European Journal of Operational Research 152 (2004) 770–780

www.elsevier.com/locate/dsw

Production, Manufacturing and Logistics

A returns policy for distribution channel coordination

of perishable items
Kyu Hun Hahn a, Hark Hwang b,*
, Seong Whan Shinn c

a
Management Consulting Services, Price Waterhouse Coopers, Asem Tower, 159-1 Samsung-dong, Kangnam-ku,
Seoul 135-798, South Korea
b
Department of Industrial Engineering, Korea Advanced Institute of Science and Technology (KAIST), 373-1 Gusung-dong,
Yusung-gu, Taejon 305-701, South Korea
c
Department of Industrial Engineering, Halla University, San 66, Heungup, Wonju, Kangwon-do 220-712, South Korea
Received 4 April 2001; accepted 20 September 2002

Abstract

This paper deals with a retailerÕs operating policies for a perishable product when he agrees with his supplier not to
return the unsold product to his supplier provided that the supplier gives some discount on the wholesale price. Math-
ematical formulations are developed based on a periodic-review inventory model under LIFO and FIFO issuing policies.
The demand rate is assumed to be a function of the retail price and instantaneous inventory level. Decision variables
are the amount of supplierÕs price discount that the retailer can accept in return for adopting the no-returns condition,
the retail price and order size. Also, numerical examples are solved with Tabu search algorithm for sensitivity analysis.
Ó 2002 Elsevier B.V. All rights reserved.

Keywords: Perishable product; Periodic-review inventory model; LIFO; FIFO; Returns policy

1. Introduction service and information that add value for cus-

Supply chain management (SCM) is a term that
has grown significantly in use and popularity since
the late 1980s. Many people use the term as a
substitute or synonym for logistics. However, as
stated by Lambert et al. [7], the definition of SCM
can be defined much broader than logistics. SCM
is the integration of business process from end user
through original suppliers that provides products,
*
Corresponding author. Tel.: +82-42-869-3113; fax: +82-42-
869-3110.
E-mail address: hhwang@mail.kaist.ac.kr (H. Hwang).
tomers. SCM represents a relatively new way of
approaching business, and different views exist
regarding the processes involved. The key pro-
cesses typically would include: customer relation-
ship management, customer service management,
demand management, order fulfillment, manufac-
turing flow management and procurement.
Coordination among manufacturers (suppliers),
distributors and retailers is a very important stra-
tegic issue in SCM. One of the important subjects
related to the channel coordination is returns
policy. Returns policy is commitment by supplier
(manufacturer) or distributor upstream to retrieve
excess inventories from downstream channel

