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IN OPERATIONAL
Intl. Trans. in Op. Res. 12 (2005) 83–100 RESEARCH

Deterministic inventory lot-size models with shortages for


fluctuating demand and unit purchase cost
Jinn-Tsair Tenga, Maw-Sheng Chernb and Ya-Lan Chanb
a
Department of Marketing and Management Sciences, The William Paterson University of New Jersey, Wayne,
NJ 07470, USA
b
Department of Industrial Engineering and Engineering Management, National Tsing-Hua University, Hsinchu 30043,
Taiwan
E-mail: tengj@wpunj.edu (J.-T. Teng)
Received 16 May 2002; received in revised form 12 March 2003; accepted 5 May 2004

Abstract
The classical economic order quantity (EOQ) model assumes not only a constant demand rate but also a
fixed unit purchasing cost. In today’s time-based competition, the unit cost of a high-tech product declines
significantly over its short product life cycle while its demand increases. Therefore, using the classical EOQ
formulation for a high-tech product will cause varying magnitudes of error. In addition, the cost of
purchases as a percentage of sales is often substantial. Consequently, adding the purchasing strategy into
the EOQ model is vital. In this paper, we assume that not only the demand function but also the unit
purchase cost is fluctuating with time. We then provide an easy-to-use algorithm to find the optimal
replenishment number and schedule. In a numerical example, we show that the total cost obtained by our
proposed model is 32.4% less expensive than that obtained by the classical EOQ model.

Keywords: inventory; lot-size; fluctuating demand; fluctuating cost; shortages

1. Introduction

The classical economic order quantity (EOQ) model assumes not only a constant demand rate but
also a fixed unit purchasing cost. However, as we know, the demand rate remains stable only in
the maturity stage of a product life cycle. Moreover, in time-based competition today, the unit
cost of a high-tech product declines significantly over its short product life cycle. For example, the
cost of a personal computer drops almost linearly with time as shown in Lee et al. (2000).
Therefore, using the EOQ formulation in stages other than the maturity stage of a product life
cycle or for a high-tech product with constantly declining cost will cause varying magnitudes of
error. In addition, the cost of purchases as a percentage of sales is often substantial (52% for all

r 2005 International Federation of Operational Research Societies.


Published by Blackwell Publishing Ltd.
84 J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100
industry) as shown in Heizer and Render (2000). Consequently, adding the purchasing strategy
into the EOQ model is vital.
One method of dealing with EOQ models with time-varying demand and cost over a finite-
planning horizon is the use of discrete Dynamic Programming (e.g., Wagner and Whitin, 1958).
Based on our decades of teaching experience, students do not have any difficulty learning the
continuous version of EOQ (or Linear Programming). However, there are many students who
have difficulty handling tedious and cumbersome Dynamic Programming (or Integer Program-
ming). As stated in Friedman (1982), ‘‘In particular, Wagner and Whitin use this approach (i.e.,
Dynamic Programming) to formulate a dynamic version of the economic lot size model. Although
this may be a satisfactory approach, it is generally preferable to solve analytically for the optimal
replenishment policy, whenever possible.’’ As a result, for easy understanding and application, we
will solve the EOQ problem here by a continuous version with a simple analytical solution, instead
of using a discrete version of Dynamic Programming.
Another methodology to solve the EOQ models with time-varying demand and cost
over a finite horizon could be the Optimal Control Theory (e.g., see Sethi and Thompson,
1981). The major assumptions used in EOQ-related articles in Optimal Control Theory are
summarized in Table 1, where M stands for a manufacturer and R for a retailer. It is clear from

Table 1
Summary of related literature in Optimal Control Theory
Author(s) User(s) Demand Purchase (or Backlogging Other factors
production) cost

