Mathematical and Computer Modelling 49 (2009) 1326–1330

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Mathematical and Computer Modelling

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

An integrated economic lot-size model for vendor–buyer inventory

system when input is random
Nita H. Shah a,∗ , Ajay S. Gor b
a
Department of Mathematics, Gujarat University, Ahmedabad – 380 009, Gujarat, India
b
Pramukh Swami Science & H. D. Patel Arts College, SVKM, Kadi – 382 715, Gujarat, India

article info a b s t r a c t

Article history: An integrated strategy is discussed for both vendor and buyer when the input is random.
Received 17 July 2007 It is shown numerically that the cooperative approach is beneficial to reduce the cost
Received in revised form 22 August 2008 when compared with an independent decision by both the parties. Though the integrated
Accepted 28 August 2008
total cost decreases, the buyer’s cost increases due to random input in his inventory. To
encourage the buyer to order a large quantity, a trade credit is offered by the vendor to the
Keywords:
buyer to settle the account. A conciliation factor is suggested to share the benefits.
Integrated strategy
Trade credit
© 2008 Elsevier Ltd. All rights reserved.
Random input

1. Introduction

Till the mid-twentieth century, the logistical development was only from the buyer’s point of view. The buyer was
deciding on ‘‘when to order?’’ and ‘‘how much to order?’’. This buyer’s optimal decision may not be economical for the
vendor. However, if both the parties agree, a joint (cooperative) policy can be worked out to benefit them. Clark and Scarf [1]
suggested the idea of the vendor–buyer integration. Banerjee [2] developed a joint economic lot-size with finite production
rate. Goyal [3] extended Banerjee’s model by relaxing the lot-for-lot production assumption.
Goyal [4] formulated a mathematical model when trade credit is offered by the vendor to the buyer. He derived a model
by assuming different rates for interest earned by the buyer and the interest charged by the vendor. Shinn [5] derived optimal
pricing and ordering policies when the end demand is price sensitive and a delay in payments is offered by the vendor to
the buyer. Kingsman [6] studied the relationship between the inventory cost and payment rules. Mandal and Phaujdar [7]
developed the EOQ model with permissible delay in payments. Weng [14] derived integrated lot-size model with quantity
discounts.
The stringent assumption taken in the above models is that the buyer receives the same order which he has replenished.
In the market, it is observed that due to an unavailability of the raw material, a worker’s strike or electricity failure, a vendor
may not able to deliver the goods which were ordered by the buyer. As a result, the quantity received by the buyer does
not match the quantity ordered. Silver [8] discussed an EOQ model when quantity received in the buyer’s inventory is
uncertain and is a random variable with a specified mean and variance. Kalro and Gohil [9] extended Silver’s model by
allowing shortages. Noori and Keller [10] gave a stochastic model when the quantity received is uncertain. Yano [11] gave
an up-to-date review of articles on the inventory model when the quantity received is uncertain.
In this paper, a cooperative vendor–buyer inventory system is developed when the input is random. A conciliation factor
is used to balance the benefits, and trade credit is offered to the buyer to make the cooperative relationship the most
beneficial to both the parties. The sensitivity analysis of various parameters is carried out by a numerical example.

∗ Corresponding author.
E-mail addresses: nita_sha_h@rediffmail.com (N.H. Shah), ajaygor@yahoo.co.in (A.S. Gor).

0895-7177/$ – see front matter © 2008 Elsevier Ltd. All rights reserved.
doi:10.1016/j.mcm.2008.08.017
 N.H. Shah, A.S. Gor / Mathematical and Computer Modelling 49 (2009) 1326–1330 1327

2. Mathematical model

The mathematical development of the problem is carried out on the basis of the following assumptions:
• A system deals with single vendor and single buyer.
• The demand is deterministic and constant during the period under review.
• The replenishment rate is infinite.
• The shortages are not allowed and the lead-time is zero.
• The quantity requisitioned does not necessarily match with the quantity received but it is a random variable following a
normal distribution. If Q denotes the quantity requisitioned and Y is the quantity received then Y is a random variable
with mean and variance as

