Systems Engineering — Theory & Practice

Volume 29, Issue 8, August 2009

Online English edition of the Chinese language journal

Cite this article as: SETP, 2009, 29(8): 19–27

Collection Pricing Decision in a Remanufacturing System

Considering Random Yield and Random Demand
LI Xiang1,∗ , LI Yong-jian2 , CAI Xiao-qiang3
1. Research Center of Logistics, College of Economic and Social Development, Nankai University, Tianjin 300071, China;
2. Business School, Nankai University, Tianjin 300071, China;
3. Department of Systems Engineering & Engineering Management, The Chinese University of Hong Kong, Shatin, N.T., Hong Kong

Abstract: In a remanufacturing system considering random yield and random demand, the enterprise pays for the used product to end
users to control the collection quantity. The collection price is determined before the random yield is realized, and the selling price
is determined before the demand randomness is realized. The objective is to maximize the enterprise’s utilization, which is the mean-
variance function of the profit. An optimization model is addressed to derive the analytical solution of the optimal selling price, given
the quantity of remanufactured products. Moreover, the uniqueness of the optimal collection price is proved with consideration of the
risk attitude of the remanufacturer. The extensions to the model are developed and the numerical examples are provided to show the
influence of the parameters on the system.
Key words: remanufacturing; collection pricing; random yield; risk attitude.