0377-2217/$ - see front matter Ó 2002 Elsevier B.V. All rights reserved.
doi:10.1016/S0377-2217(02)00753-1
 K.H. Hahn et al. / European Journal of Operational Research 152 (2004) 770–780
member. The format of returns policies varies in
across industries. A most generous policy promises
to refund all returned products with full wholesale
price, while less generous policies offer credits
against future orders. Partial returns policy gives
only partial credit or refund for returned products.
There are some research works into the reasons
why manufacturers might accept returns from re-
tailers. Pasternack [13] examined how a manufac-
turer could utilize returns policies to induce
multiple retailers to carry an optimal level of
stocks. Padmanabhan and Png [12] presented a
framework that explains when and how to adopt
returns policies and analyzed the benefits and costs
of accepting returns from distributors. Tayur et al.
[16] provided major findings on returns policy in
the supply contract literature.
Most foodstuff, photographic film and phar-
maceutical products have their expiration date,
that is, they have a fixed known lifetime. Any
units, which remain unsold by their expiration
date, are considered outdated, and must be re-
moved from inventory to be discarded with dis-
posal cost or sold at discounted price. In this
regard, a number of research papers appeared
which deal with the inventory model for the per-
ishable product. Fries [5] examined the optimal
ordering policy for the perishable products. Nose
et al. [11] discussed a perishable inventory system
with stochastic procurement lead-time under both
last-in-first-out (LIFO) and first-in-first-out
(FIFO) policy. Also, Nandakumar and Morton
[10] derived near myopic bounds on the order
quantities and used the bounds to develop heu-
ristics. Recently, Perry and Posner [14] considered
an ðS  1; SÞ system in which an order for exactly
one item is placed at each time that a demand is
satisfied as well as at each occurrence of an out-
dating of an item.
For retailer who deals with foodstuff such as
fishcakes or milk, the dependency of sales volume
on the amount of inventory displayed, as well as
the perishable nature of the product, become im-
portant factors in the determination of his pro-
curement policy. Levin et al. [9] reported that sales
at the retail level tend to be proportional to in-
ventory level and a large pile of goods displayed
will lead the customer buy more. Baker and Urban
771
[3] studied a basic model in which the demand rate
is a function of the inventory level. Datta and Pal
[4] extended the model to the case in which the
demand rate of an item is dependent on the in-
stantaneous inventory level until a given inventory
level is achieved, after which the demand rate be-
comes constant. They assumed that at the end of
each cycle, the inventory level is zero. Noting that it
can be more profitable to have higher inventory
levels which result in greater demands, Urban [17]
relaxed the terminal conditions of zero ending in-
ventory. Recently, Hwang and Hahn [6] evaluated
an optimal procurement policy for the perishable
item with an inventory-level-dependent demand
rate in FIFO issuing policy. Another important
factor related to the variation of the customerÕs
demand rate is retail price. Many research papers
examined the inventory model assuming that the
customerÕs demand rate is a decreasing function of
selling price. Abad [1] and Lee [8] dealt with the
joint price and lot size determination problem
when the supplier offers all-unit quantity discounts.
Also, Shinn et al. [15] introduced the retailerÕs price
and lot size determination problem under the
condition of permissible delay in payments.
Recently, in Korea, a new marketing practice is
drawing attentions from some suppliers (manu-
facturers) and large-scale retailers in dealing with
perishable consumer goods. It has been customary
for the retailers to return the goods unsold until
their expire date of its validity time. Thus the re-
tailers did not give much attention to their order-
ing policy since the items outdated could be simply
returned to the supplier at almost no cost, which
made the supplier quite perplexed. In the new
practice, in return for the suppliers to offer a lower
unit price to the retailers, they are not permitted
returning the goods unsold to the suppliers. As a
result, the suppliers become able to maintain better
accounting and inventory systems while the re-
tailers can lower the unit retail price, which, in
turn, increases the product demand from con-
sumers. Consequently, both parties are enjoying
higher financial gains in addition to the satisfied
customers. In other words, the benefits coming
from the decreased quantity of outdated goods
and increased sales are being shared among the
suppliers, retailers and customers.
772 K.H. Hahn et al. / European Journal of Operational Research 152 (2004) 770–780
This paper is motivated by the new market
practice and attempts to gain an insight into the
question of Ôhow costs/benefits can be distributed
over the related parties such that everyone of them
have benefits from itÕ. We will analyze the new
practice from the retailerÕs point of view by ad-
dressing the following problems: (1) the discount
rate the retailer can accept on the current sup-
plierÕs unit selling price in return for his accep-
tance of no return policy, and (2) determination of
the new unit retail price and order size that max-
imize his profit. For the study, we adopt an EOQ-
type model where an order is assumed to be
placed automatically at the end of each unit
period.
Some literature on fixed-lifetime item assumed
that retailer enforces a FIFO issuing policy in the
interest of minimizing outdates. In reality, many
retailers arrange their goods from the oldest up or
front to the new items down or back so that the
customers may pick the oldest goods. But many
customers select the newest items at the stack that
will generally results in a LIFO policy. Thus in this
study, the effects of the two issuing policies are
investigated through the development of mathe-
matical models. The remainder of this paper is
organized as follows. In Section 2, we describe the
assumptions and notations adopted for this study.
Considering the supplier–retailer relationships
under the new market practice, Section 3 develops
models based on a periodic-review inventory
model under LIFO and FIFO for the retailerÕs
problem. In Section 4, to examine how the pro-
posed model behaves under the two different
issuing policies, numerical examples are solved by
Tabu search algorithm. Finally, concluding re-
marks appear in Section 5.
2. Assumptions and notations
The following assumptions and notations are
used to develop the model:
Assumptions
(1) The system consists of single supplier and sin-
gle retailer.
(2) The retailer adopts a single critical number
(Ôorder-up-toÕ) inventory ordering policy with
periodic review. That is, at the end of each unit
period, the inventory level is reviewed and or-
ders are placed.
(3) The supplier processes the retailerÕs orders by
lot-for-lot and each order is satisfied instanta-
neously.
(4) The lifetime of the perishable item is known
and constant (deterministic), i.e., it is assumed
as a multiple m of a unit time period.
(5) Demand is deterministic and decreasing with
respect to the retailerÕs unit retail price P and
increasing with respect to the instantaneous in-
ventory level i. Thus the demand rate Dði; P Þ
of the item is expressed as
ib
Dði; P Þ ¼ a ; 0 < b < 1; c > 1;
Pc
where a is a scale parameter, b is a shape pa-
rameter which measures the responsiveness of
the demand rate to changes in the level of on-
hand inventory, and c is the index of price
elasticity.
(6) LIFO and FIFO issuing policies for a perish-
able item are considered.
(7) Replenishments are instantaneous with zero
leadtime. So all ordered units arrive new and
fresh, that is, their age equals zero.
(8) The time horizon of the inventory model is
infinite.
(9) The salvage value or disposal cost of retailer
is the same as those of the supplier.
Notations
(1) About supplier
Cs setup cost for each setup of the supplier
Cu unit producing cost of the supplier
Ps unit selling cost of the supplier ð¼ Cp Þ
(2) About retailer
S order up to level of the retailer (decision
variable)
P unit selling price of the retailer (decision
variable)
Qt the order size at time t
 K.H. Hahn et al. / European Journal of Operational Research 152 (2004) 770–780
iðtÞ the inventory level at time t
Ib the inventory level of the retailer at the
end of cycle before outdating
Ia the inventory level of the retailer at the
end of cycle after outdating
Cp unit purchasing cost of the retailer from
the supplier
Co retailerÕs procurement cost paid per order
Ch unit inventory holding cost of the retailer
per unit time
Cw disposal cost per unit outdated. Negative
Cw indicates the unit salvage value for the
outdated units where Cw < Cp
3. Development of the model
In the model, the inventory level is reviewed at
each unit period and orders are placed only at the
beginning of each period. The order quantity Q is
just the difference between the current available
inventory level and order up-to level S. Also, from
the dependency of sales volume on the amount of
inventory displayed, the quantity demanded will
be greater at a high level of inventory, and so at
the beginning of a cycle the inventory level de-
creases rapidly. As the inventory is depleted, the
quantity demanded decreases at a decreasing rate.
Considering the potential profits expected from a
high demand rate associated with a high level of
inventory, it might be desirable to order a larger
quantity allowing some unsold stocks be outdated.
Thus, at the end of each cycle, the items whose age
is m time periods, if any, will be disposed of.
Now, we investigate the changes of inventory
level during a repetitive order cycle. There is no
need to study the stock out case since without in-
ventory no demand is created. The differential
equation describing the instantaneous states of
inventory level iðtÞ in the cycle is given by
diðtÞ
b
a½iðtÞ
¼ ; 0 < t < 1:
dt Pc
Solving the differential equation (1) with the
initial condition iðtÞ ¼ S at t ¼ 0, we have

