Mathematical and Computer Modelling 57 (2013) 12591269

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Mathematical and Computer Modelling

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

A continuous review (s, Q ) inventory system with priority customers

and arbitrarily distributed lead times
K.P. Sapna Isotupa , S.K. Samanta
School of Business and Economics, Wilfrid Laurier University, Waterloo, Ontario, Canada N2L 3C5

article

info

Article history:
Received 29 August 2011
Received in revised form 28 August 2012
Accepted 7 October 2012
Keywords:
Inventory
Customer differentiation
Lost sales
Positive lead times
Rationing policy

abstract
In this article we analyze a lost sales (s, Q ) inventory system with two types of customers
and stochastic lead times. Demands from each type of customer arrive according to two
independent Poisson processes. A comparative study of the average cost rate for the cases
where there is differentiation between service to customers based on the type of customer
and the case where there is no differentiation between customers is carried out by using
the concepts of rationing. We provide numerical examples where differentiation between
customers yield lower cost and lower shortage rates for both types of customers.
Crown Copyright 2012 Published by Elsevier Ltd. All rights reserved.

1. Introduction
Organizations recognize the need to develop a strategy that will allow them to provide different service levels for different
customers. One of the methods by which companies are addressing this issue is through the practice of rationing inventory
among different customer classes thus giving the company agility in satisfying customer demand.
In this paper we analyze a continuous review inventory system with two types of customers under the lost sales
framework using concepts of rationing. In many cases similar parts are installed in machines of different companies. Rotables
in aeroplanes would be a typical example of such parts. The supplier of rotables may have a contractual agreement with
one company to provide them with their demand immediately, say 95% of the time and have no such agreement with
another company which requires the same part. Hence it is important for the supplier to differentiate between these two
companies and provide better service to the company with which it has a contractual agreement. In these types of situations,
many suppliers have resorted to stocking enough items to meet the demand from both types of customers 95% of the time
and treating both these companies exactly alike. However, if the supplier were to provide differentiated service to these
two companies, they could lower their inventories which would in turn lower their total cost. One method by which the
inventory could be lowered is by reserving some stock for the companies with whom they have contractual agreements and
using some kind of rationing policy which is the policy we use in this paper.
We analyze a continuous review, lost sales, (s, Q ) inventory system with two types of customers, unit Poisson demand
and arbitrarily distributed lead times. The choice of Poisson distribution for demands seems to be a reasonable one and
has been justified in other papers like Isotupa [1]. From here on we refer to companies that the supplier has contractual
agreements with as high priority customers and companies where there is no such contractual agreement as low priority
customers. In this paper we propose a rationing policy by which a supplier can reserve some stock for high priority customers
thus enabling them to meet their contractual obligations. When the stock on-hand drops below a threshold level, k, all
remaining stock is reserved for high priority customers and all demand from low priority customers will result in lost-sales.

Corresponding author.
E-mail addresses: sisotupa@wlu.ca (K.P. Sapna Isotupa), ssamanta@wlu.ca (S.K. Samanta).

0895-7177/$ see front matter Crown Copyright 2012 Published by Elsevier Ltd. All rights reserved.
doi:10.1016/j.mcm.2012.10.029

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K.P. Sapna Isotupa, S.K. Samanta / Mathematical and Computer Modelling 57 (2013) 12591269

