An Integrated Inventory Model Involving Probabilistic Demand And Lead Time

Monika Aditia Putri and Chairul Saleh

Abstract
In this competitive era, Just-in-time purchasing has become one of major solution in
solving many problems in manufacturing system. Several problems that usually
emerge in JIT environment include maintaining a high quality product, small lot sizes,
frequent delivery, short lead time, and close supplier ties. A particular characteristic of
JIT based company is the close and long term relationship they have with their
supplier. Derived from that developing relationship between a single supplier and a
single purchaser, an integrated inventory model is established. Inventory integrated
model is a model created with the purpose of minimizing the sum of the
ordering/setup cost, holding cost, quality improvement and crashing cost by
concurrently optimizing the order quantity, the lead time, the process quality, and the
number of deliveries when the probability of the lead time demand is normal. This
paper presents the model in the form of mathematical model in addition it also
provides a comparison of the traditional model and the proposed model, specifically in
two factors, those are order quantity and total cost. The optimization of the model is
using the heuristic algorithm.
management is a popular practice in

1. Introduction
In

the

competitive

manufacturing system, and just-in-time

companies

(JIT) production plays a crucial role in

have devoted considerable attention on

supply chain environments. Companies

reducing inventory cost and lead time

are using JIT production to gain and

and improving quality simultaneously.

maintain a competitive advantage. The

Therefore, nowadays supply chain

characteristics of JIT systems are

environment,

dynamic,
succesful

consistent high quality, small lot sizes,

factors affecting the total costs related

frequent delivery, short lead time, and

to purchasing. By shortening the lead

close supplier ties (Pan and Yang,

time, a company can lower the safety

2004).

stock, reduce loss caused by stock out,

In recent years, companies have

improve customer service level and

found that there are substantial benefits

thus increase the competitive edge in

from establishing a long-term sole-

business (Ouyang and Wu, 1997). The

supplier relationship with a supplier

reduction of lead time mainly consists

(Martinich,

JIT

of the following components: order

environment, a close cooperation exists

preparation, order transit, supplier lead

between supplier and purchaser to

time, and delivery time (Tersine,

solve problem together, and thus to

1982).

1997).

maintain

In

stable,

the

long-term

The

integrated

model

can

relationships. Since both purchaser and

contribute significantly to improve the

supplier

vendor-purchaser

may

benefit

from

the

relationship.

The

negotiation process, the two sides must

success and resulting performance of

then negotiate to determine how to

the integrated model is based upon the

divide

and

cooperation between the purchaser and

Griffin, 1996). The advantages of the

supplier; for example, the integrated

integrated inventory model include

model practices characterized by a

improved quality, lowered inventory

sole-supplier base whose firms are

cost, technology sharing and reduction

located close to the buyers plant, make

of lead time.

frequent deliveries, and are considered

In

the

JIT

savings

(Thomas

production,

lead

time

long-term partners with the buying

reduction has become one of the main

company (Gunasekaran, 1999). When

establishing a long-term relationship, it

the number of deliveries, with a

is important that the purchaser selects

condition where the probability of lead

the vendors that have consistently

time demand is normal.

exhibited high levels of quality and

2. Notation and assumptions

delivery reliability (Schonberger and

Ansari, 1984).
In

relation

To

establish

the

mathematical

model, the notation and assumptions

with

the

above

explanations, we know that the object

employed throughout the paper are as

follows:

of this research is involving two areas

Q*

= Order quantity.

of organization, those are supplier and

M*

= number of deliveries.

purchaser.

= Probability of process being

The

objective

of

this

research is to minimize the total

out of control.

relevant costs that include purchasers

L*

= Lead time.

ordering cost, vendors setup cost,

= Average demand per year.

holding cost, quality improvement and

= Production rate.

crashing costs. In order to accomplish

= Purchasers ordering cost

them, an integrated inventory model

per order.

proposed by Jin-Shan Yang and Jason

Chao-Hsien Pan (2004) is implemented

setup.

in the manufacturing process, JIT

CV

production, involving both supplier and

by the vendor.

purchaser. At the same time, the

CP

implementation of the proposed model

the purchaser.

can also optimize the order quantity,

the lead time, the process quality, and

cost per dollar invested in stocks.