1=ð1bÞ
1b að1  bÞt
iðtÞ ¼ S  ; 0 < t < 1: ð2Þ
Pc
773
So, the inventory level Ib at the end of period
before outdating is

1=ð1bÞ
að1  bÞ
Ib ¼ ið1Þ ¼ S 1b  : ð3Þ
Pc
And, the number of items carried as inventory
during the period is
Z 1
Pc
H¼ iðtÞ dt ¼ fS 2b  Ib2b g: ð4Þ
0 að2  bÞ
3.1. LIFO model
In this model, we assume that the inventory is
depleted according to the last-in-first-out (LIFO)
issuing principle. In LIFO, customers select the
last-in item from the displayed goods. Thus during
each period, the products which were delivered at
the beginning of the period will be sold first. At the
end of the period, the products whose age is m time
periods, if any, will be disposed of. That is, if a
newly arrived lot is not sold out during each pe-
riod, the remaining products will be eventually
outdated at some future period. Fig. 1 shows a
pictorial representation of the inventory levels
under the proposed policy.
Let time t0 be a reorder point as shown in Fig.
1. If some products in the inventory are outdated
at t0 , those are part of the quantity received at the
time t0  m. Let Wt0 m be the outdated quantity at
t0 . The inventory at t0 before receiving Qt0 consists
of the unsold products Wi , i ¼ t0  ðm  1Þ;
t0  ðm  2Þ; . . . ; t0  1. Note that due to the static
nature of the problem, Wi ¼ W and Qi ¼ Q for
every i where W is the number of items that are
outdated at the end of period and Q the order
quantity. Therefore, Ib ¼ mW and Ia ¼ ðm  1ÞW .
Thus W can be expressed as

1=ð1bÞ
1 1 1b að1  bÞ
W ¼ Ib ¼ S  : ð5Þ
m m Pc
ð1Þ
The following property holds on the retailerÕs
order quantity under LIFO issuing principle.
Property 1. In an optimal solution under LIFO,
the retailer’s order quantity Q, Q > W , becomes
S ðm  1ÞW .
774 K.H. Hahn et al. / European Journal of Operational Research 152 (2004) 770–780

Inventory level
S

Q
Ib
W
Ia

(m-1)W
m

1 m time
0

to - m to- (m-1) to
Fig. 1. An inventory time plot with inventory-level-dependent demand rate and LIFO issuing policy.

