Int. J.

Production Economics 71 (2001) 467}472

Project procurement and disposal decisions:

An inventory management model
Keith A. Willoughby*
Department of Management, Bucknell University, Lewisburg, PA 17837, USA

Abstract

In this paper, we develop a two-stage mathematical model to examine an important inventory management problem
within a large-scale project context. Speci"cally, we analyze the procurement and disposal of an important, expensive
item (e.g. pipeline). There is uncertainty surrounding total requirements of this item during a project. Surplus stock
on-hand at the conclusion of the project may be disposed for revenue. However, it may be retained to satisfy requirements
during a subsequent project. The time between projects follows a discrete probability distribution. The key decision
variables involve the procurement quantity in the initial project as well as the best disposal quantity (should a surplus
exist) at the conclusion of the project.  2001 Elsevier Science B.V. All rights reserved.

Keywords: Excess stock disposal; Stochastic inventory models; Large-scale projects

1. Introduction problems, mid-stream engineering design changes

`Except in the midst of a battle"eld, nowhere
must men coordinate the movement of other
men and all materials in the midst of such chaos
and with such limited certainty of present facts
and future occurrences as in a huge construction
projecta.
(Blake Construction Co. v. C.J. Oakley Co. [1], emphasis
added)
Clearly, inventory management within large-
scale projects is subject to a tremendous amount of
uncertainty. Delays in vendor shipments, quality
* Corresponding author. Tel.: #1-570-524-2939 (Res), #1-
570-577-1751 (work); fax: #1-570-577-1338.
E-mail address: kwilloug@bucknell.edu (K.A. Willoughby).
(even project cancellation), environmental condi-
tions (e.g. unpredictable project `windowsa in
remote, harsh climates) and labour disruptions,
among others, contribute to the extreme di$culty
in e!ectively managing project inventories.
This paper examines critical inventory manage-
ment decisions encountered in large-scale projects.
Speci"cally, we develop a mathematical model to
analyze the procurement and disposal of an impor-
tant, expensive item (e.g. pipeline). Due to the
inherent uncertainty of subsurface work, total
requirements of this item during construction are
not known with certainty.
Surplus units on-hand after project completion
may be salvaged (disposed for revenue), or retained
to satisfy requirements during a subsequent project
(retention may prove especially bene"cial if pro-
curement prices in the subsequent project increase

0925-5273/01/$ - see front matter  2001 Elsevier Science B.V. All rights reserved.
PII: S 0 9 2 5 - 5 2 7 3 ( 0 0 ) 0 0 1 4 6 - 8
468 K.A. Willoughby / Int. J. Production Economics 71 (2001) 467}472
signi"cantly, and the cost of holding stock is not
prohibitive). The time until the next project is
modelled as a random variable following a discrete
probability distribution. Although one could incor-
porate continuous probability distributions to rep-
resent inter-project time, our selection of a discrete
distribution is practitioner-motivated. Representa-
tive parameter values in our study were obtained
via interviews with materials management and
logistics personnel. We felt it was more reasonable
to elicit discrete data from these practitioners (i.e.
a certain likelihood of a subsequent project occur-
ring within a speci"c time interval), rather than
querying them for continuous inter-project distri-
butions. In essence, a greater understanding (and
appreciation) of model development may lead to
improved prospects of model implementation.
The vital decision variables include the appropri-
ate quantity to procure at the beginning of the
initial project and the proper amount to dispose, in
the event of on-hand surplus, after construction
completion. The procurement and disposal quant-
ities are to be selected so as to provide lowest
overall costs. We note here that we are not taking
into account the total costs associated with a sec-
ond (and any additional) project(s). We are only
concerned with how the presence of various cost
and revenue values a!ect initial project procure-
ment and subsequent disposal decisions.
Silver [2,3] conducted a survey of senior inven-
tory management personnel involved in large-scale
oil and gas projects in the Province of Alberta
(Canada). Critical decision areas faced by these
professionals involved coping with uncertainty
surrounding total project requirements, and the
disposal of project surplus. Hence, there would
appear to be a practitioner-oriented motivation for
a systematic method to analyze the procurement
and disposal problem. To the best of our know-
ledge, no previous attempt has been made to jointly
investigate procurement and disposal decisions in
a project context.
Only a handful of articles have jointly considered
procurement (acquisition) and disposal decisions in
any context, let alone within a project environment.
Fukuda [4] examined ordering and disposal
policies in a multiechelon, multiperiod inventory
situation. Considering such factors as ordering
costs, disposal values, shortage penalties and hold-
ing costs, he was able to determine optimal policies
for an entire planning horizon. Teisberg [5] de-
veloped a multi-period, stochastic dynamic pro-
gramming tool to guide the ongoing acquisitions
and disposals (releases) of the United States stra-
tegic petroleum reserve. For each entering stockpile
size and each possible oil market state, and using
the present value of all relevant costs, he was able
to determine optimal stockpile acquisition or re-
lease rates for a speci"c time period.
Several models have been developed to examine
the disposal of excess stock, given that an organiza-
tion is currently in a surplus inventory situation.
A few of the more signi"cant contributions will be
cited. Simpson [6] was an early contributor to the
excess stock literature. Basing his analysis on
inventories held at Naval supply stores, he found
an economic retention quantity by developing
a tradeo! between storage and obsolescence costs
versus the expenses of repurchasing the material in
the future (if and when required). Tersine and
Toelle [7] generated relationships for the economic
time supply of an item, under the existence or
non-existence of present value and in#ation consid-
erations. Incorporating stochastic (Poisson) de-
mand, Rosen"eld [8] developed optimal quantities
for excess stock disposal. He applied his methodo-
logy to an actual distributor of durable goods faced
with excessive amounts of slow-moving items. The
model showed that substantial savings could be
earned by the judicious disposal of surplus stock.
Some researchers have examined various inven-
tory management issues within a project manage-
ment context. In particular, Smith-Daniels and
Smith-Daniels [9] examined the performance
of several heuristics for determining lot sizes in
projects. Inventory management was especially
complex in projects due to uncertainty surrounding
the quantity and timing of requirements, as well as
the `lumpya nature of those requirements.
The format of this paper is as follows. Section 2,
by analyzing the inter-project period costs, deter-
mines optimal disposal quantities at the conclusion
of the initial project. Section 3 then develops
expressions for initial project costs. Numerical
examples are provided in both sections 2 and 3.
Conclusions are included in the "nal section.
 K.A. Willoughby / Int. J. Production Economics 71 (2001) 467}472 469