= Vendors setup cost per

= Unit production cost paid

= Unit purchase cost paid by

= Annual inventory holding

= The fractional per unit time

3. The reorder point (ROP) equals

opportunity cost of capital.

the

Ai

= Minimum duration.

demand during lead time and

Bi

= Normal duration.

the safety stock, that is, the

Ci

= Crashing cost per unit time.

reorder point equals ROP = L

R(L) = Lead time crashing cost per

+ kL, where k is known as

cycle.

the safety factor.

Cost

of

replacing

defective unit.

sum

of

4. Inventory

the

is

expected

continuously

reviewed and replenished.

5. The out-of-control probability

= Safety factor.

= Standard deviation.

is

= Current probability that the

variable, and is described by a

continuous

production can go out of control.

logarithmic

function.

= Percentage decrease in

decision

investment
The

quality

per dollar increase in q().

improvement

The assumptions made in the paper

investment is represented by

and

capital

q() = qln(0/) for 0 < 0,

are as follow:
1. The product is manufactured

where

is

the

current

with a finite production rate P,

probability that the production

and P > D.

process can go out of control,

2. The demand X during the lead

and q =1/, with denoting the

normal

percentage decrease in per

distribution with mean DL and

dollar increase in q(). The

standard deviation .

application of the logarithmic

time

follows

function

on

quality

improvement

and

capital

investment has been proposed

by many authors, for example,
Porteus

(1986),

Hong

and

Hayya (1995), Ouyang and

Chang (2000) and Ouyang et al.
(2002).
6. The lead time L has n mutually
independent components and
these components are crashed

where m is an integer representing the

number of shipments of the item
delivered to the purchaser, and ai, bi, ci
are the minimum duration, normal
duration and crashing cost per unit
time,

respectively,

component

of

one at a time starting with the

of

lead

the

ith

time.

Let

, and let Li be

one of least crashing cost per

the length of the ith component of the
unit time, and so on.
lead time crashed to its minimum
3. A basic model
duration. Then Li can be expressed as
The expected annual total cost of
Li =

i = 1, 2, .

an integrated inventory model with

. . , n. Also let R(L) denote the leadnormally distributed lead-time demand
time crashing cost per cycle for a given
for minimizing the sum of the ordering
,

cost, holding cost and crashing cost can

and

be expressed as (Pan and Yang 2002):

.
In order to include the essence of
an

imperfect

production

process,

consider the assumption made in the

model proposed by Porteus (1986).

The integrated inventory model is

designed

for

vendor

4. Investment in quality

production

improvement

situations in which, once an order is

placed,

production

begins

and

Based on equation (2), we wish to

study the effect of investment on

constant number of units is added to

quality improvement. Consequently,

the inventory each day until the

the objective of the integrated model is

production run has been completed.

to

The vendor produces the item in the

ordering/setup

quantity mQ with a given probability

quality improvement and crashing cost

of that the process can go out of

by simultaneously determining the

control. Porteus (1986) suggested the

optimal values of Q, m, and L,

expected number of defective items in

subject to the constraint that 0 < 0.

a run of size mQ can be evaluated as

Thus, the total relevant cost per year is

minimize

the

sum

of

cost,

holding

the
cost,

m2Q2/2. Suppose g is the cost of

replacing a defective unit, and the
production quantity for the supplier in
a lot of mQ. Then its expected
defective cost per year is given by
gmQD/2.
Hence, the total expected annual
cost incorporating the defective cost
per year can be represented by

for 0 < 0, where i is the fractional

opportunity cost of capital per unit
time.
Therefore, the problem under study
can be formulated as the following
nonlinear programming model:

Minimize

However, for fixed values of Q and ,

TRC(Q, m, , L) is concave in
Subject to 0 < 0

, because

In order to find the minimum cost

for

this

non-linear

programming

problem, ignore the constraint 0 <

0 for the moment and minimize the

Therefore, for fixed Q and , the

total relevant cost function over Q,

minimum joint total expected annual

and L with classical optimization

cost will occur at the end-points of the

techniques by taking the first partial

interval. On the other hand, for a given

derivatives of TRC(Q, m, , L) with

value

respect to Q, and L as follows:

equations (5) and (6) equal to zero and

of

setting

solving for Q and , it follows that

and

Theoretically,

for

fixed

, one can find the optimal

values of Q* and * from (8) and (9).
In addition, for fixed

, the

Hessian matrix of TRC(Q, m, , L) is

positive definite at Q* and *. The

proof is shown in the appendix.
For a particular value of m, the
total relevant annual cost is described
Once again, ignoring the terms that
by
are independent of m, the minimization
of the problem can be reduced to that
of minimizing

Ignore

the

terms

that

are

independent of m, and take the square

The optimal value of m = m* is

obtained when
and

of (10); then, minimizing TRC(m) is

equivalent to minimizing

(12)
Substituting relevant values in (12), the
following condition holds:

Hence, for fixed

when the constraint 0 < 0 is

ignored, one can find the optimal
values of Q*, m* and * such that the

annual total relevant cost reaches a

Li), for i = 0, 1, . . . , n, and go

minimum.

to step 4.

The

following

procedure

is

constructed to find optimal values of

Q, m, and L for the problem under
investigation.

> 0, set

Step 3. If

= 0 for the

given Li, then substitute

into

equation (13) to compute

and use

and

to determine

Step 1. For each Li, i = 1, 2, . . . , n, set

from equation (8); so use
i = 0 and perform (i)(iii):
(i) Substitute i into equation
(13) to find mi, and use i and mi to

equation
TRC(

(4)
,

to

calculate

, Li), for i = 0,

1, . . . , n.

compute Qi

Step 4. Set TRC(Qs, ms, s, Ls) = mini =

using equation (8).

(ii) Use Qi and mi to determine

0,1, . . ., n{

TRC(

, Li)}.

Then TRC(Qs, ms, s, Ls) is a set

i from equation (9).

(iii) Repeat (i)(ii) until no
change occurs in the values of Qi, mi

of optimal solutions.
5. Traditional integrated inventory
model

and i. Denote
these solutions by

and

Without crashing, frequent delivery

and quality investment, the traditional

, respectively.

integrated inventory model is given by:

Step 2. If

0, then the solution

found in step 1 is optimal for

the given Li; so use equation (4)
to compute TRC(

To obtain the minimum cost lot

ln(0.0002/), and lead time has four

size, take the first derivative of

components with data shown on table

TRC(Q), and set it to zero; thus,

1. The data shown in lead time data

table applies the characteristic of
probabilistic,

which

is

by

implementing the random method,

therefore it can change anytime a

The function TRC (Q) is convex in

production process is performed.

Q, since

Unit

Therefore, solving for the optimal

Lead time

Normal

Minimum

crashing

component i

Duration

Duration

cost ci

bi (days)

ai (days)

(Rp/day)

10600

11000

8500

9000

order quantity in (15), we obtain

Table 1. Lead time data for the

6. An illustrative example

illustrative example

In order to illustrate the above

Since the value of demand and lead

solution problem, let us consider an

inventory integrated system with the

time

are

applying

probabilistic

following data: P = 14200 unit/year, A

characteristic in its data establishment,

= Rp. 24550/order, S = Rp. 150/setup,

that is why we cannot put the exact

CP = Rp. 550/unit, CV = Rp/450/unit, r

number of demand and lead time.