Now, we formulate the average net profit of the outdated products. Then the retailerÕs profit would
retailer under returns policy. In this case, the be reduced by the amount of the DRC, if no
supplier promises to refund all returned products compensation measure were undertaken. The DRC
with full wholesale price, and so any disposal re- can be expressed as
lated costs (DRCs) would not occur to the retailer.
DRCðS 0 ; P 0 Þ ¼ ðCp þ Cw ÞW
Thus the retailerÕs average net profit p0LIFO ðS; P Þ
can be formulated as follows: 1
¼ ðCp þ Cw Þ
m
p0LIFO ðS; P Þ ¼ Sales revenue  Purchasing cost
1=ð1bÞ
1b að1  bÞ
 Holding cost  Ordering cost
ðS 0 Þ  c ; ð8Þ
ðP 0 Þ
¼ P ðQ  W Þ  Cp ðQ  W Þ
where ðS 0 ; P 0 Þ are the optimal values from Eq. (6).
 Ch H  Co : ð6Þ And the retailerÕs average net profit under no-
returns policy pN 0 0
LIFO ðS ; P Þ would become
And the objective of this problem is to find an
optimal order up-to level S and selling price P , pN 0 0 0 0 0 0 0
LIFO ðS ; P Þ ¼ pLIFO ðS ; P Þ  DRCðS ; P Þ: ð9Þ
which maximizes p0LIFO ðS; P Þ. Once optimal values, 0 0
We assume that DRCðS ; P Þ > 0. Otherwise,
S 0 and P 0 , are found, with the assumption (3) the
there is no motivation for the supplier to alter the
supplierÕs average net profit p0S ðS 0 ; P 0 Þ can be ex-
current marketing policy. In return for accepting
pressed as follows:
the supplierÕs request, it is natural for the retailer
p0S ðS 0 ; P 0 Þ ¼ Sales revenue  Production cost to ask some kind of compensating measures
commensurate to DRCðS 0 ; P 0 Þ. Among possible
 Setup cost  Disposal cost
measures, the supplier offers lowering the present
¼ Cp ðQ0  W 0 Þ  Cu Q0  Cs  Cw W 0 ; unit selling cost. From the retailerÕs point of view,
ð7Þ it is natural that the level of discount must be large
0 0
enough to maintain his current profit.
where W and Q are from Eq. (5) and Property 1, Let r be the unit discount amount he can expect
respectively. from the supplier. Then the following relation
Now, we turn to the new marketing practice, needs to be held:
no-returns policy. Suppose that the supplier re-
quests the retailer not to return his unsold and rQ P DRCðS 0 ; P 0 Þ: ð10Þ
 K.H. Hahn et al. / European Journal of Operational Research 152 (2004) 770–780 775

From Eqs. (8) and (10) and Property 1, we have Max pN

LIFO ðS; P Þ ¼ f P ðQ  W Þ  Cd ðQ  W Þ
the break-even discount quantity r0 and
 Ch H  Co g  fðCd þ Cw ÞW g
h i1=ð1bÞ
1b
ðCw þ Cp Þ S 0  að1bÞ
1=ð1bÞ
P 0 c
að1  bÞ
r0 ¼ h i1=ð1bÞ : ð11Þ s:t: S P S0 ¼ ;
Pc
mS 0  ðm  1Þ S 01b  að1bÞ
P 0 c

ðm  1ÞIb
Q¼S ;
From the supplierÕs point of view, the price cut by m ð15Þ
r0 to the current selling price would have no 1
harmful effect on his average net profit with the W ¼ Ib ;
m
following reason. Due to a lower unit purchasing
cost, the retailer could also lower the retail price, Pc
H¼ fS 2b  Ib2b g;
which might result in an increased product de- að2  bÞ
mand from customers. Consequently, the supplier
1=ð1bÞ
1b að1  bÞ
could expect an increase in sales volume that Ib ¼ S  :
eventually contributes to a higher profit. Let the Pc
discounted unit purchasing cost be Cd ¼ Cp  r0 .
Then under no-returns policy, the supplierÕs aver- 3.2. FIFO model
age net profit pN S ðS; P Þ becomes

pN In this model, it is assumed that the inventory is

S ðS; P Þ ¼ Cd Q  Cu Q  Cs : ð12Þ
Now, we face a problem of determining the
retailerÕs new order up-to level and retail price with
the discounted unit purchasing cost Cd . The re-
tailerÕs objective becomes the maximization of the
average net profit pN LIFO ðS; P Þ under no-returns
policy. For the formulation of the retailerÕs aver-
age net profit, we consider two kinds of order up-
to levels, S0 and S1 as stated by Hwang and Hahn
[6]. S1 is the largest order up-to level which makes
W ¼ 0, i.e., no outdated items is generated. S0 is
the level which makes ið1Þ ¼ 0 and becomes a low
bound of S. But, due to the LIFO issuing policy,
the number of outdated items W becomes nonzero
if the inventory level at the end of order cycle is
not zero. And so, S1 equals S0 and has the fol-
lowing identity:

1=ð1bÞ
að1  bÞ
ið1Þ ¼ S01b  ¼ 0; ð13Þ
Pc

1=ð1bÞ
að1  bÞ
S1 ¼ S0 ¼ : ð14Þ
Pc
Therefore, the retailerÕs new order up-to level and
retail price with the discounted unit purchasing
cost Cd which maximize the retailerÕs average net
profit, pNLIFO ðS; P Þ can be formulated as follows:
depleted according to the first-in-first-out (FIFO)
issuing principle. Fig. 2 shows a pictorial repre-
sentation of the inventory levels under the pro-
posed policy.
Let time t0 be a reorder point as shown in Fig. 2.
If some products in the inventory are outdated at
t0 , those are part of the quantity received at the
time t0  m. The inventory at t0 before receiving Qt0
consists of Qi , i ¼ t0  ðm  1Þ; t0  ðm  2Þ; . . . ;
t0  1. Note that Qi ¼ Q for every i. Therefore, the
inventory level after disposing of the outdated
items can be written as Ia ¼ ðm  1ÞQ. And so, the
number of items W that are outdated at the end of
period becomes
W ¼ Ib  ðm  1ÞQ