1 Introduction
The increasing environmental concern is driving man-
ufacturers to take back and recover the end-of-life products,
thus remanufacturing is rapidly growing in popularity. By
the end of last century, there had been over 73,000 remanu-
facturing firms in America [1] . Some enterprises in China are
also involving themselves in remanufacturing activity. For
example, the first Chinese self-R&D recycle system for toner
cartridge was put into operation in Shanghai in 2006.
However, many management problems have not been
studied and solved, yet, in the remanufacturing field. A most
complicated characteristic of the remanufacturing is the un-
certainty in timing, quantity, and quality of the returns [2] .
One way to mitigate this uncertainty is to pay a collection
price to end users to collect the used product. This ap-
proach grants the firm a control on the used product returns
and thus is widely adopted in the remanufacturing industry.
Even so, not all of the collected cores can be remanufactured
due to the quality uncertainty. Therefore, the random yield
in remanufacturing process is another important factor. Fi-
nally, the demand for the remanufactured product, is usually
stochastic and highly relies on the selling pricing strategy.
All these aspects provide novel challenges to the currently
adopted Remanufacture-to-stock system [3] .
Motivated by the above facts, this article studies the
system with the following features: (1) The collection quan-
tity of used products is dependent on the collection price; (2)
The remanufacturing yield is random; (3) The demand for
the remanufactured product is random and sensitive to the
selling price. The firm first chooses the collection price, then
Received date: May 4, 2007
∗ Corresponding author: Tel: +86-22-23506871; E-mail: xiangli@mail.nankai.edu.cn
Foundation item: Supported by the National Nature Science Foundation(No.70971069, 70501014), and 2009 Humanities and Social Science Youth Foun-
dation of Nankai University NKQ09027.
Copyright c 2009, Systems Engineering Society of China. Published by Elsevier BV. All rights reserved.
inspects the collected used product to check whether they are
qualified for remanufacturing, and finally decides the selling
price after the remanufacturing. We seek to maximize the
expected revenue, when determining the selling price, so the
firm is assumed to be risk-neutral to the demand uncertainty.
On the other hand, we regard the optimization objective as
the weighed mean-variance function of the profit (As shown
in reference [4]) when making the collection price decision.
Therefore, the firm’s risk attitude towards the remanufactur-
ing yield uncertainty is taken into account. We derive the
analytic solution of the selling price and prove the unique-
ness of the optimal collection price. Model extensions and
numerical studies are developed to further analyze the influ-
ence of system parameters.
There have been extensive researches on the remanu-
facturing and reverse logistics. While most of them are re-
garding the reverse logistics networks design and the inven-
tory planning [5] , the literature on used product acquisition
and pricing is limited. Guide et al. [6] were the first to in-
vestigate the quantitative model with collection pricing and
proposed an algorithm to determine the optimal pricing de-
cision. Karakayali et al. [7] developed decentralized supply
chain models to determine the optimal collection price and
selling price of the remanufactured parts. Bakal et al. [8] ex-
plored the collection pricing issue when the remanufacturing
yield is random and price-sensitive. Sun et al. [9] studied
a multi-period problem with exogenous stochastic demands
and collection pricing decisions.
The main contribution of this article is as follows:
 Li Xiang et al./Systems Engineering — Theory & Practice, 2009, 29(8): 19–27
Remanufacturing system
ce cr
r( f ) r( f ) ˜ [
End users Inspection Remanufacturing
r( f ) D  E f
Dispose
Dispose
Figure 1. Remanufacturing system
(1) We consider both the collection pricing and selling
pricing decisions, under the assumption that the demand and
remanufacturing yield are both random. The model is more
realistic and has never been studied in the previous research.
For example, the models in [6–7] are deterministic; the de-
mand in [8] is also deterministic; The article [9] doesn’t con-
sider the selling price decision.
(2) We take account of the firm’s risk attitude towards
the random yield, while all the previous works suppose the
firm as risk-neutral. We find that the yield randomness and