Isotupa [1] noted that in the Markovian case of exponentially distributed lead times, there is a sub-optimal set of values
for k, s and Q in the rationing case where the service levels for both the high and low priority customers are better than
the service levels in the no-rationing case and also the total cost is lower in the rationing case when compared to the norationing case. In this paper we have noted that even in the non-Markovian case, these same results are observed. More
specifically the results are illustrated for the case of Erlang and constant lead times. This result is very counter-intuitive
because when one company has some stock reserved for them, it is expected that the service level for this company will
increase and service level for the other company will decrease if total cost is to decrease when compared to the case of no
differentiation between the companies.
The model studied in this paper has a wide range of fields where it is applicable. Consider for example, a company which
has a central depot in Canada and a regional depot in Mexico. At the central depot there are two types of demand-direct
customer demand and replenishment orders from the regional depot. The inventory control manager at the central depot
knows that these demands are not equally important and may want to set different service levels for different types of
demand, or, in other words, apply some type of rationing policy. Not satisfying a direct customer order will, in general
be more costly than not satisfying the regional depots order and therefore it is desirable to set a higher level for direct
customer demand. Blood inventory, direct market firms with inventory, inventory of spare parts, military operations are
other potential areas of application of our model. In a review of inventory systems with multiple demand classes, Kleijn and
Dekker [2] provide a wide variety of examples where such models are applicable.
The paper is organized as follows. In Section 2, we position our research in relation to the existing literature. Section 3
deals with describing the rationing model in detail and deriving the transient performance measures. Section 4 deals with
the steady state case. Cost analysis of the (k, s, Q ) model is carried out in Section 5. In that section, the models with and
without rationing are compared and the benefits of the rationing policy are emphasized. It also presents numerical results
and discussion. Section 6 provides conclusions, summary and possible extensions of the rationing model.
2. Literature review
The early work on systems with assigning goods to different demand classes is in yield management problems and a
detailed description of these types of problems which are analyzed in the literature is available in the review article by
Kimes [3]. The traditional yield management problems are single period models with perishable items whereas we plan to
analyze a continuous review system with multiple replenishment opportunities for items with infinite lifetimes.
The first traditional inventory control paper on systems with multiple classes of customers was by Veinott [4] who
analyzed a zero leadtime, periodic review system with multiple classes of customers and employed the notion of critical
levels to ration inventory. One noteworthy paper is that by Topkis [5] who proved the optimality of Vienotts policy in
both the lost sales and back ordering cases in the periodic review realm. Kleijn and Dekker [2] present a review of literature
on inventory systems with several demand classes. Isotupa [1] provides details on periodic review inventory systems with
multiple classes of customers which have appeared in the literature since 1998. Since this paper deals with a continuous
review inventory system, we do not delineate the details of periodic review systems with multiple customer classes.
In the continuous review framework, one of the earliest papers is the one by Nahmias and Demmy [6]. They analyze
an (s, Q ) inventory system with backlogging, fixed lead times and two classes of customers. The focus of the paper was
to determine the proportion of time the orders from each type of customer is met. Moon and Kang [7] analyzed the same
situation as the one dealt with by Nahmias and Demmy [6] and generalized their model to one with compound Poisson
demands. Dekker, Kleijn and de Rooij [8] analyzed a system with the same demand, lead time and stock out policy as Nahmias
and Demmy [6] for the lot-for-lot policy and determined the fill rates. Ha [9] showed that in the complete Markovian
case, the lot-for-lot model with two demand classes and backlogging can be formulated as a queueing model. Sivakumar
and Arivarignan [10] analyzed an (s, Q ) inventory system with Markovian arrival process and exponentially distributed
leadtimes for the case of items which are perishable and have an exponentially distributed lifetime. They present a system of
equations which when solved recursively will determine the inventory level distribution and total cost function. Numerical
illustration of determining inventory level distribution and optimal cost is provided.
All the work on continuous review inventory systems with multiple classes of customers deal with the case of backlogging
unmet demand as these systems are mathematically more tractable. However, in this paper we focus on the lost sales case
and build on the existing literature. One of the early papers in the lost sales case is by Ha [11] who studied a make-tostock production system with multiple demand classes under the Markovian framework. He determined conditions under
which a lot-for-lot production policy and a critical level rationing policy are optimal by modeling the system as an M /M /1/S
queueing system. Dekker et al. [12] generalized Ha [11] to multiple demand classes and modeled it as an M /M /S /S queueing
system. However, they did not establish the optimality of the policy. Deshpande et al. [13] compared four different control
policies: priority clearing of backlog, threshold clearing of backlog, hybrid policy and optimal rationing policy for a system
using a threshold rationing policy.
One of the first papers on continuous review (s, Q ) inventory systems with lost sales was by Melchiors et al. [14] who
developed a heuristic for cost optimization for the case of Poisson demands and fixed lead times. Isotupa [15] analyzed a
similar system for the case of exponentially distributed lead times and derived an expression for the long-run expected cost
rate. Isotupa [1] dealt with the same model as that of Isotupa [15] but with a different focus and determined conditions
under which a rationing policy provides better service levels for both types of customers and yields lower costs for the

K.P. Sapna Isotupa, S.K. Samanta / Mathematical and Computer Modelling 57 (2013) 12591269