1=ð1bÞ
að1  bÞ
¼ S 1b   ðm  1ÞQ: ð16Þ
Pc
As stated by Hwang and Hahn [6], the follow-
ing property holds on the retailerÕs order quantity
under FIFO issuing principle.
Property 2. In an optimal solution under FIFO, the
retailer’s order quantity Q becomes S=m.
The retailerÕs average net profit p0FIFO ðS; P Þ
under returns policy can be formulated as follows:
776 K.H. Hahn et al. / European Journal of Operational Research 152 (2004) 770–780

Inventory level
S

Q
Ib
W
Ia

(m - 1)Q
m

1 m time
0

to - m to- (m-1) to
Fig. 2. An inventory time plot with inventory-level-dependent demand rate and FIFO issuing policy.

p0FIFO ðS; P Þ ¼ Sales revenue  Purchasing cost In the case with FIFO, two kinds of order up-to
levels, S1 and S0 need to be considered. S1 is the
 Holding cost  Ordering cost
largest order up-to level which makes W zero, and
¼ P ðQ  W Þ  Cp ðQ  W Þ S0 , a lower bound of S, is the level which makes
 Ch H  Co : ð17Þ ið1Þ ¼ 0.
Note that the number of outdated items W
Using the same procedure as LIFO, the DRC can becomes nonzero if the sales volume during m time
be expressed as follows: periods is less than S1 . Thus S1 has the following
DRCðS 0 ; P 0 Þ identity:
Z 1 b
¼ ðCp þ Cw ÞW aðiðtÞÞ
m dt ¼ S1 : ð20Þ
(" #1=ð1bÞ 0 Pc
0 1b að1  bÞ Substituting Eq. (2) into (20),
¼ ðCp þ Cw Þ ðS Þ 
ðP 0 Þc ( )1=ð1bÞ
) 1 að1  bÞ
S1 ¼  : ð21Þ
ðm  1Þ  S 0 P c 1  ½ðm  1Þ=m1b
 ; ð18Þ
m
Also, from the definition of S0 ,
where ðS 0 ; P 0 Þ are the optimal values of the retailer " #1=ð1bÞ
under the returns policy. And the break-even dis- 1b að1  bÞ
ið1Þ ¼ S0  ¼0 ð22Þ
count quantity r0 , Pc
(" #1=ð1bÞ )
0 að1  bÞ m1 and
r ¼ m  ðCw þ Cp Þ 1  1b c  :
1=ð1bÞ
S P m að1  bÞ
S0 ¼ : ð23Þ
ð19Þ Pc
Now, we consider a problem of determining the Therefore, the retailerÕs new order up-to level and
retailerÕs new order up-to level and selling price retail price can be found by searching over the
to customers with the unit purchasing cost following two regions: (1) S > S1 and (2) S0 6
Cd ¼ Cp  r0 . S 6 S1 .
 K.H. Hahn et al. / European Journal of Operational Research 152 (2004) 770–780 777

3.2.1. Case 1 (for S > S1 ) dination efforts between the supplier and retailer.
In the region of S > S1 , the outdating quantity For the study, a problem is considered with the
becomes nonzero and the retailerÕs problem is following parameter values:
formulated as follows:
a ¼ 500; c ¼ 1:5; Cs ¼ $10; Cu ¼ $3;
Max pN
FIFO1 ðS; P Þ ¼ fP ðQ  W Þ  Cd ðQ  W Þ
Cp ¼ $10; Co ¼ $10; Ch ¼ $0:5; Cw ¼ 0;
 Ch H  Co g  fðCd þ Cw ÞW g
m ¼ 5:
( )1=ð1bÞ
1 að1  bÞ Though the objective function is differentiable
s:t: S>  ;
P c 1  ½ðm  1Þ=m1b with respect to S, P and Cd , the resulting equation
is mathematically intractable, i.e., it seems impos-
S sible to find a general explicit solution for S, P and
Q¼ ;
m Cd . The Tabu search (TS) is a higher level heuristic
m1 procedure for solving optimization problems, de-
W ¼ Ib  S;
m signed to guide other methods to escape the trap of
Pc local optimality. Al-Sultan and Al-Fawzan [2] de-
H¼ ðS 2b  Ib2b Þ; veloped a Tabu search algorithm to solve global
að2  bÞ

1=ð1bÞ optimization problem and showed that the algo-
að1  bÞ rithm is more efficient than the most competitive
Ib ¼ S 1b  : ð24Þ
Pc algorithms in the literature, i.e., it requires less
function evaluations. To solve the proposed
models, we developed a TS-based algorithm. The
3.2.2. Case 2 (for S0 6 S 6 S1 )
algorithm was programmed in C language and run
In this region of S, no item is outdated and so
on an IBM PC Pentium II with 300 MHz micro-
W ¼ 0, Ib ¼ Ia hold. Thus the retailerÕs problem
processor running Windows 98. To examine the
is formulated as follows:
effects of the shape parameter, the example was
Max pNFIFO2 ðS; P Þ ¼ PQ  Cd Q  Ch H  Co solved varying b from 0.00 to 0.30 with an incre-