TRC(Qi, mi,

= 2.59, k = 1.162, = 339.11 unit/

year, I = 0.125/Rp/year, g = Rp. 45 per
defective

unit,

q()

3000

Li

mi

Qi

i, Li)

15

510

0.00000487280

1219124.56

14

610

0.00000487280

13
13390
1411843.097

19

515

0.00000242

1460667.18

11

850

0.00000487280

14
13995
1868938.727

19

500

0.00000119

1487685.64

11

850

0.00000487280

1868938.727

Table 3. Order quantity and total

10

904

0.00000487280

1971016.019

relevant cost for probabilistic demand

Table 2. Summary of the solution

and lead time

procedure for the illustrative example

The following table exhibits the

However the following table is

result of order quantity and total

displayed to show several possible

relevant

amounts of demand and its effect on

cost

involving probabilistic demand and

and total relevant cost. For the record,

lead time.

the amount of demand cannot exceed

bi

implementing

traditional integrated inventory model

the calculation result of order quantity

the production rate (P > D).

by

bi
Sample

TRC

7215

18

426

1011473.146

TRC
7872

19

438

1067608.984

Sample

7215

18

426

0.00000542

3999361.1283
8461 3

10

18

449

1110839.979

7872

19

438

0.00000482

41053829.773
8639 4

16

452

1117709.438

8461

10

18

449

0.00000438

51095532.176
9226 4

19

462

1174093.064

8639

16

452

0.00000426

61101933.877
9547 4

14

467

1180859.328

9226

19

462

0.00000391

71156757.255
10232 3

13

477

1229595.786

9547

14

467

0.00000374

81162659.476
10662 3

17

483

1277654.964

10232

13

477

0.00000341

9 1209528.57
11001

15

487

1296100.945

10662

17

483

0.00000324

101256400.321
11702 4

15

496

1349130.666

11001

15

487

0.00000311

111273902.474
12328 5

19

503

1410445.729

10

11702

15

496

0.00000287

121324960.45
12562

14

506

1409840.811

11

12328

19

503

0.00000268

131384493.575
13390 5

19

515

1489683.389

12

12562

14

506

0.00000262

141383217.793
13995 5

19

521

1534537.889

Table 4. Order quantity and total

7. Conclusion

relevant cost using traditional model

From the last two tables, we can

From the results above, we can also

observe

the

compare the result of total relevant cost

disadvantages

implementing

deterministic

the

proposed

and

advantages
of
or

and

and

involving
the

probabilistic

traditional integrated inventory model.

demand

The total relevant cost yielded from the

implementation of integrated inventory

calculation using the proposed model

model

results in smaller value compared to

Comparing between the two models,

traditional model.

whether it is including deterministic or

and

lead

the

time

traditional

in

the

model.

Applying the proposed solution

probabilistic of demand and lead time,

procedure yields the optimal lead time

the total relevant cost resulted from

Ls = 19 days, optimal number of

proposed model is smaller than the

deliveries ms = 2, optimal probability

traditional model. It happened because

s = 0.00000119, and optimal order

the

quantity Q* = 500 units. The total

proposed by Pan and Yang (2004)

relevant

annual

1487685.643.

integrated

inventory

model

cost

is

Rp.

includes some additional elements,

Compare

to

the

those are crashing of activity lead time,

application of traditional model, yields

and quality investment.

the optimal lead time L = 19 days,

However, the proposed model by

optimal number of deliveries m = 1,

Pan and Yang (2004) which involves a

optimal probability = 0.0002, and

deterministic lead time and demand has

optimal order quantity Q = 521 units.

a disadvantage in contrast with the

Thus, the total relevant cost is Rp.

probabilistic. As explained in the first

1534537.889.

paragraph, the deterministic based

model is not suitable when it is being

implemented in the real business
world. Since, the demand and also
length of activity lead time always in
dynamic

condition.

Customers

demand keeps changing every time a

The determinant f the Hessian matrix

can be calculated as

production process is performed and

lead time of activity also depends on
the actual situation. Aside from that,
deterministic

model

also

advantage

compared

has
to

an
the

probabilistic. Since, the demand and

lead time in probabilistic model always
change, thus the company has to give
more attention in recording the data.
Therefore, there will not be any
miscalculation in finding the total
relevant cost that will cause a deficit in
the company.
Appendix
For fixed L (Li, Li 1, TRC(Q, m,
, L) is convex with respect to Q and ,
since

References