
in evaluating performance of the proposed model. It
shows the reduction of the total cost by using the opti-
mal lead-time, compared to procuring at the lowest cost.
Values larger than zero indicate that Lopt < Lmax and
reduction of the inventory cost by using more accurate
demand information outweighs additional procurement
expenses. The shorter lead-time reduces the inventory
cost because the resulting smaller lead-time variance al-
lows carrying less safety stock and improving the cus-
tomer service.
3.2. Example
In order to illustrate inventory management under
autoregressive demand with lead-time dependent pro-
curement cost, the following example is elaborated. The
parameters are set to the following values: A=100$ per
 C. Chandra, J. Grabis / Omega 36 (2008) 877 – 887 883

Table 1
Experimental design parameters

Factors A v B2 1 /

Values 100, 1000 10, 20, 40 0.25, 0.5, 1 0.2, 0.8 2, 5, 10

Table 2
Sample optimization results for each iteration and at the endpoints of the lead-time range

Iterations k Q L TC L v

First 2.18 289 5.09 62,840 201.6 50.6

Second 2.16 352 5.15 62,757 203.1 50.6
Third 2.09 366 5.19 62,746 204.7 50.5
Fourth 2.07 370 5.20 62,747 204.7 50.5
Fifth 2.07 371 5.20 62,748 204.7 50.5

Minimum L 2.07 371 1 78,381 47.5 54.6

Optimal integer-valued L 2.07 371 5 62,754 198.4 54.6
Maximum L 2.07 371 20 68,189 497.7 49.8

order, D = 5000 units/year, v = 40$/item, B2 = 1, r =
0.25 per year, weekly demand is yt =38.4+0.6yt−1 +t ,
where t ∼ N(0, 47.5), Lmax = 20 weeks and procure-
ment cost per unit is determined as c(L)=9.583+5L−1 .
The optimal result is found after five iterations
(Table 2) (the maximum number of iterations encoun-
tered among other cases analyzed is 11). Variation of
lead-time values over the iterations is small, which
can be explained by relatively minor impact of Q and
k on the optimal lead-time. The table also shows re-
sults obtained at the endpoints of the lead-time range
and using the integer-valued optimal lead-time. Min-
imization of the total cost yields Q = 317, k = 2.07
and Lopt = 5.2. The optimized total inventory man-
agement and purchasing cost is 62, 747$/year while
TC(Lmax , Q, k) = 68, 006$/year. Thus, using the opti-
mal lead-time results in cost savings of about 8%.
3.3. ANOVA analysis
The ANOVA analysis shows whether the cost dif-
ference TC is statistically significant and highlights
factors that most substantially influence the trade-off
between procurement cost and lead-time reduction.
Results of the ANOVA analysis for each of PCFs
separately are reported in Table 3. The mean TC
column shows the average reduction in total cost for
low and high values of the factors (the mean value for
combinations of both low values and both high values,
respectively, are reported in the case of second order
interactions). These results suggest that the signal-to-
noise ratio has the most significant impact on the trade-
off between the inventory cost and the procurement cost
(distribution of TC is skewed to the left causing con-
cern for applicability of ANOVA. Therefore, ANOVA
was also conducted after applying the logarithmic
transformation to TC. The same results concerning
significance of factors were obtained, suggesting that
the procedure is sufficiently robust. The results for the
non-transformed case are reported because the averages
obtained are more informative). The added value is the
second most significant factor and the most significant
out of all parameters for the inventory system consid-
ered. The backlogging penalty and the fixed ordering
cost do not have significant impact on the trade-off. The
second level interactions between factors are significant
only for combinations among v, 1 and /. The largest
absolute cost difference between using optimal L and
Lmax is observed for the high value of the signal-to-
noise ratio. The average absolute difference is relatively
small because in many cases Lopt =Lmax as can be seen
in Table 4 , which reports fraction of the experimental
cells with TC > 0. These results are reported for the
most important factors. There are few cases when the
optimal lead-time is smaller than Lmax in the case of
the linear PCF. The fraction is substantially larger for
the nonlinear PCF with b1 = 5. The lead-time reduc-
tion is almost never beneficial, if demand is weakly
autocorrelated because the speed of lead-time variance
increase is relatively low.
The total cost also has been calculated for all ex-
perimental cells using the integer value of the optimal
884 C. Chandra, J. Grabis / Omega 36 (2008) 877 – 887