1=ð1bÞ ment of 0.02 and the results are presented in Table
að1  bÞ 1 for LIFO and Table 2 for FIFO. Also, Tables 3
s:t: SP ;
Pc and 4 list the results obtained from the sensitivity
( )1=ð1bÞ studies of c for the same problem with b ¼ 0:1
1 að1  bÞ fixed.
S6  ;
P c 1  ½ðm  1Þ=m1b The following observations can be made from
the tables:
Q ¼ S  Ib ;

1=ð1bÞ (1) When no outdated item occurs under return
að1  bÞ
Ib ¼ S 1b  : ð25Þ policy, both the supplier and retailer cannot
Pc
expect additional benefits by adopting no-
We can find an optimal solution of the retailerÕs return policy across all the values of b and c
problem by solving the two problems in Eqs. (24) tested. We find the results significant since
and (25) and then picking up the one that gives the existence of outdated items motivates the
the maximum objective function value. coordinating efforts between the two parties.
(2) Both S and Q tend to increases as either b
increases or c decreases. The opposite holds
4. Solution methodology and numerical example for P .
(3) Regardless of the issuing policy, no-return pol-
In this section, we study the effects of the two icy generates at least equal or more benefits
issuing policies on the performances of the coor- over return policy for all the parties involved,
778 K.H. Hahn et al. / European Journal of Operational Research 152 (2004) 770–780

the supplier, retailer, and customers. The level
of the benefits tends to increase as either b in-
creases or c decreases.
(4) The amount of outdated items W becomes not
smaller as either b increases or c decreases.
No-return policy results in at least equal or
smaller amount of W over return policy across
all the values of b tested.
(5) The additional profits obtained by switching
to no-return policy are generally larger under
LIFO than under FIFO. The benefits come
mainly from the reduction of W , that in turn
results in cheaper retail price, higher demand
rate and satisfied customers.
(6) The additional profits of the both parties tend
to decrease as c increases. The retailerÕ profit is

Table 1
Test results of the two policies (LIFO case)
b Returns policy No-returns policy
S P Q W p0LIFO p0S Cd S P Q W pN
LIFO pN
S

0.00 2.7 33.3 2.70 0.00 51.51 8.90 10.00 2.7 33.3 2.70 0.00 51.51 8.90
0.02 2.6 34.2 2.60 0.00 51.58 8.20 10.00 2.6 34.2 2.60 0.00 51.58 8.20
0.04 2.8 32.6 2.80 0.00 51.85 9.60 10.00 2.8 32.6 2.80 0.00 51.85 9.60
0.06 3.0 31.2 3.00 0.00 52.09 11.00 10.00 3.0 31.2 3.00 0.00 52.09 11.00
0.08 7.5 30.1 4.28 0.80 54.17 11.94 8.12 4.8 23.2 4.80 0.00 60.01 14.59
0.10 9.4 30.1 4.84 1.14 56.87 12.49 7.65 5.5 21.5 5.50 0.00 63.52 15.55
0.12 11.7 30.1 5.52 1.55 60.17 13.18 7.20 8.5 20.3 6.98 0.38 68.52 19.30
0.14 14.3 30.1 6.29 2.00 64.12 14.04 6.82 10.5 19.2 8.24 0.57 74.60 21.47
0.16 17.5 30.1 7.24 2.57 68.81 15.03 6.46 13.1 18.1 9.87 0.81 81.95 24.13
0.18 21.2 30.1 8.34 3.22 74.35 16.21 6.14 16.3 17.2 11.81 1.12 90.46 27.12
0.20 25.7 30.0 9.69 4.00 80.89 17.80 5.87 20.1 16.4 14.11 1.50 100.42 30.47
0.22 31.1 30.0 11.28 4.95 88.63 19.42 5.61 25.1 15.6 17.11 2.00 112.43 34.61
0.24 37.7 30.0 13.22 6.12 97.82 21.32 5.37 31.4 14.9 20.81 2.65 126.84 39.30
0.26 45.9 30.0 15.61 7.57 108.78 23.50 5.15 39.3 14.3 25.36 3.48 144.31 44.44
0.28 56.0 30.0 18.53 9.37 121.95 26.06 4.95 49.6 13.7 31.29 4.58 165.47 50.89
0.30 68.8 30.0 22.21 11.65 137.87 29.03 4.76 62.9 13.2 38.76 6.04 191.59 58.10

Table 2
Test results of the two policies (FIFO case)
b Returns policy No-returns policy
S P Q W p0FIFO p0S Cd S P Q W pN
FIFO pN
S