Desai (1996) 1M and 1R Seasonal and Constant for M, Yes 1 Season duration
linear in price time-varying for R
Eliashberg and 1M and 1R Seasonal and Constant for both No Distribution
Steinberg (1987) linear in price M and R channel
Eliashberg and 2Ms Linear in price Constant for both No Competing
Steinberg (1991) M and R duopolists
Feichtinger and 1M Time-varying and Strictly convex in Yes Convex inventory
Hartl (1985) linear in price production rate cost
Gaimon (1988) 1M Time-varying Time-varying No Capacity
acquisition
Jorgensen (1986) 1M and 1R Linear in price Constant for M, Yes Quadratic
time-varying for R inventory cost
Jorgensen et al. 1M Diffusion demand Learning curve No Cost and demand
(1999) learning
Pekelman (1974) 1M Linear in price Strictly convex in No Planning and
production rate forecast horizons
Pekelman (1975) 1M Production rate Strictly convex in No Known price
production rate
Rajan et al. (1992) 1R Time-varying in Constant No Monopolistic
price retailer
Thompson et al. 1M Linear in price Constant No Planning and
(1984) forecast horizons
Present paper 1R Time-varying Time-varying Yes Ordinary retailer;
no control theory
J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100 85
Table 1 that most relevant literature in Optimal Control Theory deals with how a monopolistic
manufacturer determines the optimal price policy and production rate over a given planning
horizon. However, how an ordinary (i.e., not monopolistic) retailer decides its EOQ is absent
from the literature in Optimal Control Theory. The main reason seems to be the difficulty in
modelling the order quantity for a retailer as an impulsive control in Optimal Control Theory.
In the growth stage of a product life cycle, the demand rate can be approximated well by a
linear form. Consequently, Resh et al. (1976) and Donaldson (1977) established an algorithm to
determine the optimal replenishment number and timing for a linearly increasing demand pattern.
Barbosa and Friedman (1978) then generalized the solutions for various, similar demand models.
Furthermore, Henery (1979) extended the demand to any log-concave demand function.
Following the approach of Donaldson, Dave (1989) developed an exact replenishment policy for
an inventory model with shortages. In contrast to the traditional replenishment policy that does
not start with shortages, Goyal et al. (1992) proposed an alternative that starts with shortages in
every cycle. By using two numerical examples, they suggested that their policy outperforms the
traditional approach. More recently, Teng et al. (1997) investigated various inventory
replenishment models with shortages and mathematically proved that the alternative by Goyal
et al. is, in fact, less expensive to operate than the traditional policy. Hariga and Goyal (1995) then
developed an iterative procedure that is simpler than that of Goyal et al. Teng (1996) proposed a
simple and computationally efficient optimal method in recursive fashion to solve the problem.
In contrast to the traditional EOQ model, we assume that not only the demand function but
also the unit cost is positive and fluctuating with time. As a result, our proposed model is suitable
for any given time horizon in a product life cycle including high-tech products. The proposed
model is developed with shortages. However, we can easily apply it to the case of no shortages
(with shortage cost 5 1).
This paper is structured as follows. In Section 2, we establish the assumptions and notation for
the proposed inventory lot-size models. In Section 3, we prove that the optimal replenishment
schedule not only exists but also is unique. Then we propose a one-dimensional iterative method
to find the optimal replenishment schedule. Moreover, we also show that the relevant cost (i.e., the
sum of the ordering, inventory, shortage and purchase costs) is a convex function of the number
of replenishments. Therefore, the search for the optimal number of replenishments is simplified to
find a local minimum. Furthermore, we provide an intuitively accurate estimate for the optimal
number of replenishments, which significantly reduces computational complexity in finding the
optimal replenishment number. In Section 4, we discuss the influences of both demand and cost
over the length of the replenishment cycle, the economic order quantity and others. Then two
numerical examples are provided to illustrate the theoretical results in Section 5. Finally, we make
a summary and provide some suggestions for future research in the last section.

2. Assumptions and notation

The mathematical model of the inventory replenishment problem here is based on the following
assumptions:
(a) Lead time is zero.
(b) Shortages are allowed and backlogged.
86 J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100
(c) The initial inventory level is zero.
(d) The inventory charge is based on per unit per unit time.

Note that the authors visited a high-tech e-warehouse in Taiwan and learned that the
e-warehouse charged customers based on either the total sales per month (i.e., inventory
charge is related to its value) or the average rented boxes per month (i.e., inventory charge is
related to its size). Similar to the traditional EOQ model, we assume here that the inventory
charge is related to its size. In a second paper, we will deal with the inventory charge related to its
value.
In addition, the following notation is used throughout this paper.

H 5 time horizon under consideration.


f(t) 5 demand rate at time t; we assume without loss of generality that f(t) is greater than zero in
(0, H] and continuous in the planning horizon [0, H].
c(t) 5 purchase cost per unit at time t; we assume that c(t) is greater than zero and differentiable.
co 5 ordering cost per order.
ch 5 inventory holding cost per unit per unit time.
cs 5 shortage cost per unit per unit time.
n 5 total number of replenishments over [0, H] (a decision variable).
ti 5 ith replenishment time (a decision variable), i 5 1, 2, . . . , n.
si 5 time at which the inventory level reaches zero in the ith replenishment cycle (a decision
variable), i 5 1, 2, . . . , n, with ti )si )tiþ1 .
LIi 5 length of the in-stock (or inventory) period in the ith replenishment cycle 5 si  ti, i 5 1, 2,
. . . , n.
LSi 5 length of the out-of-stock (or shortage) period in the ith cycle 5 ti11  si, i 5 0, 1, . . . , n  1.
LCi 5 length of the ith replenishment cycle 5 ti11  ti 5 LIi1LSi, i 5 1, 2, . . . , n  1.
ILi 5 inventory level at time ti, i 5 1, 2, . . . , n.
SLi 5 shortage level on backorder prior to ti11, i 5 0, 1, . . . , n  1.
OQi 5 economic order quantity at ti in the ith cycle 5 ILi 1 SLi  1, i 5 1, 2, . . . , n.

3. Mathematical model and solution

The ith replenishment is made at time ti. The quantity received at ti is used partly to
meet the accumulated shortages in the previous cycle from time si  1 to ti (si  14ti). The inventory
at ti gradually reduces to zero at si (siXti). Then the accumulated shortages increase
until the i11th replenishment at ti11 (si4ti11). The decision maker wishes to know how
many orders to place, when to place the orders and how much to order each time so that
the total relevant cost (which is the sum of the ordering, holding, shortage and purchase costs)
over a finite time horizon [0, H] is minimized. Based on whether the inventory is permitted
to start and/or end with shortages, we have four possible models, which were introduced in
Teng et al. (1997). To ensure no lost sales, the inventory model proposed here is depicted
graphically in Fig. 1.
J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100 87
Inventory
level

Time
s0 =0 t1 s1 t2 s2 t3 ... tn−1sn−1 tn sn =H

Fig. 1. Graphical representation of inventory model.