E (Y ) = bQ and V (Y ) = σ02 + σ12 Q 2 (2.1)

respectively where b > 0 is the bias factor and σ02 and σ12 (σ02  σ12 ) are non-negative constants. Q is the decision
variable.
• Trade credit of M units is offered by the vendor to attract the buyer to cooperate in the integrated strategy.
The proposed model is developed using following notations :
T (Y ) Vendor’s replenishment cycle time when Y -units are received
Tb ( Y ) Buyer’s replenishment cycle time when Y -units are received
Q Vendor’s replenishment size
n Number of orders that buyer can put during the cycle time T (Y )
Q /n Buyer’s replenishment size
R Demand rate
cb Buyer’s purchase cost per unit (buyer’s decision variable)
cv vendor’s purchase cost per unit
Ab Buyer’s ordering cost per order
Av vendor’s ordering cost per order
Iv ( t / Y ) vendor–buyer combined inventory level when Y - units are received
Ib (t /Y ) Buyer’s inventory level when Y -units are received
hb Buyer’s annual holding cost per unit
hv vendor’s annual holding cost per unit
TCb (Y , n) Buyer’s total cost when Y -units are received
TCv (Y , n) vendor’s total cost when Y -units are received
K b ( Q , n) Buyer’s expected total cost per time unit
Kv (Q , n) vendor’s expected total cost per time unit
K annual total cost for both vendor and buyer
M Trade credit offered by the vendor to the buyer
r Continuous interest rate
E (T (Y )) Expected cycle time when Y units are received = E (Y )/R = bQ /R
E (Y ) = bQ , the mean of received random variable Y when Q units are ordered; b > 0
V (Y ) = σ02 + σ12 Q 2 , the variance of the received random variable Y when Q units are ordered; where σ02 and σ12
(σ02  σ12 ) are non-negative constants.

The on-hand inventory of the vendor or buyer depletes with a constant demand rate. The instantaneous state of the
inventory at any instant of time t is given by

dIb (t /Y ) T (Y )
= −R, 0≤t ≤ (2.2)
dt n
and
dIv (t /Y )
= −R, 0 ≤ t ≤ T (Y ). (2.3)
dt
 
T (Y )
The boundary conditions are Ib n
= 0 and Iv (T (Y )) = 0. Then the solutions of the differential equations are

T (Y ) T (Y )
 
Ib (t /Y ) = R −t , 0≤t ≤ (2.4)
n n
and
Iv (t /Y ) = R[T (Y ) − t ], 0 ≤ t ≤ T (Y ). (2.5)
1328 N.H. Shah, A.S. Gor / Mathematical and Computer Modelling 49 (2009) 1326–1330
h i
T (Y )
In the interval 0, n
, the buyer’s holding cost when Y -units are received is

hb
IHCb (Y , n) = Y 2. (2.6)
2Rn
The vendor’s inventory level when Y -units are received, in the integrated two-echelon inventory model is the difference
between the vendor–buyer combined average inventory level and the buyer’s average inventory level. Thus, vendor’s
holding cost during [0, T (Y )] is given by
T (Y ) T (Y )/n
Z Z   
hv 1
IHCv (Y , n) = hv Iv (t /Y )dt − n Ib (t /Y )dt = Y 2
1− . (2.7)
0 0 2R n
Hence, buyer’s and vendor’s total costs, when Y -units are received, are
hb
TCb (Y , n) = Y 2 + nAb (2.8)
2Rn
and
 
hv 1
TCv (Y , n) = Y2 1 − + Av (2.9)
2R n
respectively. Using Renewal theory [12] and Eq. (2.1), the buyer’s expected total cost for Q -units is

E (TCb (Y )) hb  nAb R
Kb (Q , n) = σ0 + (σ12 + b2 )Q 2 +
 2
= (2.10)
E (T (Y )) 2bnQ bQ
and the vendor’s expected total cost for Q -units is

E (TCv (Y ))
 
hv 1   Av R
K v ( Q , n) = = 1− σ02 + (σ12 + b2 )Q 2 + (2.11)
E (T (Y )) 2bQ n bQ
respectively. Hence, the integrated expected total cost is the sum of Kb (Q , n) and Kv (Q , n) where n is a positive integer and
Q is continuous decision variable; i.e.
K (Q , n) = Kb (Q , n) + Kv (Q , n). (2.12)

3. Computational algorithm

Two cases may arise : Either the buyer and the vendor take an independent decision or by conciliation they agree upon
a joint decision policy. Next, let us derive the optimal solution in both cases.
Case 1 : When the buyer and the vendor take an independent decision:
For the buyer’s cost Kb to be minimum, for fixed n, set the partial derivative of Kb with respect to Q to be zero which
yields
s
hb σ02 + 2n2 Ab R
Q (n) =
∗
. (3.1)
hb (σ12 + b2 )
For the vendor to minimize Kv , since the n is a discrete positive integer, it must satisfy

Kv (Q ∗ (n), n − 1) ≥ Kv (Q ∗ (n), n) ≤ Kv (Q ∗ (n), n + 1). (3.2)

Therefore, the total expected cost per time unit when the vendor–buyer does not agree to have integration, is

KNI = minn minn Kb (Q ∗ (n), n) + Kv .