0.00 2.9 31.0 2.90 0.00 49.38 10.28 10.00 2.9 31.0 2.90 0.00 49.38 10.28
0.02 3.3 30.5 2.99 0.00 49.59 10.96 10.00 3.3 30.5 2.99 0.00 49.59 10.96
0.04 4.4 30.3 3.12 0.00 50.48 11.83 10.00 4.4 30.3 3.12 0.00 50.48 11.83
0.06 5.8 30.2 3.28 0.00 52.03 12.93 10.00 5.8 30.2 3.28 0.00 52.03 12.93
0.08 7.5 30.1 3.48 0.00 54.17 14.35 10.00 7.5 30.1 3.48 0.00 54.17 14.35
0.10 9.4 30.1 3.70 0.00 56.87 15.91 10.00 9.4 30.1 3.70 0.00 56.87 15.91
0.12 11.7 30.1 3.97 0.00 60.17 17.82 10.00 11.7 30.1 3.97 0.00 60.17 17.82
0.14 14.3 30.1 4.29 0.00 64.12 20.04 10.00 14.3 30.1 4.29 0.00 64.12 20.04
0.16 17.5 30.1 4.67 0.00 68.81 22.72 10.00 17.5 30.1 4.67 0.00 68.81 22.72
0.18 21.2 30.1 5.12 0.00 74.35 25.86 10.00 21.2 30.1 5.12 0.00 74.35 25.86
0.20 25.7 30.0 5.69 0.00 80.89 29.80 10.00 25.7 30.0 5.69 0.00 80.89 29.80
0.22 31.1 30.0 6.33 0.00 88.63 34.29 10.00 31.1 30.0 6.33 0.00 88.63 34.29
0.24 37.7 30.0 7.54 0.44 97.82 38.35 9.41 39.3 28.2 7.85 0.00 102.19 40.35
0.26 45.9 30.0 9.18 1.15 108.78 42.78 8.75 50.3 26.2 10.04 0.00 119.99 47.72
0.28 56.0 30.0 11.20 2.03 121.95 48.06 8.18 64.8 24.4 12.94 0.00 141.61 57.09
0.30 68.8 30.0 13.76 3.19 137.87 54.39 7.68 84.1 22.8 16.81 0.00 168.50 68.64
 K.H. Hahn et al. / European Journal of Operational Research 152 (2004) 770–780 779

Table 3
Test results of the two policies (LIFO, b ¼ 0:1)
c Returns policy No-returns policy
S P Q W p0LIFO p0S Cd S P Q W pN
LIFO pN
S

1.40 13.3 35.1 6.14 1.78 88.42 15.19 7.10 9.4 23.4 7.63 0.45 97.82 21.28
1.42 12.4 33.9 5.86 1.63 80.97 14.74 7.22 8.9 23.0 7.24 0.40 89.69 20.55
1.44 11.6 32.8 5.59 1.49 74.15 14.24 7.34 8.3 22.6 6.87 0.35 82.22 19.79
1.46 10.8 31.8 5.33 1.36 67.90 13.68 7.44 7.8 22.3 6.53 0.31 75.38 18.98
1.48 10.1 30.9 5.09 1.25 62.15 13.09 7.54 5.9 21.5 5.88 0.00 69.23 16.70
1.50 9.4 30.1 4.85 1.15 56.87 12.47 7.64 5.7 21.1 5.69 0.00 63.61 16.38
1.52 8.8 29.4 4.62 1.05 52.02 11.84 7.72 5.4 20.8 5.42 0.00 58.45 15.60
1.54 8.3 28.6 4.41 0.97 47.55 11.18 7.81 5.1 20.8 5.08 0.00 53.68 14.42
1.56 7.7 28.0 4.20 0.89 43.43 10.52 7.89 4.8 20.7 4.82 0.00 49.27 13.55
1.58 7.3 27.3 4.00 0.82 39.63 9.85 7.96 4.6 20.4 4.61 0.00 45.18 12.87
1.60 6.8 26.8 3.81 0.75 36.12 9.19 8.03 4.3 20.5 4.31 0.00 41.40 11.69

Table 4
Test results of the two policies (FIFO, b ¼ 0:1)
c Returns policy No-returns policy
S P Q W p0FIFO p0S Cd S P Q W pN
FIFO pN
S

1.40 13.3 35.1 4.36 0.00 88.42 20.54 10.00 13.3 35.1 4.36 0.00 88.42 20.54
1.42 12.4 33.9 4.24 0.00 80.97 19.65 10.00 12.4 33.9 4.24 0.00 80.97 19.65
1.44 11.6 32.8 4.11 0.00 74.15 18.76 10.00 11.6 32.8 4.11 0.00 74.15 18.76
1.46 10.8 31.8 3.98 0.00 67.89 17.84 10.00 10.8 31.8 3.98 0.00 67.89 17.84
1.48 10.1 30.9 3.84 0.00 62.15 16.90 10.00 10.1 30.9 3.84 0.00 62.15 16.90
1.50 9.4 30.1 3.70 0.00 56.87 15.91 10.00 9.4 30.1 3.70 0.00 56.87 15.91
1.52 8.8 29.4 3.56 0.00 52.02 14.91 10.00 8.8 29.4 3.56 0.00 52.02 14.91
1.54 8.3 28.6 3.45 0.00 47.55 14.13 10.00 8.3 28.6 3.45 0.00 47.55 14.13
1.56 7.7 28.0 3.30 0.00 43.43 13.12 10.00 7.7 28.0 3.30 0.00 43.43 13.12
1.58 7.3 27.3 3.20 0.00 39.63 12.38 10.00 7.3 27.3 3.20 0.00 39.63 12.38
1.60 6.8 26.8 3.06 0.00 36.12 11.41 10.00 6.8 26.8 3.06 0.00 36.12 11.41