Table 3
F -Ratio with p -values given in parenthesis and mean cost difference estimates (for low and high levels) for each factor

Factor Linear PCF, b1 = 0.15 Nonlinear PCF, b1 = 5 Nonlinear PCF, b1 = 10

F -ratio Mean TC F -ratio Mean TC F -ratio Mean TC

A 1.87 479 1.62 206 2.90 553

(0.18) 232 (0.21) 111 (0.09) 340

v 11.90 0 12.23 0 22.68 22

(0.00) 977 (0.00) 416 (0.00) 1021

B2 0.89 207 1.50 80 2.06 291

(0.42) 502 (0.23) 238 (0.14) 602

1 15.50 0 18.12 0 49.77 5

(0.00) 711 (0.00) 316 (0.00) 888

/ 15.50 0 17.03 0 35.68 6

(0.00) 1067 (0.00) 465 (0.00) 1190

A∗v 0.89 0 0.84 0 0.92 9

(0.42) 670 (0.43) 222 (0.40) 678

A ∗ B2 0.01 314 0.02 118 0.00 391

(0.99) 360 (0.98) 183 (1.00) 491

A ∗ 1 1.87 0 1.62 0 2.71 11

(0.18) 467 (0.21) 330 (0.10) 926

A ∗ /  1.87 0 1.38 0 1.63 35

(0.16) 696 (0.26) 302 (0.20) 802

v ∗ B2 0.45 0 0.76 0 0.63 1

(0.78) 1319 (0.55) 476 (0.64) 1192

v ∗ 1 11.9 12.23 0 21.92 0

(0.00) 1954 (0.00) 930 (0.00) 2364

v ∗ /  11.9 0 11.35 0 14.30 0

(0.00) 2930 (0.00) 832 (0.00) 2026

B 2 ∗ 1 0.89 0 1.50 0 1.93 1

(0.42) 1004 (0.23) 693 (0.15) 1579

B 2 ∗ /  0.89 0 1.31 0 1.23 3

(0.48) 1506 (0.27) 603 (0.31) 1334

1 ∗  /  15.5 0 17.03 0 34.69 0

(0.00) 2134 (0.00) 1219 (0.00) 2653

Table 4
A fraction of experimental cells with TC > 0

/ 1 Linear PCF, b1 = 0.15 Nonlinear PCF, b1 = 5 Nonlinear PCF, b1 = 10

v = 10 v = 20 v = 40 v = 10 v = 20 v = 40 v = 10 v = 20 v = 40

10 0.2 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
0.8 0.00 0.00 0.00 0.00 0.00 0.83 0.00 0.00 0.00

5 0.2 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
0.8 0.00 0.00 0.00 0.00 0.83 1.00 0.00 0.00 0.67

2 0.2 0.00 0.00 0.00 0.00 0.00 0.83 0.00 0.00 0.17
0.8 0.00 0.50 1.00 0.83 1.00 1.00 0.00 0.83 1.00
 C. Chandra, J. Grabis / Omega 36 (2008) 877 – 887 885

85000 85000
μ /σ = 2
79000 79000
73000 μ /σ = 2
μ /σ = 5 73000

TC
TC
67000 67000 μ /σ = 5
61000 μ /σ = 10 61000 μ /σ = 10
55000 55000
0 3 6 9 12 0 3 6 9 12
(a) L (b) L

Fig. 1. TC according to noise: (a) linear procurement cost function; and (b) nonlinear procurement cost function, b1 = 5. The value added is
40$/unit and  = 0.8.

85000 85000
v = 40
79000 79000
73000 v = 20 73000 v = 40
TC

TC
v = 10
67000 67000 v = 20
61000 61000 v = 10

55000 55000
0 3 6 9 12 0 3 6 9 12
(a) L (b) L

Fig. 2. TC according to added value; (a) linear procurement cost function; and (b) nonlinear procurement cost function. The signal-to-noise
ratio is 47.5 and  = 0.8.