firm’s risk-attitude have great influence on the decisions.
2 Remanufacturing system
Consider that a remanufacturing firm collects used
products from end-users, inspects them, and remanufactures
the qualified ones. The remanufactured product is resold in
the remanufacturing product market. The system is shown in
Figure 1 and the sequence of events is depicted as follows:
(1) The firm determines the collection price f , and the
collection quantity r(f ) is a deterministic function.
(2) The firm inspects the collected used product and the
random yield ξ is realized. The qualified used product is
remanufactured and the unqualified is disposed.
(3) The firm determines the selling price p for the re-
manufactured product.
(4) The stochastic demand D(p) is realized and the un-
sold remanufactured product is disposed.
We make the following assumptions:
(1) The collection quantity r(f ) is linearly increas-
ing in f , that is, r(f ) = α + βf , where α, β > 0 and
f ∈ [f , f ]. This linear functional form of the collection
quantity is adopted in many articles, such as [7] and [8].
(2) The demand for the remanufactured product D(p)
has the formula D(p) = ap−k · ε, where a > 0 is the mar-
ket scale constant, k > 1 is the price-elasticity index, and
ε reflects the random fluctuation of the demand. Suppose
the mean of ε is 1. This multiplicative functional form of
the market demand is adopted in many articles, such as [10],
[11] and [12].
(3) The PDF and CDF of ε are denoted as f (x) and
F (x), respectively. We suppose that ε has a generalized in-
creasing failure rate (GIFR) and limx→∞ x[1 − F (x)] = 0.
GIFR is known to be satisfied by several distributions such
as normal, uniform, as well as the Gamma and Weibull fam-
ilies, subject to parameter restrictions ([13] and [14]). The
condition limx→∞ x[1 − F (x)] = 0 is also satisfied by the
above-mentioned distribution functions. Therefore, both the
above two conditions are very mild assumptions on the dis-
tribution of ε.
(4) The random remanufacturing yield ξ is independent
of the demand randomness ε and the collection price f . This
r( f ) ˜ [ assumption is released in Section 4.2.
Remanufacturing
product market
(5) The inspection cost and remanufacturing cost for
each used product are ce and cr , respectively. The disposal
costs of the unsold remanufactured product and unused used
D( p) apk ˜ H
product are both supposed to be 0. This assumption is re-
leased in Section 4.3.
The firm sequentially determines the collection price f
for the used product and the selling price p for the reman-
ufactured product. For the selling price decision p at the
second step, the random yield ξ has been realized and the
expected selling revenue is maximized. For the collection
price decision f at the first step, the utility incorporating the
risk-attitude towards random yield ξ is maximized.
3 Model and analysis
We formulate the model as a two-step stochastic dy-
namic programming problem.
(1) Selling pricing problem:
π1 (q) = max π2 (p|q) (1)
p≥0
where π2 (p|q) = E{p · min(D(p), q)}.
In this problem, the selling price p is chosen to max-
imize the expected revenue π2 (p|q), for any given remanu-
factured product q. The maximal expected revenue π1 (q) is
a function of the quantity of the remanufactured product q.
(2) Collection pricing problem:
max U (f ) = E[π(f )] + γD[π(f )] (2)
f
where
π(f ) = −(f + ce )(α + βf ) − cr (α + βf )ξ+
π1 ((α + βf )ξ).
In this problem, the collection price f is chosen to max-
imize the utility of the firm U (f ). In Eq. (2), π(f ) is the
profit with the collection price f , while U (f ) is a mean-
variance function. And γ is a coefficient measuring the risk
attitude of the firm: γ > 0/γ < 0/γ = 0 indicates that the
firm is risk-loving/risk-averse/risk-neutral.
Here we adopt the mean-variance objective widely used
in the portfolio theory, where most investors are considered
as risk-averse. However, in our generalized model, we in-
corporate the case that the firm is a risk-lover, as long as the
risk preference γ is not too large.
3.1 Analysis
(1) Selling pricing problem
Substituting D(p) = ap−k · ε into Problem (1), we ob-
tain: max Eε {p min(ap−k ε, q)}.
p≥0
Let z = q/(ap−k ). We call z a stocking factor, and
this transformation is widely used in the literature on joint
inventory-pricing decision [10]. Then the Problem (1) can be
transformed into a problem choosing the optimal z to maxi-
mize
az q
π1 (z|q) = E{( )1/k · min(q, ε)} (3)
q z
 Li Xiang et al./Systems Engineering — Theory & Practice, 2009, 29(8): 19–27