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supplier when compared to a policy that treats both types of customers alike. The last two papers are the ones which are
most related to this paper. In this paper we generalize the model analyzed in the earlier papers by assuming that the lead
times are arbitrarily distributed hence making the system non-Markovian.
3. Problem formulation and analysis
We consider a continuous review inventory model with two classes of customershigh priority (HP) and low priority
(LP). Each class of customer generates unit Poisson demand. The arrival rate of demand for the high priority customer class
is 1 and the arrival rate for the low priority customer class is 2 . The (s, Q ) ordering policy is adopted. In this policy the
maximum inventory level is s + Q and whenever on-hand inventory level drops to s, an order for size Q (Q > s) is placed
which arrives after a positive lead time. The restriction Q > s ensures that there are no perpetual shortages. In this paper
we assume that the lead time is arbitrarily distributed and focus on the lost sales case. The lead time probability density
function is denoted by g (t ) and the mean is m. The following rationing policy is used: When inventory level is less than
or equal to a threshold level, k, low priority demand is not satisfied and results in a lost sales situation. The high priority
customer encounters a lost sales situation only when inventory level is zero. We call this new rationing policy an (k, s, Q )
policy with lost sales.
Let I (t ) denote the on-hand inventory at time t. The process {I (t ), t 0} is a semi-regenerative process with state space
E = {0, 1, 2, . . . , Q + s}. We analyze two different situations; Case 1: 1 k s 1; Case 2: s k Q depending
on whether the threshold inventory level at which supply to low priority customers is cut-off is below the reorder level;
between the reorder level and Q . The case where there is no rationing of inventory can be obtained by taking the limit as k
goes to zero in Case 1. We use the following common notation.
I (t ) = Inventory level at time t ,
G(t ) =

g (u)du,

a () = Laplace transform of any arbitrary function a(t ),

a(n) () = n-th derivative of a () with a(0) () = a (),

E = {0, 1, 2, . . . , Q + s},
E1 = {0, 1, 2, . . . , s},
N 0 = {0, 1, 2, . . .}.

Since Q > s, there is at most one order pending at any given instant of time. As such from our assumptions it is clear that the
replenishment epochs constitute a sequence of regeneration epochs for the inventory level process Z = {I (t ); t 0} with
state space E1 . Let 0 = T0 < T1 < be the successive epochs at which replenishment occurs. Let a = 1, 2 represent Cases
1 and 2, respectively. If In = I (Tn ), then (I , T ) = {In , Tn ; n N 0 } is a Markov renewal process with state space E1 [0, ).
Define the inventory level distribution
Pa (i, j, t ) = Pr[I (t ) = j|I0 = i].
We note that once the inventory level at Tn = Supi {Ti < t } is known, the history I (t ) prior to Tn looses its predictive value.
Hence {Tn ; n N 0 } are stopping times and {I (t ); t 0} is a semi-regenerative process with embedded Markov renewal
process (I , T ) (inlar [16]). As such the functions Pa (i, j, t ) satisfy the following Markov renewal equations for i E1 and
jE
Pa (i, j, t ) = Ka (i, j, t ) +

r E1

a (i, r , u)Pa (r , j, t u)du,

(1)

where a (i, j, t ) denotes the derivative of the semi-Markov kernel of the Markov renewal process (I , T ), and where a (i, j, t )
and Ka (i, j, t ) are, respectively, defined as
1

Pr[I1 = j, t < T1 t + |I0 = i],

Ka (i, j, t ) = Pr[I (t ) = j, T1 > t |I0 = i].

a (i, j, t ) = lim

i, j E1

(2)
(3)

The functions a (i, j, t ) and Ka (i, j, t ) are derived using methods similar to those employed in Kalpakam and Sapna [17], and
Berman and Sapna [18]. In order to determine a (i, j, t ) and Ka (i, j, t ), we introduce the auxiliary functions a (i, j, t ) which
are defined between two replenishment epochs or part thereof as follows:

a (i, j, t ) = Pr[I (t + ) = j|I ( ) = i],

Tn < < t + < Tn+1 ;

The functions a (i, j, t ) are determined in the Appendix.

i E ; 0 j i.

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K.P. Sapna Isotupa, S.K. Samanta / Mathematical and Computer Modelling 57 (2013) 12591269

The functions a (i, j, t ) can now be written as

a (i, j, t ) =

Aa (i, u)Ba (j, t u)du,

i , j E1 ,

(4)

where
Aa (i, t ) = lim

= lim

Pr[a reorder in (t , t + )|I0 = i]

Pr[a demand in (t , t + )|I (t ) = s + 1] Pr[I (t ) = s + 1|I0 = i + Q ]

(1 + 2 )1 (i + Q , s + 1, t ),
= (1 + 2 )2 (i + Q , s + 1, t ),

1 2 (i + Q , s + 1, t ),
Ba (j, t ) = lim

= lim

a = 1;
a = 2, when k = s;

(5)

a = 2, when k > s,

Pr[I (t ) = j, a replenishment in (t , t + )|I0 = i]

Pr[a replenishment in (t , t + )|I (t ) = j, a reorder at 0] Pr[I (t ) = j|I0 = s]

= g (t )a (s, j, t ).