(3.3)
Case 2 : When vendor–buyer agrees to have integration:
In this case, K is to be optimized jointly. The optimal value of Q and n must satisfy the following conditions
simultaneously:
∂K
=0 (3.4)
∂Q
and K (Q , n − 1) ≥ K (Q , n) ≤ K (Q , n + 1). (3.5)
Hence, the total expected cost under integration, KI is given by
KI = minQ ,n (Kb + Kv ). (3.6)
 N.H. Shah, A.S. Gor / Mathematical and Computer Modelling 49 (2009) 1326–1330 1329

Table 4.1
The optimal solution without and with integrated strategy.
Cases Without joint decision With joint decision

n 3 1
Q 3924 2723
Kb 2446.22 3133.59
Kv 3212.16 1958.62
K 5658.38 5092.21
PICR 10%
M (in years) 0.197

Table 4.2
Sensitivity analysis of the σ02 , σ12 = 0.5 and b = 0.75.

σ02 0 5 10 15

KNI 5658.38 5658.38 5658.38 5658.38

KI 5092.22 5092.22 5092.22 5092.22
PICR 10% 10% 10% 10%
M (in years) 0.197 0.197 0.197 0.197

Table 4.3
Sensitivity analysis of the σ12 , σ02 = 5 and b = 0.75.

σ12 0.1 0.3 0.5 0.7

KNI 4468.13 5098.06 5658.38 6168.02

KI 4021.01 4587.99 5092.22 5550.83
PICR 10% 10% 10% 10%
M (in years) 0.156 0.178 0.197 0.215

Table 4.4
Sensitivity analysis of the b, σ02 = 5 and σ12 = 0.5.

b 0.25 0.50 0.75 1.00

KNI 12351.22 7131.05 5658.38 5042.30

KI 11115.40 6417.48 5092.22 4537.84
PICR 10% 10% 10% 10%
M (in years) 0.432 0.249 0.197 0.176

Clearly, KI is less than KNI . The total cost saving (say) SI = KNI − KI . Let the buyer’s cost savings, Sb , be defined by Sb = α SJ
where α is the conciliation factor for benefit sharing. When α = 1, all total cost savings benefit the buyer only, for α = 0,
total cost savings benefit the vendor only and when α = 0.5 the total cost savings are equally distributed between the buyer
and the vendor. If r is the interest rate, the present value of the unit cost after time M is e−rM . The length of the buyer’s credit
period M can be computed by solving the equation
RCb (1 − e−rM ) = Sb
which gives
 
1 RCb
M = ln . (3.7)
r RCb − α SI
The percentage of the integrated total cost reduction (PICR) is defined as
KNI − KI
PICR = × 100. (3.8)
KNI

4. Numerical example and sensitivity analysis

Consider the following parametric values in proper units.

[R, Cb , Cv , Ab , Av , hb , hv , σ12 , b, α, r ] = [4000, 12, 10, 300, 1000, 1.32, 1.00, 5, 05, 0.75, 0.5, 0.03].

In Table 4.1, the comparative study of two cases with and without an integrated decision is presented. The vendor benefits
$1254.54 while the buyer loses $687.37. Therefore, the buyer will be reluctant to accept a joint strategy. To motivate the
buyer to cooperate, the vendor offers the buyer a credit period of 72 days. The joint total cost is reduced by 10%.
1330 N.H. Shah, A.S. Gor / Mathematical and Computer Modelling 49 (2009) 1326–1330

The sensitivity analysis of σ02 is carried out in Table 4.2. It has no effect on decision variables. From Table 4.3, it is observed
that an increase in σ12 increases the total cost and delay period offered by the vendor to the buyer. Table 4.4 suggests that
an increase in the bias factor, decreases the total cost in both the cases. Also a delay period is very sensitive to changes in b.
Thus, for these two scenarios, the buyer-vendor should go for a joint strategy.
When σ02 = σ12 = 0 and b = 1, the aforesaid model reduces to that of Yang and Wee [13].

5. Conclusions

In this paper, the optimal ordering policy in the integrated vendor–buyer inventory system is analyzed when the input
is random. It is observed that the integrated approach lowers the joint cost. To keep a close eye on the buyer’s total cost,
the vendor offers him a credit period. In this study, it is observed that it is beneficial to consider the integrated policy and
to offer a credit period to settle the account when the input randomness is higher.

Acknowledgements

The authors are indebted to anonymous referees for providing valuable comments and suggestions.

Appendix. Derivation of E (Y 2 )

We know that V (Y ) = E (Y 2 ) − (E (Y ))2

Using (2.1)
σ02 + σ12 Q 2 = E (Y 2 ) − (E (Y ))2
⇒ σ02 + σ12 Q 2 = E (Y 2 ) − b2 Q 2
⇒ E (Y 2 ) = σ02 + (σ12 + b2 )Q 2 .

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