3.1. Mathematical model

The total relevant cost associated with this inventory model is established as follows:
n Z si
X n Z ti
X
Wðn; fsi g; fti gÞ ¼nco þ ch ðt  ti Þf ðtÞ dt þ cs ðti  tÞf ðtÞ dt
i¼1 ti i¼1 si1

Z ð1Þ
X
n si
þ cðti Þ f ðtÞ dt;
i¼1 si1

where the first term is the ordering costs, the second term is the inventory holding costs, the third
term is the shortage costs, and the last term is the purchase costs. Thus, the problem here is to find
an integer n and a vector of 2n components < t1 ; s1 ; t2 ; . . . ; tn ; sn> such that the total relevant cost
Wðn; fsi g; fti gÞ in (1) is minimized.
For any fixed n, the necessary conditions for Wðn; fsi g; fti gÞ to be minimized are as follows:
@Wðn; fsi g; fti gÞ=@si ¼ 0 and @Wðn; fsi g; fti gÞ=@ti ¼ 0, i 5 1, 2, . . . , n.
Consequently, we have
cðtiþ1 Þ þ cs ðtiþ1  si Þ ¼ cðti Þ þ ch ðsi  ti Þ; i ¼ 1; 2; . . . ; n; ð2Þ
and
Z si Z ti
0 0
½ch  c ðti Þ f ðtÞ dt ¼ ½cs þ c ðti Þ f ðtÞ dt i ¼ 1; 2; . . . ; n: ð3Þ
ti si1
Note that 0 denotes the first derivative with respect to time throughout the paper.

3.2. Theoretical results

Equations (1)–(3) now imply the following theorems:

Theorem 1.
(a) If ch )c0 ðtÞ for all t, then n 5 1 and t1 5 0.
(b) If c0 ðtÞ)  cs for all t, then n 5 1 and t1 5 H.
88 J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100
(c) If ch > c ðtÞ > cs for all t and t1 is unique, then the solution to (2) and (3) is also unique.
0

(d) If ch > c0 ðtÞ > cs for all t, f(t) is log-concave and c(t) is linear, then the solution to (2) and (3)
not only exists but is also unique (i.e., the optimal values of {si } and {ti } are uniquely determined).

Proof. See Appendix 1. &


The results in (a) and (b) of Theorem 1 can be interpreted as follows. For (a), the condition
c0 ðtÞ*ch > 0 means that the increasing rate of unit purchase cost is higher than or equal to the
inventory holding cost. Therefore, buying and storing a unit now is less expensive than buying it
later. Using a similar argument for (b), if c0 ðtÞ)  cs , then c0 ðtÞ*cs > 0 which implies that the
declining rate of unit purchase cost is larger than or equal to the shortage cost. Consequently,
delaying the purchase until the end of the planning horizon H is cheaper than buying it earlier.
Note that neither of these two cases happens in the real world.
Although we proved that the solution to (2) and (3) exists uniquely only under the
conditions that f(t) is log-concave and c(t) is linear, we find that for a variety of continuous
functions of f(t) and c(t), the solution to (2) and (3) still seems to be unique. For example,
see Example 1 in Section 5 below. Consequently, for generality, we assume from now on
that f(t) and c(t) are positive continuous functions such that the solution to (2) and (3) is
unique. In fact, Teng and Yang (2004) proved that if f(t) and c(t) are positive continuous
functions, then the solution to (2) and (3) is unique for a more general EOQ model. Their paper
extends the model to allow for a constant deterioration rate and a partial backlogging rate related
to the waiting time. Their model applies to deteriorating items. It does not consider the important
case of non-deteriorating items. Modifications to take account of this are developed in Theorems
3–5 below.
Note that equations (2) and (3) are also the necessary and sufficient conditions for finding the
absolute minimum Wðn; fsi g; fti gÞ, if the solution to (2) and (3) is unique. From (2), we know that
the optimal value of si (i.e., si ) is the interior point between ti and ti11 because if si 5 ti or ti11, then
equation (2) does not hold. Wðn; fsi g; fti gÞ is a continuous (and differentiable) function
minimized over the compact set [0, H]2n. Hence, there exists an absolute minimum. The optimal
value of ti (i.e., ti ) cannot be on the boundary since Wðn; fsi g; fti gÞ increases when any one of the
ti s is shifted to the end points 0 or H. Consequently, if the solution to (2) and (3) is unique, then
(2) and (3) are the necessary and sufficient conditions for the absolute minimum.
The result in (c) or (d) of Theorem 1 reduces the 2n-dimensional problem of finding
{si } and {ti } to a one-dimensional problem. Since s0 5 0, we only need to find t1 to generate
s1 by (3), t2 by (2) and then the rest of {si } and {ti } uniquely by repeatedly using (3) and (2). For
any chosen t1 , if sn ¼ H, then t1 is chosen correctly. Otherwise, we can easily find the optimal t1 by
standard search techniques. For any given value of n, the solution procedure for finding {si } and
{ti } can be obtained by the algorithm in Yang et al. (2001) with L 5 0 and U 5 H/n.
Next, we show that the total relevant cost Wðn; fsi g; fti gÞ is a convex function of the number of
replenishments. As a result, the search for the optimal replenishment number, n, is reduced to
find a local minimum. For simplicity, let

WðnÞ ¼ Wðn; fsi g; fti gÞ: ð4Þ


J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100 89
By applying Bellman’s (1957) principle of optimality, we have the following theorem:

Theorem 2. If ch > c0 ðtÞ > cs for all t, then W(n) is convex in n.
Proof. Use the same argument as in the proof of Theorem 2 of Teng et al. (1999). &

3.3. An estimate of the optimal replenishment number

Now, we establish an estimate of the optimal number of replenishments, n. If c(t) is linear, then
c(t) 5 a  bt, where a40 and ch4  b4  cs. Consequently, c(ti) 5 c(t)1b(t  ti). Hence, we can
simplify the total relevant cost in (1) as follows.

n Z
X si n Z
X ti
Wðn; fsi g; fti gÞ ¼ nco þ ðch þ bÞ ðt  ti Þf ðtÞ dt þ ðcs  bÞ ðti  tÞf ðtÞ dt
i¼1 ti i¼1 si1
ð5Þ
Z H
þ cðtÞf ðtÞ dt:
0