(6)

To obtain Ka (i, j, t ), we first note that when j > s, there is no reorder in (0, t ) and when j s, there is always one order
placed in (0, t ). Hence

a (i + Q , j, t ),
t
Ka (i, j, t ) =
Aa (i, u)Ha (j, t u)du,

s + 1 j i + Q;
(7)

0 j s,

where
Ha (j, t ) = lim

Pr[I (t ) = j, T1 > t | a reorder at 0]

= G(t )a (s, j, t ).

(8)

Now taking the Laplace transform on both sides of Eq. (1), we have for all i E1 and j E
Pa (i, j, ) = Ka (i, j, ) +

a (i, r , )Pa (r , j, ),

(9)

r E1

where a (i, j, ) and Ka (i, j, ) are obtained by taking Laplace transform on (4) and (7), respectively, and are given by

a (i, j, ) = Aa (i, )Ba (j, ),

a (i + Q , j, ),
Ka (i, j, ) =
Aa (i, )Ha (j, ),

(10)
s + 1 j i + Q;

(11)

0 j s.

The functions a (i + Q , j, ), Aa (i, ), Ba (j, ) and Ha (j, ) are determined in the Appendix.
3.1. Shortages and reorders
In order to determine the various operating characteristics, we define the following events
e1 occurrence of a reorder
e2 occurrence of a shortage for the LP
e3 occurrence of a shortage for the HP.
Each of the en (n = 1, 2, 3) events occur at demand epochs and the sequence of such events do not form renewal epochs
for the inventory level process. Let {Mn (t ); t 0} denote the counting process associated with the en events. To obtain the
corresponding mean rates, define
hn (i, t ) = lim

Pr[Mn (t + ) Mn (t ) = 1|I0 = i],

n = 1, 2, 3.

(12)

K.P. Sapna Isotupa, S.K. Samanta / Mathematical and Computer Modelling 57 (2013) 12591269

1263

Then, we have
1

h1 (i, t ) = lim

Pr[I (t ) = 0, a demand by a HP customer in (t , t + )|I0 = i]

= Pr[I (t ) = 0|I0 = i] lim

Pr[a demand by a HP customer in (t , t + )|I (t ) = 0, I0 = i]

= 1 Pa (i, 0, t ).
k
1

h2 (i, t ) = lim

(13)

Pr [I (t ) = j, a demand by a LP customer in (t , t + )|I0 = i]

j =0

Pr [I (t ) = j|I0 = i] lim

j =0

= 2

Pr[a demand by a LP customer in (t , t + )|I (t ) = j, I0 = i]

Pa (i, j, t ).

(14)

j =0

h3 (i, t ) = lim

Pr[I (t ) = s + 1, a demand in (t , t + )|I0 = i]

= Pr[I (t ) = s + 1|I0 = i] lim

(1 + 2 )P1 (i, s + 1, t ),
= (1 + 2 )P2 (i, s + 1, t ),

1 P2 (i, s + 1, t ),

Pr[a demand in (t , t + )|I (t ) = s + 1, I0 = i]

when k = s;

(15)

when k > s.

4. Steady state analysis

In order to obtain the various steady state operating characteristics, consider the Markov chain I = {In ; n N 0 } with
state space E1 embedded in the Markov renewal process (I , T ) whose transition probability functions are given by
pa (i, j) =

a (i, j, t )dt = a (i, j, 0),

a = 1, 2.

(16)

From Eq. (10) on taking the limit as 0, we have

(1)sj ( + )sj
1
2

g (sj) (1 + 2 ),

(
s

j
)!

kj r s+j

r s + k (1)r 1 2
g (r ) (1 + 2 ),
p1 (i, j) =
kj
r !(1 + 2 )ks

r
=
s

j r s+kj
r
s+k

r s + k (1)r 1 2

g (r ) (1 + 2 ),

j
r !(1 + 2 )ks
r =s j=k

(1)sj s1j (sj)

g
(1 ),

(s j)!
p2 (i, j) =
s1

(1)r r1 (r )

g
(1 ),
1
r!
r =0

k + 1 j s;
1 j k;

(17)

j = 0.