Theorem 1. (1) π1 (z|q) is a unimodal function of z;

4 2000
The optimal stocking factor z0 is the unique solution charac-
terized by *
Optimal collection price f
 z
(k − 1) xf (x)dx = z[1 − F (z)] (4)

Optimal collection price

0

Maximized utility
(2) The optimal selling price is p∗ = ( azq 0 )1/k ; The maximal 2 1000

expected revenue is π1 (q) = a1/k A · q (k−1)/k , where Maximized utility U

k 1/k
A= z F (z0 ) (5)
k−1 0
is a constant determined by the distribution of ε and the value
of k. 0
−0.1 −0.05 0 0.05
0
0.1
Proof. (1) The proof is similar to that in [12] and thus Risk attitude γ (k=2.5)

omitted here. (2) It is easy to obtain the optimal selling price

as p∗ = ( azq 0 )1/k by the definition of z. The maximal ex-
pected revenue can be obtained by substituting z0 into (3).
2
From Theorem 1, we have the following observations:
the optimal selling price is increasing in the market scale,
and decreasing in the remanufactured product quantity and
the price-elasticity; The maximal expected revenue is in-
creasing in the market scale and the remanufactured product
quantity. When k > 2, the expected revenue is more sen-
sitive to the change of the remanufactured product quantity;
When 2 > k > 1, the expected revenue is more sensitive to
the market scale.
(2) Collection pricing problem
Since π1 (q) = a1/k A · q (k−1)/k , the firm’s profit func-
tion is,
π(f ) = −(f + ce )(α + βf ) − cr (α + βf )ξ
+ a1/k A(α + βf )(k−1)/k ξ (k−1)/k
Let Eξ = τ , we have
Eπ(f ) = −(f + ce + τ cr )(α + βf )
+ a1/k A(α + βf )(k−1)/k τ (k−1)/k ,
and
Dπ(f ) = c2r (α + βf )2 Dξ
+ a2/k A2 (α + βf )2(k−1)/k Dξ (k−1)/k
− 2a1/k Acr (α + βf )(2k−1)/k cov(ξ, ξ (k−1)/k ).
Theorem 2. The collection price f that maximizes the
expected profit Eπ(f ) is characterized by
k − 1 1/k (k−1)/k
α+β(ce +τ cr ) = −2βf + βa Aτ (α+βf )−1/k
k
(6)
Proof. Differentiating Eπ(f ) yields
dEπ(f ) = −α − β(c + τ c ) − 2βf
df e r
k−1 1/k (k−1)/k
+ k βa Aτ (α + βf )−1/k ,
Figure 2. Effect of risk attitude γ on the collection price
and maximized utility
Corollary 1. When γ = 0, the optimal collection price
and the maximal expected profit is only relative to the mean
of ξ and independent on its specific distribution.
Proof. Let f0 be the unique solution of Eq. (6). From
the proof of Theorem 2, the optimal collection price f ∗ is
only one of values f0 , f , and f when r = 0. The value and
the resulting expected profit is only relative to the mean of ξ
and independent on its specific distribution. 2
The above results indicate that the uncertainties both in
the market demand and in the remanufacturing yield have
different effects on the remanufacturing system. The vari-
ance of the demand exerts influence on the expected profit,
while the variance of remanufacturing yield does not.
Theorem 3. There exists a r0 > 0 such that when
|r| ≤ r0 , the collection price that maximizes the utility U (f )
is unique.
2
Proof. Let B1 (f ) = d dEπ(f )
B (f ) = d2 Dπ(f ) ,
yf 2
and 2 df 2
d2
U (f )
we have df 2 = B1 (f ) + rB2 (f ). Note B1 (f ) < 0,
so | B 1 (f )
B2 (f ) | is bounded and continuous in [f , f ], and it has a
unique positive minimizer. Let it be r0 , then when r < r0 ,
2
we have d dUf(f 2
)
= B1 (f ) + rB2 (f ) < 0 and U (f ) is strictly
concave. The optimal collection price is, therefore, unique.
2
4 Numerical analysis and model extensions
4.1 Numerical analysis
In this section we investigate the model with numeri-
cal experiments to obtain more managerial insights, which
can not be derived by the theoretic analysis. Moreover, the
model is extended into two more generalized cases.
The basic data is set as follows.

and α = 30; β = 8; ce = 2; cr = 8; a = 500000;

2 μ = 1; σ = 0.2; τ = 0.7; Δ = 0.2; f = 0; f = 25
d Eπ(f ) k−1
2
= −2β− 2 β 2 a1/k Aτ (k−1)/k (α+βf )−(k+1)/k < 0.
df k
where ε and ξ follow the normal distribution N (μ, σ) and
Therefore, Eπ(f ) is strictly concave in f and the collection the uniform distribution U (τ − Δ, τ + Δ), respectively.
price maximizes Eπ(f ) is characterized by Eq. 6. 2 (1) Effect of risk attitude γ
 Li Xiang et al./Systems Engineering — Theory & Practice, 2009, 29(8): 19–27

4
x 10
680 25 5

670
20 4

Optimal collection price

660

Maximized utility
Optimal collection price f*
Expected profit

15 3

650

10 2
640

5 1
630 Maximized utility U

620 0 0
−0.1 −0.05 0 0.05 0.1 1.5 2 2.5
Risk attitude γ (k=2.5) Price−elasticiy k (γ=0.05)

Figure 3. Effect of risk attitude γ on the expected utility Figure 5. Effect of price-elasticity k on the collection price
and maximized utility (risk-loving)