more sensitive to c compared with those of the supplier, retailer, and customers, tend to have
supplier. additional benefits from the new policy.
(2) The success of the win–win game for all the
parties involved is mainly coming from the
5. Conclusions drastic reduction of the outdated items.

This paper attempts to quantify the benefits
of coordinating efforts between a supplier and a
retailer on returns policy. The followings are
major findings obtained from the models:
(1) Although the supplier guarantees current prof-
its of the retailer in return for his acceptance of
the new no-returns policy, the supplier does
not experience any loss in his profit. In fact,
the test results show that all the related parties,
The above provides the retailer and supplier
with theoretical basis of the validity of the coor-
dinating efforts for the new market practice, es-
pecially, when the quantity of outdated items is
large.
There are several interesting opportunities for
future researches in this subject. Stochastic rather
than deterministic demand function seems more
realistic in evaluating the merit of no-returns pol-
icy. While our model focuses on a single retailer,
780 K.H. Hahn et al. / European Journal of Operational Research 152 (2004) 770–780
the case with multiple retailers of different oper-
ating conditions could be suggested for further
study. Also, a case of multiple items with limited
space in retailerÕs display stand could be an inter-
esting subject to study.
References
[1] P.L. Abad, Determining optimal selling price and lot size
when the supplier offers all-unit quantity discount, Deci-
sion Sciences 19 (1988) 622–634.
[2] K.S. Al-Sultan, M.A. Al-Fawzan, A tabu search Hooke
and Jeeves algorithm for unconstrained optimization,
European Journal of Operational Research 103 (1) (1997)
198–208.
[3] R.C. Baker, T.L. Urban, A deterministic inventory system
with an inventory-level-dependent demand rate, Journal of
the Operational Research Society 39 (9) (1988) 823–831.
[4] T.K. Datta, A.K. Pal, A note an inventory model with
inventory-level dependent rate, Journal of the Operational
Research Society 41 (10) (1990) 971–975.
[5] B.E. Fries, Optimal ordering policy for a perishable
commodity with fixed lifetime, Operations Research 23
(1) (1975) 46–61.
[6] H. Hwang, K.H. Hahn, An optimal procurement policy
for item with an inventory-level-dependent demand rate
and fixed life time, European Journal of Operational
Research 127 (3) (2000) 537–545.
[7] D.M. Lambert, J.R. Stock, L.M. Ellram, Fundamentals of
Logistics Management, McGraw-Hill, New York, 1998.
[8] W.J. Lee, Determining order quantity and selling price by
geometric programming: Optimal solution, bounds, and
sensitivity, Decision Sciences 24 (1993) 76–87.
[9] R.I. Levin, C.P. McLaughlin, R.P. Lamone, J.F. Kottas,
Productions/Operations Management: Contemporary Pol-
icy for Managing Operating Systems, McGraw-Hill, New
York, 1972.
[10] P. Nandakumar, T.E. Morton, Near myopic heuristics for
the fixed-life perishability problem, Management Science
39 (12) (1993) 1490–1498.
[11] T. Nose, H. Ishii, T. Nishida, LIFO/FIFO issuing perish-
able inventory control subject to stochastic procurement
lead time, Mathematical Japonica 29 (2) (1984) 259–271.
[12] V. Padmanabhan, I.P.L. Png, Returns policies: Make
money by making good, Sloan Management Review (Fall)
(1995) 65–72.
[13] B.A. Pasternack, Optimal pricing and return policies for
perishable commodities, Marketing Science 4 (2) (1985)
166–176.
[14] D. Perry, M.J.M. Posner, An ðS  1; SÞ inventory system
with fixed shelf life and constant lead times, Operations
Research 46 (Suppl. 3) (1998) s65–s71.
[15] S.W. Shinn, H. Hwang, S.S. Park, Joint price and lot size
determination under conditions of permissible delay in
payments and quantity discounts for freight cost, Euro-
pean Journal of Operational Research 91 (3) (1996) 528–
542.
[16] S. Tayur, R. Ganeshan, M. Magazine, Quantitative Mod-
els for Supply Chain Management, Kluwer Academic
Publishers, 1998.
[17] T.L. Urban, An inventory model with an inventory-level-
dependent rate and relaxed terminal conditions, Journal of
the Operational Research Society 43 (7) (1992) 721–724.