2. Inter-project analysis and, for t )t )t ,

G\ M G
p
We shall introduce the development of our f (t )" G .
model by analyzing inter-project period costs. The R  t !t
G G\
following notation is required:
Evaluation of (2) gives
t time interval i associated with the subsequent
G h(1!exp(
t ))!v exp(
t ). (3)
project (i"1, 2, 2, n)   
p probability of the subsequent project begin- Since we are dealing with a discrete probability
G
ning within time interval (t , t ] distribution, we may rewrite (1) as
G\ G
Common probability rules maintain that each

L RG p
p is non-negative and that the sum of the respective R(t ) G dt
G  t !t 
probabilities over all time intervals is equal to one. G RG\ G G\
We assume that the subsequent project is equally which is
likely to occur any time within the time interval


(t , t ] and that t "0. L p RG
G\ G M G R(t ) dt . (4)
Surplus stock may be retained after completion t !t  
G G G\ RG\
of the initial project to satisfy subsequent project
requirements. Maintaining available on-hand Substituting (3) into (4) gives


stock, then, means that those speci"c units will not L p RG
need to be procured during the future project. This G [h(1!exp(!
t ))
t !t 
represents a cost savings. However, one must pay G G G\ R G\

holding charges to carry these units in inventory. !v exp(!
t )] dt . (5)

  
We shall use continuous discounting (see Gurnani
[10]) in determining these holding costs. Let us Evaluation of the integral in (5) gives
introduce some further notation:

RG RG
ht  (h exp(!
t )#v exp(!
t )) dt
h out-of-pocket inventory carrying charges ($     
RG\ R G\
per unit of inventory per unit time)

continuous discount rate (i.e. a cost of x in- which can be expressed as
curred at time t has a present value of h(t !t )
x exp(!
t)) G G\


v unit procurement cost in the subsequent pro- h#v
Q ! Q [exp(!
t )-exp(
t )]. (6)
ject (due to varying market conditions, this
G\ G
future unit procurement cost may be greater
than, the same as or less than the unit cost in Thus, the expected present value of the inter-
the initial project) project period costs per surplus unit retained
h h/
(EIPC) becomes


L p h#v
The present value of the inter-project costs may EIPC" G h(t !t )! 
t !t G G\

be modelled as G G G\ (7)


R [exp(!
t )!exp(!
t )]).

f (t )[R(t )] dt , (1) G\ G
R    Note that the unit inter-project period costs are

where t represents the largest t value under linear with respect to the quantity of retained stock.
 G In essence, they are independent of the on-hand
consideration and
surplus after initial project completion (assuming


R that all units retained are needed in the subsequent
R(t )" h exp(!
z) dz!v exp(!
t ) (2)
   project, a rather reasonable assumption).