Figure 2 shows that the optimal collection price is in-

(3) Effect of the uncertainty in the remanufacturing
creasing in the risk-love degree and decreasing in the risk-
yield
averse degree. This is because the increase in the collection
From the previous analysis we have known that the ex-
price raises not only the value but also the uncertainty of the
pected profit is dependent on the mean of remanufacturing
collection quantity, which is good for the risk-lover and bad
yield while it has no relationship with the specific distribu-
for the risk-averser. And the firm’s utility is increasing in the
tion. So, the decision and utility of a risk-neutral firm is
risk attitude index. Figure 3 shows that the expected profit
not relevant to the uncertainty in the remanufacturing yield.
is maximized by the risk-neutral firm and decreases in either
Thus, we consider the effect of uncertainty in the remanufac-
the risk-averse or risk-love degree.
turing yield when the firm is not risk-neutral. The data in the
(2) Effect of price-elasticity k numerical experiments is the same as previously mentioned,
Figures 4-6 show the different effects of price-elasticity except that we vary the value of δ, which measures the yield
k on the optimal collection price and the maximized utility uncertainty, for the cases with different γ.
when the risk attitude is γ = 0, γ = 0.05, and γ = −0.02, Figures 7 and 8 show the different effects of the un-
respectively. For the risk-neutral and risk-loving firms, the certainty in the remanufacturing yield on the optimal collec-
collection price is decreasing in the price-elasticity. How- tion price and the maximized utility, when the risk attitude
ever, for the risk-averse firm, the collection price is first in- is γ = 0.05, and γ = −0.05, respectively. The collection
creasing and then decreasing in the price-elasticity. On the price is increasing/decreasing in the uncertainty for the risk-
other hand, the maximized utility is decreasing in the price- loving/risk-averse firm. This is because that, when the uncer-
elasticity for all cases. Therefore, the firm has an incentive tainty increases, raising the collection price would increase
to decrease the price sensitivity of customers by marketing the profit variance and thus good/bad for the risk-loving/risk-
and advertising, no matter what the risk-attitude of the firm averse firm. On the other hand, the maximized utility is also
is. increasing/decreasing in the uncertainty for the

14 14000 3 6000

Optimal collection price f*

12 12000

10 10000
Optimal collection price
Optimal collection price

2 4000
Optimal collection price f*
Maximized utility
Maximized utility

8 8000

6 6000

1 2000
4 4000 Maximized utility U
Maximized utility U

2 2000

0 0 0 0
1.5 1.6 1.7 1.8 1.9 2 2.1 2.2 2.3 2.4 2.5 1.5 2 2.5
Price−elasticity k (γ=0) Price−elasticity k (γ=−0.02)

Figure 4. Effect of price-elasticity k on the collection price Figure 6. Effect of price-elasticity k on the collection price
and maximized utility (risk-neutral) and maximized utility (risk-averse)
 Li Xiang et al./Systems Engineering — Theory & Practice, 2009, 29(8): 19–27

12 5500 2700
Star: optimal collction price f*
2600
11 Diamond: maximized utility U 5000
2500

10 4500 2400
Optimal collction price

Maximized utility

Expected profit
2300
9 4000
2200

8 3500 2100

2000
7 3000
1900

6 2500 1800
0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.18 0.2 0 5 10 15
Uncertainty in remanufacturing yield Δ (k=2,γ=0.05) Optimal collection price f (k=2)

Figure 7. Effect of uncertainty in remanufacturing yield on Figure 9. Relationship of collection price and expected profit.
the collection price and maximized utility (risk-loving)
4.3 Extension 2: the salvage value is nonzero
Denote the disposal costs of unqualified used product
risk-loving/risk-averse firm, which is an intuitive result. and unsold remanufactured product as s1 and s2 , respec-
tively. The above discussion is based on the assumption
4.2 Extension 1: The remanufacturing yield is sensitive s1 = s2 = 0. Nevertheless, in some cases the disposal
to the collection price costs can not be neglected since disposing the used product
In the previous model, we supposed that the remanu- is costly (s1 > 0) or the salvage value of the remanufactured
facturing yield is an exogenous random variable. In reality product is high (s2 < 0). In this case the uniqueness of the
the end-user might be stimulated to return the used product optimal collection price is also difficult to prove and thus the
with better quality, if the collection price offered is higher. numerical study is required. Suppose s1 ≥ s2 , which is a
Thus the remanufacturing yield could be related to the col- reasonable assumption indicating that the salvage value of
lection price. Bakal et al. [8] studied such a case and we the remanufactured product is higher than that of the used
adopt their assumption on the mean of the yield τ = ff+m product.
+n ,
where m < n. We only maximize the expected profit and do First, extensive numerical experiments show that the
not consider the firm’s risk attitude any more. It is difficult to uniqueness of the collection price is valid since the utility
theoretically prove the uniqueness of the optimal collection function is still concave. For example, Figure 11 shows the
price in this case. However, extensive numerical experiments relationship between the maximized utility and the collec-
show that the uniqueness holds since the concavity of the ex- tion price when k = 2.5, γ = 0.03, s1 = 3, s2 = −2.
pected profit is still valid. For example, Figure 9 shows the Second, Figure 12 shows that both the optimal collec-
relationship between the expected profit and the collection tion price and the maximized utility are increasing in s1 , for
price when k = 2. And the expected profit also decreases in the risk-averse and risk-neutral firms. However, for the risk-
the price-elasticity as Figure 10 indicates. lover, the optimal collection price and the maximized utility
are decreasing in s1 , as Figure 13 illustrates. This is because
the increased variance compensates the