12 73000 12 73000
->
9 9
-> 67000 67000
TC

TC
6 6 <-
L

<- 61000 61000

3 3
0 55000 0 55000
0 0.25 0.5 0.75 1 2 14 26 38
(a) b1 (b) b1

Fig. 3. Lead-time and total cost according to coefficient of: (a) liner procurement function and; (b) nonlinear procurement function. The value
added is 40$/unit, the signal-to-noise ratio is 47.5 and  = 0.8.

lead-time. The average relative difference between this
total cost and TC(Lopt , Q, k) is of order 10−5 and the
maximum absolute difference observed is of order 10−3 .
Therefore, using the integer-valued optimal lead-time
results in negligible additional costs. However, this re-
sult depends upon forecasts updating period.
Similarly, the total cost with the inventory holding
cost determined using expression (3) has been calcu-
lated for all experimental cells. Previously found op-
timal values of the decision variables have been used.
Expression (3) has been evaluated using simulation and
the total cost is averaged over 50 replications. The av-
erage absolute difference between the total cost calcu-
lated using the inventory cost approximation as in (2)
and using expression (3) is 103$ and the maximum is
1514$, while the total cost TC is of order 104 . The width
of 95% confidence interval of the simulated total cost
estimate is in the range between 18$ and 1288$.
3.4. Characteristics of the total cost function
Figs. 1 and 2 show the total cost according to the
lead-time for various levels of the signal-to-noise ratio
and the added value, respectively. The figures confirm
that the previously identified convexity properties of the
total cost function according to the lead-time also hold,
if the impact of the demand autocorrelation is accounted
for in calculating the lead-time demand variance.
Results depend upon the speed of increase of the
procurement cost. For the particular PCFs, the speed is
defined by b1 . Fig. 3 shows Lopt and TC according to b1
with the factors fixed at their upper values. In the case
of the linear PCF, the shift from Lopt = 1 to Lopt = Lmax
occurs abruptly as suggested by the analytical analysis.
It occurs when the procurement cost at Lopt = 1 has
increased by more than 44% relative to b0 . The shift is
gradual in the case of the nonlinear PCF.
886 C. Chandra, J. Grabis / Omega 36 (2008) 877 – 887
4. Conclusion
In this paper, the traditional continuous review re-
order point inventory management policy has been mod-
ified by considering the variable lead-time and including
the lead-time dependent procurement cost. Optimiza-
tion of the total inventory and procurement cost yields
values of the lead-time, the order quantity and the safety
factor characterizing the trade-off between the inven-
tory cost and the procurement cost.
The trade-off depends upon the particular structure
of the procurement cost function. Linear and nonlinear
PCFs have been considered. The linear PCF causes the
total cost to be a concave function according to the
lead-time. In the case of nonlinear PCF, convexity prop-
erties of the total cost function depend upon the PCF’s
parameters and the parameters of inventory system and
demand process. The added value parameter is partic-
ularly important. In the case of convex PCF, the min-
imum of the total cost function generally occurs at the
inflection point. Concave nonlinear purchasing func-
tions yield results similar to those of the linear function.
The numerical studies conducted show that the lead-
time reduction, which increases the procurement cost
and is aimed to reduce the inventory cost, is justified
only if, (a) the increase of the procurement cost is slow,
(b) the external demand is highly uncertain, and (c)
a product has large added value. Therefore, the lead-
time reduction under covariance stationary demand re-
duces the total inventory and procurement cost only for
marginal situations. This occurs because the procure-
ment cost comprises a major share of the total cost. Ad-
ditionally, procuring at the higher cost also contributes
to an increase of the inventory cost through the higher
variable cost v  . If these conclusions are viewed from
the supply chain perspective, then there are many sit-
uations when a retailer is willing to consider a supply
discount in return for an early commitment.
The model has been presented under the assumption
that demand is a first order autoregressive process. If
higher order autoregressive processes are considered, a
discontinuous approach to finding the optimal lead-time
can be used (illustrative results are presented in [24]).
One of the future research directions is the analysis of
serial multi-stage systems utilizing re-order point poli-
cies under autoregressive demand and lead-time depen-
dent procurement cost. Under some circumstances de-
pending upon the type of collaboration, suppliers may
prefer the retailer to use shorter lead-times because the
retailer’s lead-time also affects safety stock require-
ments for suppliers. Therefore, the product exchange
price may not be a monotonically decreasing function
of the lead-time. Another research direction is establish-
ing a link between manufacturing scheduling models
that consider cost and lead-time trade-off at the supply
side and the proposed inventory management models at
the demand side.
Acknowledgment
Valuable comments and suggestions made by referees
and Dr. math. Vineta Minkevicha is gratefully acknowl-
edged. This research has been partially supported by
the Henry W. Patton, Center for Engineering Education
and Practice, University of Michigan-Dearborn, and by
the European Social Fund within the Latvian National
Program “Support for the carrying out doctoral study
program and post-doctoral-research”.
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