1 j s;
(18)
j = 0.

The finite Markov chain I is irreducible and hence possesses a unique stationary distribution. From (17) and (18), it can be
seen that pa (i, j) > 0 and is independent of i. Let pa (i, j) = a (j) for all i, j E1 . Since the Markov chain I is irreducible and
positive recurrent, the Markov renewal process (I , T ) is also irreducible and positive recurrent. The Markov renewal process
is also aperiodic since the derivative of the semi-Markov kernel exists. Then we have (inlar [16])
s

Pa (j) =

a (i)Ka (i, j, 0)

i=0
s

i=0

,
a (i)ma (i)

(19)

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K.P. Sapna Isotupa, S.K. Samanta / Mathematical and Computer Modelling 57 (2013) 12591269

where Ka (i, j, 0) is obtained from (11) by taking the limit as 0, and ma (i) is the mean sojourn time in state i and is
given by
Q +s

ma (i) =

Ka (i, j, 0)

j =0

i+Q s

m + + ,
1
2
=

ks
i+Q k

m +
+
,
1
1 + 2
Let Da =

a = 1;
a = 2.

a (i)ma (i). Then, we have

1
Q s

+
i1 (i),
m+

1 + 2
1 + 2

Da =

i =0

a = 1;

i=1

ks
Q k
1

i2 (i),
m + + + + +
1
1
2
1
2 i =1

a = 2.

When 0 j Q , we note that Ka (i, j, 0) is independent of i in both cases. Hence from (19), we have
Pa (j) =

Ka (i, j, 0)
Da

0 j Q.

Substituting for Ka (i, j, 0) from (11) in the above equation, we obtain

j r s+kj
r
s+k

r s + k (1)r 1 2
(r )
G (1 + 2 )
P1 (0) =
D1 r =s j=k
j
r !(1 + 2 )ks
1

P1 (j) =

P1 (j) =

kj r s+j

r s + k (1)r 1 2
(r )
G (1 + 2 ) ,
kj
r !(1 + 2 )ks
r =sj

D1
1

D1

(1)sj (1 + 2 )sj (sj)

G
(1 + 2 ) ,
(s j)!

1jk

k+1js

, s+1jQ
(1 + 2 )D1

s 1

(1)r r1 (r )
1
m
G (1 )
P2 (0) =
D2
r!
r =0

P1 (j) =

P2 (j) =
P2 (j) =
P2 (j) =

(1)sj s1j (sj)

G
(1 ),
(s j)!D2
1

1 D2

1js

s+1jk

(1 + 2 )D2

k + 1 j Q.

When Q + 1 j Q + s, substituting for Ka (i, j, 0) from (11) in (19), we obtain

Pa (j) =

(1 + 2 )Da

i=jQ

a (i),

Q + 1 j Q + s.

5. Optimal cost analysis

In this section we discuss the problem of minimizing the steady state expected cost rate under the following cost
structure. K is the setup cost per order, c is the purchase price per unit, 1 is the shortage cost per unit shortage demand by

K.P. Sapna Isotupa, S.K. Samanta / Mathematical and Computer Modelling 57 (2013) 12591269

1265

Table 1
Deterministically distributed lead times with 1 = 10, 2 = 30, = 1, c = 10, 1 = 20, 2 = 15, K = 200.
h

No rationing
Optimal cost

1
2
3
4
5

C0 (39, 129) = 531.84

Rationing
HP shortage
rate

LP shortage
rate

0.2302

0.6905

0.5181

1.5542

C0 (32, 74) = 624.29

1.0051

3.0153

3.8835

11.6505

C0 (0, 54) = 670.48

4.2553

12.7660

C0 (36, 91) = 585.39

C0 (0, 63) = 653.05

Optimal cost
C1 (1, 39, 129) = 531.68

C1 (1, 35, 91) = 584.89

C1 (5, 20, 73) = 622.40

C2 (11, 5, 61) = 645.37

C2 (11, 0, 51) = 659.84

Sub-optimal cost

HP shortage
rate

C1 (1, 40, 130) = 531.73

0.1192

C1 (1, 37, 92) = 585.13

LP shortage
rate
0.6872

0.2946

1.5466

C1 (1, 33, 75) = 623.51

0.6423

3.0059

1.3766

11.5870

C1 (5, 8, 55) = 666.71

1.9864

12.7478

C1 (6, 10, 63) = 647.27

HP customer, 2 is the shortage cost per unit shortage demand by LP customer, h is the inventory carrying cost per unit per
unit time. Then the long-run expected cost rate is given by
Ca (k, s, Q ) = hI + 1 1 + 2 2 + (K + cQ )3 ,