Using the similar estimate of the optimal number of replenishments as in Teng (1996), we propose
an estimate as

 1=2
ðch þ bÞðcs  bÞQðHÞH
n1 ¼ rounded integer of ; ð6Þ
2co ðch þ cs Þ

where Q(H) is the cumulative demand over the time interval [0, H]. Note that the result in (6) is a
generalization of the corresponding result in Teng (1994, 1996), in which the purchase cost per unit is
constant and the demand rate is linear. If c(t) is not linear, then we simply use b  [c(0) – c(H)]/H in (6)
to estimate n. It is obvious that searching for the optimal number of replenishments by starting with n1
in (6) instead of n 5 1 will reduce the computational complexity significantly. The algorithm for
determining the optimal number of replenishments n and the optimal timing {ti } and {si } can be
obtained by the algorithm in Teng et al. (1997) with n1 in (6).

4. Influences of demand and cost

In this section, we discuss the influences of both demand and unit cost over the following events:
(1) the length of the in-stock period (i.e., LIi 5 si  ti), (2) the length of the out-of-stock period
(i.e., LSi 5 ti11  si), (3) the length of the replenishment cycle (i.e., LCi 5 ti11  ti 5 LIi1LSi), (4)
the inventory level at time ti (i.e., ILi), (5) the number of stockouts prior to ti (i.e., SLi  1), and (6)
the economic order quantity at ti (i.e., OQi).
90 J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100
By applying the Mean Value Theorem into equations (2) and (3), we know that there are li, ui11
and vi with si )li )tiþ1 )uiþ1 )siþ1 and ti )vi )tiþ1 such that
Z siþ1
0 0
ðch  c ðtiþ1 ÞÞðsiþ1  tiþ1 Þf ðuiþ1 Þ ¼ðch  c ðtiþ1 ÞÞ f ðtÞ dt
tiþ1
Z tiþ1
¼ðcs þ c0 ðtiþ1 ÞÞ f ðtÞ dt ¼ ðcs þ c0 ðtiþ1 ÞÞðtiþ1  si Þf ðli Þ
si

cs þ c0 ðtiþ1 Þ
¼ðcs þ c0 ðvi ÞÞ ðtiþ1  si Þf ðli Þ
cs þ c0 ðvi Þ
cs þ c0 ðtiþ1 Þ
¼ðch  c0 ðvi ÞÞðsi  ti Þ f ðli Þ:
cs þ c0 ðvi Þ ð7Þ

Therefore, we have

ch  c0 ðvi Þ cs þ c0 ðtiþ1 Þ f ðli Þ


siþ1  tiþ1 ¼ ðsi  ti Þ : ð8Þ
ch  c0 ðtiþ1 Þ cs þ c0 ðvi Þ f ðuiþ1 Þ

By using a similar argument, we can easily obtain

cs þ c0 ðti Þ ch  c0 ðvi Þ f ðli1 Þ


tiþ1  si ¼ ðti  si1 Þ ; ð9Þ
cs þ c0 ðvi Þ ch  c0 ðti Þ f ðui Þ

Z siþ1 Z si
ch  c0 ðvi Þ cs þ c0 ðtiþ1 Þ f ðli Þ
f ðtÞ dt ¼ f ðtÞ dt ; ð10Þ
tiþ1 ti ch  c0 ðtiþ1 Þ cs þ c0 ðvi Þ f ðui Þ

Z tiþ1 Z ti
cs þ c0 ðti Þ ch  c0 ðvi Þ f ðli Þ
f ðtÞ dt ¼ f ðtÞ dt ; ð11Þ
si si1 cs þ c0 ðvi Þ ch  c0 ðti Þ f ðui Þ

cs þ c0 ðti Þ ch  c0 ðvi1 Þ f ðli1 Þ


tiþ1  ti ¼ ðti  ti1 Þ ; ð12Þ
cs þ c0 ðvi Þ ch  c0 ðti Þ f ðui Þ

and
Z siþ1 Z si
cs þ c0 ðti Þ ch  c0 ðvi Þ f ðli Þ
f ðtÞ dt ¼ f ðtÞ dt ; ð13Þ
si si1 cs þ c0 ðvi Þ ch  c0 ðtiþ1 Þ f ðui Þ

where si )li )tiþ1 )uiþ1 )siþ1 and ti )vi )tiþ1 . Consequently, we have the following
theorem:

Theorem 3. If ch > c0 ðtÞ > cs for all t, then we obtain:


J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100 91

c' (t ) Increasing Constant Decreasing


f (t)
{ LI i } { ILi } { LI i } { ILi } { LI i } { IL i }
Increasing { LS i } { SL i } { LS i } { SL i } { LS i } { SL i }
{ LC i } { OQi } { LCi } { OQi } { LC i } { OQ i }
{ LI i } { ILi } { LI i }= { IL i }= { LI i } { IL i }
Constant { LS i } { SL i } { LS i }= { SL i }=
{ LS i } { SL i }
{ LC i } { OQi } { LC i }= { OQi }= { LC i } { OQi }
{ LI i } { ILi } { LI i } { IL i } { LI i } { ILi }
Decreasing { LS i } { SL i } { LS i } { SL i } { LS i } { SL i }
{ LC i } { OQi } { LC i } { OQ i } { LC i } { OQi }