470 K.A. Willoughby / Int. J. Production Economics 71 (2001) 467}472
Disposing surplus stock upon completion of the
initial project generates immediate revenues. The
following notation is used:
g unit salvage value for surplus stock dis-
posal
w disposal quantity (W* represents the op-
timal disposal quantity)
I on-hand surplus stock after completion
of the initial project (but before any
disposal decision)
EPV*(I) expected present value of completing
the initial project with I units of inven-
tory on-hand, and proceeding in an op-
timal fashion from thereon (with respect
to disposal decisions)
Since we have constant marginal inter-project
period costs and disposal revenues, the determina-
tion of optimal disposal quantities upon comple-
tion of the initial project is quite straightforward.
We simply compare the associated costs and
revenues in the following fashion:
E If EIPC#g)0 (this implies that EIPC)!g),
then =*"0. No surplus stock is disposed
(equivalently, all units are retained) since the
bene"t (cost reduction) of retention is higher
than the bene"t of disposal.
E If EIPC#g'0 (this implies that EIPC'!g),
then =*"I. All surplus stock is disposed
(equivalently, no units are retained) since the
bene"t (cost reduction) of retention is less than
the bene"t of disposal.
The disposal choice after the initial project is,
essentially, an `all-or-nothinga decision. We either
dispose everything on-hand, or retain all of it to
satisfy future project requirements. One could sug-
gest that, if one were indi!erent between surplus
stock retention or disposal (i.e. EIPC"!g), then
it could be attractive to dispose a portion of the
on-hand surplus. However, in this extreme case,
observe that total costs would be equivalent under
any disposal strategy. The key "nding is that an
organization could never be better o! by disposing
a portion of the on-hand surplus.
The EPV*(I) values are quite important to our
analysis, for they `linka the two stages of our
model. Since disposal decisions are independent of
on-hand stock, the EPV*(I) values are either:
E EIPC*I, if W*"0 (all surplus stock is retained),
E !g*I, if =*"I (all surplus stock is disposed)
As a numerical example, assume the following
values:
p : 0.60 t : 1.0
 
p : 0.30 t : 2.0
 
p : 0.10 t : 3.5
 
h: $13 per unit of inventory per year

: 0.10
v : $100
Q
Using (7), we determine that EIPC"!78.22.
Consequently, one would need to obtain a unit
salvage value of more than $78.22 in order to make
disposal attractive. Since the unit acquisition cost is
$100, this indicates that (given the parameter values
under consideration) the retention of excess stock is
quite bene"cial. Decision-makers in our inventory
management context would rarely observe a sal-
vage value in excess of 3/4 of the unit acquisition
cost!
3. Initial project analysis
We shall now model those costs incurred during
the initial project. Without loss of generality, we
assume that on-hand inventory at the beginning of
this project is zero. The following notation is
required:
Q initial project procurement quantity
ETC(Q) expected total discounted costs (initial
project costs plus costs relating to post-
project disposal decisions) as a func-
tion of the initial project procurement
quantity
The best procurement quantity, Q*, is the one
that minimizes ETC(Q).
As mentioned earlier, there exists uncertainty
surrounding total requirements during the initial
project. We shall model this uncertainty with a dis-
crete probability distribution. Speci"cally, let
D total requirements in the initial project

P (D ) probability of observing a speci"c re-
" 
quirements value
 K.A. Willoughby / Int. J. Production Economics 71 (2001) 467}472 471

The following additional notation will be re- Although we explicitly recognize holding costs
quired to determine ETC(Q): prior to a stockout, we shall ignore any carrying
charges incurred subsequent to the receipt of ex-
v unit procurement cost in the initial pro-
 pedited stock. In all likelihood, the relatively large
ject stockout penalties would dominate these holding
T duration of initial project (in years) costs.
B "xed cost per stockout occasion
 To determine the present value of stockout
B penalty (expressed as a fraction of the
 penalties, these costs must be discounted from the
unit value) per unit short moment at which they occur. The B stockout

The respective cost components of ETC(Q) will penalty is given as
now be described. Since procurement costs occur at


the beginning of the initial project, there is no need
Q¹
B P (D )exp ! (11)
to discount them. Quite simply, they are  "  D
" / 
Qv . (8) while the B stockout penalty is
 
For any procurement quantity Q, we have the



Q¹
following expression for carrying charges: (1#B )v (D !Q)P (D )exp ! . (12)
   "  D
" / 



2 D
h P (D ) Q!  t exp!(
t) dt, In the previous section, we derived the expres-
"  ¹
" W/  sion for EPV*(I). We note here that the quantity of
which is evaluated as on-hand surplus at the conclusion of the initial