(20)

where
I =

Q +s

j =0

jPa (j),

1 = 1 Pa (0),

2 = 2

j=0

Pa (j),

3 =

1
Da

Analytical determination of the optimal values for the parameters was not possible. Hence we resorted to numerical
determination of the optimal values of the rationing level, k; the reorder point, s and the order quantity, Q . We compare
the optimal cost of the system with rationing to the optimal cost of a system without rationing. In the no-rationing case,
there is no differentiation between customers. Hence both types of customers are served as long as there is stock on hand.
The no-rationing case is a special case of Case 1 where k tends to 0. Let us denote by C0 (s, Q ) the long-run expected cost
rate in the no-rationing case. Since the long-run expected cost rate in both cases are now determined, the costs in the case
of rationing can be compared to the costs in the case of no rationing. The shortage costs can be interpreted as the selling
price of the items. As such it is only logical that the selling price of the item is greater than the effective cost price of the
item. Hence, 1 > (c + K /Q ) and 2 > (c + K /Q ) for the optimal value of Q in both the rationing and no rationing cases.
Further, the only difference between HP and LP customers in this case is the selling price to each type of customer and hence
we assume that 1 > 2 . Our numerical examples yielded a very interesting result. When we compare our model with a
system with no rationing, we find that the optimal cost is lower in our model than in the models with no-rationing in a
wide selection of cases. Further, when the optimal cost in our model with rationing is lower than the optimal cost in the
model without rationing, we can find a sub-optimal set of parameters (k, s and Q ) such that the cost of the rationing model
is still lower than the no-rationing model. In addition the shortage rates for both high and low priority customers are also
lower in the model with rationing. This is a counter-intuitive result as we would expect the shortage rate for low priority
customers to be higher in the model with rationing. However, we noted that raising the inventory level a little bit in the
rationing model yielded better service levels and lower costs than the no-rationing case. Hence the rationing model would
be socially optimal if the vendors were willing to forgo some profit. We followed the following two steps procedure for our
numerical analysis. Step 1: Optimize the system with no rationing. Step 2: Optimize the system with rationing along the
constraints that (i) Shortage rate for HP in case of rationing less than the shortage rate for HP without rationing. (ii) Shortage
rate for LP in case of rationing less than the shortage rate for LP without rationing.
The following two tables present the cases of deterministic and Erlang distributed lead times for 5 different values of
the inventory carrying cost (1st column). The second column gives the optimal cost when there is no rationing as well as
the optimal values of the reorder point and reorder quantity. The third and fourth columns provide the HP and LP shortage
rates in the case where there is no rationing of inventory. The second part of the table deals with the rationing case. The fifth
column gives the optimal cost in the rationing case, the optimal level at which supply is cut off for LP customers, the optimal
reorder point and optimal reorder quantity. The sixth column gives a sub-optimal cost for the system with rationing where
the shortage rates for both types of customers as well as the total cost are lower under the rationing policy when compared
to the case of no rationing. The seventh and eighth columns give the shortage rates for the HP and LP customers under the
sub-optimal rationing policy. From Tables 1 and 2, we see that the inventory carrying cost increases, the difference between
the optimal cost in the no-rationing and rationing models grow. We also note that the order quantity is always lower in the
case of the rationing model. In most cases if the vendor were to give up half the cost savings he obtains by using a rationing
policy, both the high priority and low priority customers would have better service levels than if the no-rationing policy
were employed.
From Tables 1 and 2, we also see that as inventory carrying costs increase to 4 or more, the optimal reorder point in the
no-rationing case is 0. Also, the reorder point and reorder quantity seem to be independent of the lead time distribution
when the inventory carrying cost is at least 4. It appears from all our numerical experience that when the reorder point is
zero, in both the rationing and no-rationing cases, the optimal cost and optimal order quantity are independent of the lead
time distribution. One final observation is that the optimal costs and service levels in the deterministic lead time case are at

1266

K.P. Sapna Isotupa, S.K. Samanta / Mathematical and Computer Modelling 57 (2013) 12591269

Table 2
Erlang of order 3 distributed lead times with 1 = 10, 2 = 30, = 3, c = 10, 1 = 20, 2 = 15, K = 200.
h