Note that an up arrow (or down arrow or equal sign) behind a sequence denotes that the sequence is
increasing (or decreasing or constant, respectively) with time. A blank behind a sequence means the
characteristic of the sequence is neither unique nor clear.
Proof. It immediately follows from (8) to (13). &
Theorem 3 reveals that: (a) If f(t) is increasing (or decreasing) and c(t) 5 a  bt where a40,
ch4  b4  cs and t4min{H, a/b}, then the optimal shortage intervals {LSi }, the optimal inventory
intervals {LIi } and the optimal replenishment cycles {LCi } will be decreasing (or increasing) whereas
the optimal order quantities {OQi } will be increasing (or decreasing). A simple economic
interpretation of this result is as follows. Since demand is increasing (or decreasing) with time, we
need to shorten (or enlarge) the shortage intervals as well as the inventory intervals and hence the
replenishment cycles with time in order to lower the shortage cost as well as the holding cost and
hence the total cost. In the meantime, we need to increase (or decrease) the order quantities with time
in order to meet the increasing (or decreasing) demand. (b) If f(t) 5 D and c 0 (t) is increasing (or
decreasing) with ch4c0 (t)4  cs, the optimal shortage intervals {LSi } will be decreasing (or
increasing) whereas the optimal inventory intervals {LIi } will be increasing (or decreasing). A simple
economic interpretation of this is as follows. The marginal cost for storing an additional unit at time t
is ch  c0 (t) and the marginal cost for shortening an additional unit at time t is cs  c0 (t). Consequently,
if c0 (t) increases (or decreases), then the marginal inventory cost will decrease (or increase) whereas the
marginal shortage cost will increase (or decrease). Therefore, if c0 (t) increases, then the optimal
inventory intervals will increase whereas the optimal shortage intervals will decrease and vice versa.
Next, we investigate the conditions under which {LIi}, {LSi}, {ILi} and {SLi} increase or
decrease with time. By assuming li ! vi and ui11 ! ti11, we know from (8) and (11) that
ch  c0 ðvi Þ cs þ c0 ðtiþ1 Þ f ðvi Þ
siþ1  tiþ1  ðsi  ti Þ ; ð14Þ
cs  c0 ðtiþ1 Þ cs þ c0 ðvi Þ f ðtiþ1 Þ
and
Z tiþ1 Z ti
cs þ c0 ðti Þ ch  c0 ðvi Þ f ðvi Þ
f ðtÞ dt  f ðtÞ dt : ð15Þ
si si1 cs þ c0 ðvi Þ ch  c0 ðti Þ f ðti Þ
92 J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100
For convenience, let
NðxÞ ¼ ðch  c0 ðxÞÞf ðxÞ=ðcs þ c0 ðxÞÞ: ð16Þ
We then simplify (14) and (15) as:
siþ1  tiþ1  ðsi  ti ÞNðvi Þ=Nðtiþ1 Þ; ð17Þ
and
Z tiþ1 Z ti
f ðtÞ dt  f ðtÞ dt Nðvi Þ=Nðti Þ; ð18Þ
si si1
respectively. Taking the partial derivatives of N(x) with respect to x, we obtain:
c00 ðxÞf ðxÞðcs þ ch Þ þ ðch  c0 ðxÞÞðcs þ c0 ðxÞÞf 0 ðxÞ
N 0 ðxÞ ¼ ; ð19Þ
ðcs þ c0 ðxÞÞ2
where c00 (x) denotes the second derivative of c with respect to x. For simplicity, let the first
discrimination term
D1 ¼ c00 ðxÞf ðxÞðcs þ ch Þ þ ðch  c0 ðxÞÞðcs þ c0 ðxÞÞf 0 ðxÞ: ð20Þ
Consequently, if DR140, then N(vRi)/N(ti11)o1 and N(vi)/N(ti)41 which in turn imply that siþ1 
t ti
tiþ1 < si  ti and siiþ1 f ðtÞ dt > si1 f ðtÞ dt; respectively. Similarly, let
D2 ¼ c00 ðxÞf ðxÞðcs þ ch Þ þ ðch  c0 ðxÞÞðcs þ c0 ðxÞÞf 0 ðxÞ; ð21Þ
D3 ¼ c00 ðxÞf ðxÞðch  cs  2c0 ðxÞÞ þ ðch  c0 ðxÞÞðcs þ c0 ðxÞÞf 0 ðxÞ; ð22Þ
and
D4 ¼ c00 ðxÞf ðxÞðch  cs  2c0 ðxÞÞ  ðch  c0 ðxÞÞðcs þ c0 ðxÞÞf 0 ðxÞ: ð23Þ
By using a similar argument, we can easily obtain the following theorem.

Theorem 4. If ch > c0 ðtÞ > cs for all t, we obtain:


(a) If D140, then {LIi} & and {SLi} % , else if D1 5 0, then {LIi}  and {SLi}  , else {LIi} %
and {SLi} & .
(b) If D240, then {LSi} & and {ILi} % , else if D2 5 0, then {LSi}  and {ILi}  , else {LSi} %
and {ILi} & .
(c) If D340, then {LCi} & , else if D3 5 0, then {LCi}  , else {LCi} % .
(d) If D440, then {OQi} & , else if D4 5 0, then {OQi}  , else {OQi} % .
Note that the sequence before  denotes that the sequence stays approximately the same at that
time when Di 5 0, for i 5 1, 2, 3, or 4.

5. Subclasses of the general model

While the general formulation discussed in the above section is useful to gain an insight into the
basic concepts as shown in Theorems 1–4, we can obtain stronger results for specific cases.
Consequently, we consider the following two special cases: (a) the case where the unit purchase
J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100 93
cost is either increasing or decreasing linearly while the demand rate is constant, and (b) the case
where the demand is increasing but the unit purchase cost is strictly convex and declining.