6 3000

Optimal collection 9950

*
price f
9940
Optimal collection price

4 2000
9930
Maximized utility

Maximized utility

9920
Maximized utility
U
9910
2 1000

9900

9890
0 0
0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.18 0.2
Uncertainty in rmanufacturing yield Δ (k=2,γ=−0.05) 9880
12 12.5 13 13.5 14 14.5 15
Collection price f
Figure 8. Effect of uncertainty in remanufacturing yield on
the collection price and maximized utility (risk-averse) Figure 10. Relationship of collection price and maximized utility
 Li Xiang et al./Systems Engineering — Theory & Practice, 2009, 29(8): 19–27

4
x 10
4 2500 18 1.46

Optimal collection price f*

17.5 1.44

Optimal collection price

Optimal collection price

Maximized utility
17 1.42

Maximized uility
Optimal collection price f*

2 2000
Maximized utility U 16.5 1.4

16 1.38
Maximized utility U

0 1500
−4 −3 −2 −1 0 1
Dispose cost s1 (k=2,γ=−0.01,s2=−5)
Figure 11. Effect of disposal cost s1 on the collection price
and maximized utility (risk-averse)
decreased expected profit caused by the raise of the disposal
cost. As for s2 , on the other hand, the optimal collection
price and the maximized utility are always decreasing in s2 .
Figure 14 shows the case when γ = 0.03.
Finally, we point out that the above numerical experi-
ments are based on the normally distributed market demand
and uniformly distributed remanufacturing yield. It can be
verified that the above results still hold for any kind of de-
mand distribution, as long as the yield follows a uniform one.
We adopt the uniform distribution for the yield in that: first,
it is commonly used when the information of a random vari-
able is scarce; Second, it is easy to observe the influence of
uncertainty of the yield. It requires further the study in the
case of a more generalized distribution of the remanufactur-
ing yield.
5 Conclusions
This article studies the collection pricing and selling
pricing decisions in a remanufacturing system, where the re-
manufacturing yield and market demand are both random.
18
16
Optimal collection price
15.5 1.36
−4 −3 −2 −1 0 1 2 3 4 5
Dispose cost s2 (k=2,γ=0.03,s1=5)
2 3 4 5
Figure 13. Effect of disposal cost s2 on the collection price
and maximized utility
The expected revenue is maximized regarding the selling
price decision, while the optimization objective incorporates
the risk attitude with respect to the collection pricing deci-
sion. We find that the expected profit and pricing decisions
are only related to the mean of the remanufacturing yield
and has no relationship with the specific distribution, when
the firm is risk-neutral. The uniqueness of the optimal col-
lection pricing decision is also proven when the risk attitude
is considered. The numerical experiments are provided to
study the parameter effects on the system and two extensions
of the model are further explored.
Future research directions include the employment of
our single-period model in a general multi-period planning
situations. Moreover, the collection quantity of used prod-
ucts could also be stochastic, although the collection pricing
mechanism mitigates the uncertainty. Finally, the decentral-
ized scenario and coordination issue on the reverse supply
chain management are important future directions when a re-
manufacturer contracts with a collector to acquire used prod-
ucts.
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