1
2
3
4
5

No rationing

Rationing

Optimal cost

HP shortage
rate

C0 (32, 137) = 542.95

LP shortage
rate

0.8803

2.6410

C0 (21, 96) = 595.27

1.7666

5.2998

2.6481

7.9444

C0 (0, 63) = 653.05

3.8835

11.6505

4.2553

12.7660

C0 (13, 76) = 629.33

C0 (0, 54) = 670.48

Optimal cost

Sub-optimal cost

C1 (4, 31, 136) = 541.97

C1 (5, 18, 94) = 593.23

C2 (8, 5, 74) = 625.69

C2 (11, 2, 61) = 645.84

C2 (11, 0, 51) = 659.84

C1 (3, 35, 139) = 542.33

C1 (3, 24, 98) = 594.03

C1 (3, 17, 76) = 627.49

C1 (4, 6, 64) = 649.78

C1 (3, 3, 57) = 668.18

HP shortage
rate

LP shortage
rate

0.5281

2.6290

1.1130

5.2954

1.7267

7.9273

2.3826

11.5906

3.0327

12.7473

least as good as or better than the optimal costs and optimal service levels in the case where the lead times have an Erlang
distribution.
6. Conclusions and extensions
In this paper we analyze a non-Markovian continuous review inventory system with two types of customers and lost
sales. In the case of arbitrarily distributed lead times we developed an expression for the total cost. In the special case of
Erlang and constant lead times, the numerical examples illustrated the fact that there are situations where rationing policies
are better than treating both customers alike for both types of customers.
The model proposed in this paper can be generalized in several directions. First, we could introduce the situation of bulk
demand from one class of customer. This model can then be used in various supply chain situations where a node receives
demand from the end-user and lower echelon suppliers. A second possible extension is to develop a similar model for the
partial backlogging case which will have applications for businesses with online sales. Work in these directions will be
undertaken in the near future.
In addition to the contribution to the body of literature on inventory models with customer differentiation, our model is
simple enough to be useful to the practitioner in the following ways:
1. An understanding of the environment under which customer differentiation is better than no segregation of customers. Our
analysis shows that when the costs of shortage, inventory, ordering and demand and lead time parameters are related in
a certain fashion, the rationing policy is better for the organization selling the items and both types of customers if the
organization is willing to reduce their profit margin a little. This reduction in profit margin will still yield higher profits
than the situation where there is no differentiation between customers.
2. The threshold level at which the inventory control manager should use his discretion in supplying customers with items. When
stock level falls below the threshold level, the inventory control manager is alerted to the need of hoarding stock for
the high priority customer and will supply a low priority customer only after careful consideration of the merits of this
action.
3. A measure of the gains which will be made due to adopting a rationing policy. From the discussion in the numerical
illustration section, it is clear that under certain cost structures there is a huge potential for cost savings if a rationing
policy is employed and that under certain other conditions, rationing does not yield much in terms of cost reductions.
Acknowledgment
This research was performed when Dr. S.K. Samanta was a post doctoral fellow supported by Dr. Sapna Isotupas NSERC
research grant.
Appendix
Determination of the functions a (i, j, t ).
To obtain a (i, j, t ), we note that between two replenishment epochs {I (t ); t 0} is a pure death process and satisfies
the following Kolmogorovs forward differentialdifference equations

1 (s, s, t ) = (1 + 2 )1 (s, s, t ),

(21)

1 (s, j, t ) = (1 + 2 )1 (s, j, t ) + (1 + 2 )1 (s, j + 1, t ),

k + 1 j s 1,

(22)

1 (s, k, t ) = 1 1 (s, k, t ) + (1 + 2 )1 (s, k + 1, t ),

(23)

1 (s, j, t ) = 1 1 (s, j, t ) + 1 1 (s, j + 1, t ),

(24)

1 j k 1,

1 (s, 0, t ) = 1 1 (s, 1, t ),

(25)

2 (s, s, t ) = 1 2 (s, s, t ),

(26)

K.P. Sapna Isotupa, S.K. Samanta / Mathematical and Computer Modelling 57 (2013) 12591269

2 (s, j, t ) = 1 2 (s, j, t ) + 1 2 (s, j + 1, t ),

1 j s 1,

1267

(27)

2 (s, 0, t ) = 1 2 (s, 1, t ).