5.1. Linear cost and constant demand

In this subsection, we study the case where the purchase cost per unit changes linearly while the
demand rate remains constant. Consequently, the unit purchase cost at time t is c(t) 5 a  bt. If
b40, then the unit purchase cost declines linearly. Otherwise (i.e., bo0), the unit purchase cost
increases linearly. Applying f(t) 5 D and c(t) 5 a  bt to (2) and (3), we obtain the following
theorem:

Theorem 5. If f(t) 5 D and c(t) 5 a  bt, where a40, ch4  b4  cs, and t4min {H, a/b}, then we
obtain the following results:
(a) The total number of replenishments
sffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
ðch þ bÞðcs  bÞD
n¼H : ð24Þ
2ðch þ cs Þco
(b) The optimal order quantity
sffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
2ðch þ cs ÞDco
EOQ ¼ : ð25Þ
ðch þ bÞðcs  bÞ

Proof. See Appendix 2. &

In the traditional EOQ model with a constant purchase cost per unit, storing one unit for a year
costs $ch for the inventory holding cost. In contrast, storing one unit for a year in the model
proposed here costs not only $ch for the inventory holding cost but also $b for the cost adjustment
(because the unit purchase cost is $b more expensive now than a year later). Similarly, shortening
one unit for a year in the traditional EOQ model is $cs for the shortage cost only. However,
shortening one unit for a year in this proposed model costs $cs for the shortage cost but saves $b
for the cost difference (because the unit purchase cost will be $b cheaper a year from now).
Consequently, the results in Theorem 3 are straightforward extensions of the traditional EOQ
model by replacing ch and cs in the traditional EOQ model with (ch1b) and (cs  b), respectively.
Note that if n in (24) is not an integer, then let
$ sffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi%
ðch þ bÞðcs  bÞD
n1 ¼ H ; ð26Þ
2ðch þ cs Þco
where bxc denotes the largest integer not greater than x. Comparing W(n1) with W(n111), we
obtain the optimal number of replenishments as:

 n1 if Wðn1 Þ)Wðn1 þ 1Þ;
n ¼ ð27Þ
n1 þ 1 otherwise:
94 J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100
5.2. Declining cost and increasing demand

In Section 5.1, we studied the case in which demand is constant. As we know, the case only
occurs during the maturity stage of a product life cycle. In contrast to a constant demand, the
demand increases in the growth stage of a product life cycle. Therefore, in this subsection, we
investigate the case where the demand is increasing but the unit cost is strictly convex and
declining.
Example 1. Suppose that the demand function at time t is f(t) 5 150140t, the unit cost is
c(t) 5 200120 exp(  2t), H 5 3, co 5 300, ch 5 50, and cs 5 160 in appropriate units. Applying (6)
with b  [c(0) – c(H)]/H, we have n1 5 11. Hence, we start the search for n with n 5 10 and 11.
The search ends at n 5 11. The optimal values of {ti } and {si } are shown in Table 2. The
minimum total relevant cost is 134,455.49. Since c(t) is convex and f(t) is increasing, we know
from Theorem 3 that {LSi} decreases with time, while {ILi} increases, which is shown in Table 2
below. Note that the numbers in Tables 2–4 are rounded.
Table 2 also reveals that those four discrimination terms in (20)–(23) are remarkably good
estimators for the trends of the corresponding sequences as shown in Theorem 4. For instance, D1
in Table 2 correctly indicates the trends (i.e., up and then down) of both {LIi} and {SLi}.
Likewise, D4 is negative for all i, and hence the order quantity {OQi} is increasing with time.
Next, we compare the difference in total costs obtained by the traditional EOQ model and the
model proposed here.
Example 2. Suppose that the demand function at time t is f(t) 5 270t, the unit cost is
c(t) 5 20170 exp(  1.28t), H 5 1, co 5 200, ch 5 20, and cs 5 90 in appropriate units. The
computational results obtained by our proposed model are shown in Table 3. The corresponding
minimum total relevant cost is 7,975.995. By contrast, using the traditional EOQ model, we
obtain
sffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
 ffi
2ð200Þð135Þ 90 þ 20
Qopt ¼ ¼ 57:446: ð28Þ
20 90

Table 2
The computational results for Example 1
i ti si LIi SLi D1 LSi ILi D2 LCi D3 OQi D4

0 17.709 0.116
1 0.116 0.292 0.176 15.797  1639.83 0.097 27.808 2478.41 0.272  37.61 45.517  876.18
2 0.389 0.582 0.193 14.845  891.03 0.085 32.712 1665.79 0.278  58.4 48.510  833.16
3 0.667 0.869 0.203 14.442  420.54 0.078 36.644 1144.45 0.28 30.67 51.490  693.24
4 0.947 1.154 0.207 14.357  130.03 0.073 39.694 820.11 0.279 123.44 54.136  566.65
5 1.226 1.433 0.207 14.454 46.82 0.069 42.057 622.53 0.276 193.33 56.414  476.02
6 1.502 1.708 0.205 14.649 153.7 0.067 43.937 503.43 0.272 240.27 58.391  416.86
7 1.774 1.976 0.202 14.896 218.22 0.065 45.494 431.8 0.267 270.24 60.143  379.78
8 2.041 2.240 0.199 15.168 257.3 0.063 46.836 388.6 0.262 288.99 61.732  356.92
9 2.303 2.498 0.195 15.450 281.1 0.062 48.033 362.4 0.257 300.61 63.202  342.89
10 2.560 2.751 0.192 15.732 295.69 0.060 49.130 346.41 0.252 307.83 64.580  334.27
11 2.812 3 0.188 304.7 50.153 336.57 65.886  328.96
J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100 95
Table 3
The computational results for Example 2
 
i ti si c ti LCi OQi

1 0.430 0.533 60.353 0.247 38.382


2 0.678 0.786 49.398 0.210 45.116
3 0.887 1 42.477 51.502

Table 4
The computational results for the traditional EOQ model
 
i ti si c ti LCi OQi

1 0 0.348 90 0.426 57.446


2 0.426 0.774 60.602 0.426 57.446
3 0.852 1 43.551 20.109

Thus, the computational results obtained by the traditional EOQ model are shown in Table 4 with
the minimum total relevant cost of 10,557.150. As a result, using the traditional EOQ model is
32.4% more expensive to operate than ours.