Q project, I, is equivalent to maxQ!D , 0. For
h P (D ) (1!exp(!
¹)) 
" 
D *Q, one begins the inter-project period with

" W/ (9) zero units of stock on-hand. Since no disposal


 
D ¹ 1 1 revenue or holding charges will be incurred, there
#  exp(!
¹) # ! .
¹


 are no discounted inter-project period costs.
However, for D (Q, these discounted costs are
We also recognize any carrying charges incurred 
prior to the occurrence of a stockout. Since a stock-
out, should it occur, would happen at time Q¹/D , exp(!
¹) EPVH(Q!D )P (D ). (13)
  " 
these carrying charges are expressed as " /



/2" D Combining expressions (8)}(13) yields our math-
h P (D ) Q!  t exp(!
t) dt,
"  ¹ ematical model for determining the expected total
" /  discounted costs as a function of the procurement
which becomes quantity in the initial project. We note here that the


Q
Q¹ "nal model is of a news-vendor type. In other
h P (D ) 1!exp !
" 
D words, a one-time decision procurement decision is
" /  made in order to minimize both initial project and



 
D
Q¹ Q¹ 1 1
#  exp ! # ! . inter-project costs.
¹ D
D

 Let us expand on the numerical example present-
 
This expression can be simpli"ed to yield ed earlier. In particular, let:
v : $100 (same value as the unit acquisition cost in

the subsequent project)
h P (D )
"  T : 1 year
" / D : 200 P : 0.10
 



 
Q D
Q¹ 1 1 D : 300 P : 0.20
; #  exp ! ! . (10)  

¹ D

 D : 400 P : 0.40
  
472 K.A. Willoughby / Int. J. Production Economics 71 (2001) 467}472
D : 500 P : 0.20
 
D : 600 P : 0.10
 
B : $3000

B : 0.5
 Acknowledgements
We "nd that Q*"400 units and that
ETC(400)"$46,157.96. Moreover, we note that
(due to the EIPC value found in Section 2) any
on-hand stock after the conclusion of the initial
project will be retained to satisfy usage during the
subsequent project. The disposal of surplus stock is
not warranted.
4. Conclusions
This paper has developed a mathematical deci-
sion-making tool to assist practitioners in manag-
ing project inventories. There is considerable
opportunity for further exploration in this vital
decision-making area. A possible extension would
be to model an important, expensive item (e.g.
compressors, valves, electrical control devices) that
is required during the initial project, but also
has operational usage (as a spare part) during the
ongoing operations of the constructed facility. In
this case, retaining surplus stock after project con-
struction could help to satisfy both subsequent
project requirements and ongoing operational
usage. High unit costs may be incurred to replenish
small lots of this item to satisfy ongoing usage
(there would be no `quantity discountsa), so reten-
tion of surplus stock after the initial project may
become more attractive.
We have considered a situation in which there
existed only a single procurement opportunity at
the beginning of the initial project. Obviously, one
could extend this to the case of multiple procure-
ment opportunities during the project.
The research leading to this paper was partially
supported by the Natural Sciences and Engineering
Research Council of Canada under Grant No.
A1485 and by the Carma Chair at the University of
Calgary.
References
[1] Blake Construction Co. v. C.J. Oakley Co., 431 A.2d 569
(D.C. 1981). Transactions of the American Association of
Cost Engineers, 1993. C.11.1.
[2] E.A. Silver, Policy and procedural issues in procurement
and logistics for large-scale projects in the oil and gas
industry, Project Management Journal 18 (1) (1987) 57}62.
[3] E.A. Silver, Materials management in large-scale construc-
tion projects: Some concerns and research issues, Engineer-
ing Costs and Production Economics 15 (1989) 223}229.
[4] Y. Fukuda, Optimal disposal policies, Naval Research
Logistics Quarterly 8 (1961) 221}227.
[5] T.J. Teisberg, A dynamic programming model of the U.S.
strategic petroleum reserve, Bell Journal of Economics 12
(1981) 526}546.
[6] J. Simpson, A formula for decisions on retention or dis-
posal of excess stock, Naval Research Logistics Quarterly
2 (1955) 145}155.
[7] R.J. Tersine, R.A. Toelle, Optimum stock levels for excess
inventory items, Journal of Operations Management
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[8] D.B. Rosen"eld, Disposal of excess inventory, Operations
Research 37 (1989) 404}409.
[9] D.E. Smith-Daniels, V.L. Smith-Daniels, Finding lot sizes
for materials used in projects, Production and Inventory
Management Journal 27 (1986) 61}71.
[10] C. Gurnani, Economic analysis of inventory systems, In-
ternational Journal of Production Research 21 (1983)
261}277.