(28)

For Q i Q + s

a (i, i, t ) = (1 + 2 )a (i, i, t ),

(29)

a (i, j, t ) = (1 + 2 )a (i, j, t ) + (1 + 2 )a (i, j + 1, t ),

k + 1 j i 1,

(30)

a (i, k, t ) = 1 a (i, k, t ) + (1 + 2 )a (i, k + 1, t ),

(31)

a (i, j, t ) = 1 a (i, j, t ) + 1 a (i, j + 1, t ),

(32)

1 j k 1,

a (i, 0, t ) = 1 a (i, 1, t ).

(33)

Taking the Laplace Transform on both sides of (21)(25), and solve for 1 (s, j, ) recursively, we obtain

(1 + 2 )sj
, k + 1 j s,
( + 1 + 2 )s+1j

sk
kj
1 + 2
1
1

1 (s, j, ) =
,
+ 1 + 2
+ 1
+ 1
sk
k

1
1
1 + 2

.
1 (s, 0, ) =
+ 1 + 2
+ 1

1 (s, j, ) =

(34)

1 j k,

(35)

(36)

Taking the Laplace Transform on both sides of (26)(28), and solve for 2 (s, j, ) recursively, we obtain

sj
1
1
,
2 (s, j, ) =
+ 1
+ 1

s
1
1

2 (s, 0, ) =
.
+ 1

1 j s,

(37)

(38)

Taking the Laplace Transform on both sides of (29)(33), and solve for a (i, j, ) recursively, we obtain

(1 + 2 )ij
, k + 1 j i,
( + 1 + 2 )i+1j

ik
kj
1
1
1 + 2

a (i, j, ) =
,
+ 1 + 2
+ 1
+ 1

ik
k
1 + 2
1
1

a (i, 0, ) =
.
+ 1 + 2
+ 1

a (i, j, ) =

(39)

1 j k,

Solving Eqs. (34)(36) for 1 (s, j, t ) and are given by

(1 + 2 )sj t sj e(1 +2 )t
, k + 1 j s,
(s j)!
kj r s+j r (1 +2 )t

r s + k 1 2
t e
, 1 j k,
1 ( s, j , t ) =
r
!(
+
2 )ks
k

j
1
r =sj
j r s+kj r (1 +2 )t
r
s+k

r s + k 1 2
t e
1 ( s, 0 , t ) =
.
j
r !(1 + 2 )ks
r =s j=k

1 ( s, j , t ) =

Solving Eqs. (37)(38) for 2 (s, j, t ) and are given by

1sj t sj e1 t
, 1 j s,
(s j)!
s1

r1 t r
2 (s, 0, t ) = 1 e1 t
.
r!
r =0

2 ( s, j , t ) =

(40)

(41)

1268

K.P. Sapna Isotupa, S.K. Samanta / Mathematical and Computer Modelling 57 (2013) 12591269

Determination of the functions Aa (i, ).

Taking the Laplace Transform on both sides of (5), we obtain

i +Q s

1 + 2

+ 1 + 2

Aa (i, ) =
i +Q k
ks

1 + 2
1

,
+ +
+ 1
1
2

a = 1;

a = 2.

Determination of the functions Ba (j, ).

Taking the Laplace Transform on both sides of (6), we obtain

(1)sj ( + )sj
1
2

g (sj) ( + 1 + 2 ),

(s j)!

kj r s+j

r s + k (1)r 1 2

g (r ) ( + 1 + 2 ),
B1 (j, ) =
kj
r !(1 + 2 )ks

r
=
s

j r s+kj
r
s+k

r s + k (1)r 1 2

g (r ) ( + 1 + 2 ),

j
r !(1 + 2 )ks
r =s j=k

(1)sj s1j (sj)

( + 1 ),
1 j s;

(s j)! g

B2 (j, ) =
s1

(1)r r1 (r )

g ()
g
( + 1 ), j = 0.

r!
r =0

k + 1 j s;
1 j k;

j = 0.

Determination of the functions Ha (j, ).

Taking the Laplace Transform on both sides of (8), we obtain

(1)sj ( + )sj
1
2

G(sj) ( + 1 + 2 ),

(s j)!

kj r s+j

r s + k (1)r 1 2

G(r ) ( + 1 + 2 ),
H1 (j, ) =
kj
r !(1 + 2 )ks

r
=
s

r s+k

r j r s+kj

r s + k (1) 1 2

G(r ) ( + 1 + 2 ),

j
r !(1 + 2 )ks
r =s j =k

(1)sj s1j (sj)

( + 1 ),
1 j s;

(s j)! G

H2 (j, ) =
s 1

(1)r r1 (r )

G ()
G ( + 1 ), j = 0.

r!
r =0

k + 1 j s;
1 j k;

j = 0.

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