6. Conclusions and future research

High-tech products are vital to today’s economy. The traditional EOQ model could not provide a
proper ordering policy for today’s high-tech products. In this paper, we establish not only the
optimal ordering policy but also the optimal purchasing policy for today’s high-tech products.
Consequently, we have made an important and significant contribution to advance the ordering
policy for today’s high-tech products.
In this paper, we assume that not only the demand function but also the purchase cost is
positive and fluctuating with time. Consequently, our model is suitable for any given time horizon
in any product life cycle including high-tech products. In addition, the proposed model is in a
general framework that includes numerous previous models such as Resh et al. (1976), Donaldson
(1977), Barbosa and Friedman (1978), Henery (1979), Dave (1989), Giri et al. (1996) and Teng
(1994, 1996) as special cases. In Section 3, we prove that the optimal replenishment schedule not
only exists but also is unique. In addition, we also show that the total cost associated with the
inventory system is a convex function of the number of replenishments. Hence, the search for the
optimal number of replenishments is simplified to find a local minimum. Furthermore, we provide
an accurate starting value for searching the optimal replenishment number, which is more
computationally efficient than enumerative methods. In Section 4, we characterize the influences
of both demand and unit purchase cost over the length of replenishment cycle, the economic order
quantity, and others. Furthermore, we derive four myopic formulae as the discrimination terms to
identify the up- and down-trends of replenishment length, order quantity and others. The
computational results in Section 5 profoundly justify our theoretical results.
96 J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100
The proposed model can be extended in several ways. For instance, we may consider the
demand as a function of selling price as well as product quality. Also, we could extend the
deterministic demand function to stochastic fluctuating demand patterns. Finally, we could
generalize the model to allow for quantity discounts, deteriorating items and others.

Acknowledgements

The authors would like to thank one of the referees for his constructive comments. This research
was partially supported by the National Science Council of the Republic of China under
Grant NSC-92-2213-E-007-065. In addition, the principal author’s research was supported by the
ART for Research and a Summer Research Funding from the William Paterson University of
New Jersey.

Appendix 1. Proof of Theorem 1

Let
Z si Z ti
Wi ðsi1 ; ti ; si Þ ¼ ðch ðt  ti Þ þ cðti ÞÞf ðtÞ dt þ ðcs ðti  tÞ þ cðti ÞÞf ðtÞ dt;
ti si1

Lðti Þ ¼ ch ðt  ti Þ þ cðti Þ; and Kðti Þ ¼ cs ðti  tÞ þ cðti Þ:


We can easily obtain:
Z si Z ti
@Wi 0
¼  cðti Þf ðti Þ þ ðch þ c ðti ÞÞf ðtÞ dt þ cðti Þf ðti Þ þ ðcs þ c0 ðti ÞÞf ðtÞ dt
@ti ti si1
Z si Z ti ð29Þ
¼ ðch þ c0 ðti ÞÞf ðtÞ dt þ ðcs þ c0 ðti ÞÞf ðtÞ dt; si1 )ti )si ;
ti si1

L0 ðti Þ ¼ ch þ c0 ðti Þ; and K 0 ðti Þ ¼ cs þ c0 ðti Þ: ð30Þ


If c0 ðtÞ*ch , then we know from (29) and (30) that @Wi =@ti *0 and L0 ðti Þ*0. Therefore, both
L(ti) and Wi are increasing with ti. Setting ti to be si  1, we get Wi ðsi1 ; ti ; si Þ*Wi ðsi1 ; si1 ; si Þ for
all i. Similarly, L(ti)XL(t1) 5 L(0) for all i. Consequently, we obtain
n Z si
X Xn Z si
Wðn; fsi g; fti gÞ*nco þ Lðti Þ f ðtÞ dt*nco þ Lð0Þ f ðtÞ dt
i¼1 si1 i¼1 si1
ð31Þ
Z H
*co þ ½ch t þ cð0Þf ðtÞ dt:
0
This completes the proof of (a).
Similarly, if c0 ðtÞ)  cs ; then we have @Wi =@ti )0 and K 0 ðti Þ)0. Setting ti to be si,
we obtain Wi ðsi1 ; ti ; si Þ*Wi ðsi1 ; si ; si Þ. Similarly, Kðti Þ*Kðtn Þ ¼ KðHÞ for all i. Hence,
J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100 97
we get
n Z
X si n Z
X si
Wðn; fsi g; fti gÞ*nco þ Kðti Þ f ðtÞ dt*nco þ KðHÞ f ðtÞ dt
i¼1 si1 i¼1 si1
ð32Þ
Z H
*co þ ½cs ðH  tÞ þ cðHÞf ðtÞ dt;
0

which proves (b).


Since s0 5 0 and t1 is unique, if we can prove that both si generated by (3) and tiþ1 by (2) are
uniquely determined, then we prove (a). Let

Fðtiþ1 Þ ¼ cðtiþ1 Þ þ cs ðtiþ1  si Þ  cðti Þ  ch ðsi  ti Þ: ð33Þ


Since c(t) is differentiable, there exists a k (with ti4k4si) such that

Fðsi Þ ¼ cðsi Þ  cðti Þ  ch ðsi  ti Þ ¼ ðc0 ðkÞ  ch Þðsi  ti Þ < 0: ð34Þ


From F 0 ðtiþ1 Þ ¼ c0 ðtiþ1 Þ þ cs > 0, we know that there exists a unique ti114si such that
F(ti11) 5 0. This implies that ti11 is uniquely determined by (2). Similarly, let
Z si Z ti
Gðsi Þ ¼ ðch  c0 ðti ÞÞ f ðtÞ dt  ðcs þ c0 ðti ÞÞ f ðtÞ dt: ð35Þ
ti si1

We can easily obtain


Z ti
Gðti Þ ¼ ðcs þ c0 ðti ÞÞ f ðtÞ dt < 0; ð36Þ
si1

and G0 ðsi Þ ¼ ðch  c0 ðti ÞÞf ðsi Þ > 0. Thus, there exists a unique si (4ti) such that G(si) 5 0, which
implies that si is uniquely determined by (3).
For (d), we know from Hariga (1996, p. 1239) that if f(t) is positive and log-concave, then we
obtain

½ch  c0 ðti Þ½f ðsi Þ  f ðti Þ


Z Z
0 f 0 ðti Þ si 0 f 0 ðti Þ ti
)½ch  c ðti Þ f ðtÞ dt ¼ ½cs þ c ðti Þ f ðtÞ dt
f ðti Þ ti f ðti Þ si1 ð37Þ
Z ti
0
)½cs þ c ðti Þ f 0 ðtÞ dt ¼ ½cs þ c0 ðti Þ½f ðti Þ  f ðsi1 Þ;
si1

since f 0 ðti Þ=f ðti Þ)f 0 ðtÞ=f ðtÞ, for si1 )t)ti . Differentiating (2) with respect to t1 and re-
arranging terms, we get
   
0 dtiþ1 dsi 0 dsi dti dti
½c ðtiþ1 Þ þ cs   ¼ ½ch  c ðtiþ1 Þ  þ ½c0 ðti Þ  c0 ðtiþ1 Þ : ð38Þ
dt1 dt1 dt1 dt1 dt1
98 J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100
Likewise, differentiating (3) with respect to t1 and re-arranging terms, we have
 
0 dsi dti
½ch  c ðti Þf ðsi Þ 
dt1 dt1
Z si
0 00 dti
þ f½ch  c ðti Þf ðsi Þ  c ðti Þ f ðtÞ dt  ½ch  c0 ðti Þf ðti Þg ð39Þ
ti dt 1
Z ti
dti dsi1
¼ fc00 ðti Þ f ðtÞ dt þ ½cs þ c0 ðti Þf ðti Þg  ½cs þ c0 ðti Þf ðsi1 Þ :
si1 dt1 dt1
Applying (37) into (39), and simplifying terms, we obtain
 
0 dsi dti
½ch  c ðti Þf ðsi Þ 
dt1 dt1
Z si   ð40Þ
00 dti 0 dti dsi1
*½c ðti Þ f ðtÞ dt þ ½cs þ c ðti Þf ðsi1 Þ  :
si1 dt1 dt1 dt1
If c00 (t) 5 0, then using the facts that ds0/dt1 5 0 and dt1/dt1 5 1, we obtain from (40) that ds1/
dt14dti/dt1. It is obvious from (38) that dt2/dt14ds1/dt1. Using (40) and (38) repeatedly, we get
dsn dtn dsn1 dtn1 ds2 dt2 ds1 dt1
> > > >  > > > > ¼ 1 > 0: ð41Þ
dt1 dt1 dt1 dt1 dt1 dt1 dt1 dt1
Therefore, si and ti11 (with i41) obtained by (2) and (3) are monotonic increasing with t1. It is
obvious from (2) and (3) that sn(t1) o H if t1 5 0 and sn(t1) 4 H if t1 5 H. Therefore, there exists a
unique t1 in (0, H) such that sn(t1) 5 H. By using (c), we prove (d).

Appendix 2. Proof of Theorem 5

We know from (2) that the fraction of shortage in each cycle is constant as
ti  si1 ch þ b
¼ ; i ¼ 1; 2; . . . ; n: ð42Þ
si  si1 cs þ ch
Next, we know from Theorem 3 that the length of each replenishment cycle remains the same, as
H/n. Consequently, we have
     
 t1  s0 H cs  b H
t1 ¼ ¼ ; ð43Þ
s1  s0 n cs þ ch n
and
     
H cs  b H
ti ¼ ði  1Þ þ t1 ¼ ði  1Þ þ ; for i ¼ 1; 2; . . . ; n: ð44Þ
n cs þ ch n
J.-T. Teng et al. / Intl. Trans. in Op. Res. 12 (2005) 83–100 99
Substituting (43) and (44) into (1), and simplifying the terms, we get:
 
 ðch þ bÞðcs  bÞDH 2 bH
WðnÞ  Wðn; fti gÞ ¼ nco þ þ a DH: ð45Þ
2ðch þ cs Þn 2
Differentiating (45) with respect to n, and letting the result be zero, we then obtain the optimal
number of replenishments as
sffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
ðch þ bÞðcs  bÞD
n ¼ H : ð46Þ
2ðch þ cs Þco
Therefore, the optimal order quantity is
sffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
 DH 2ðch þ cs ÞDco
EOQ ¼ Dðt2  t1 Þ ¼ ¼ : ð47Þ
n ðch þ bÞðcs  bÞ

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