Optimal Ordering and Issuing for Perishable Inventory Management

Problem with A Minimum Inventory Volume Constraint

Yen-Ming Lee Shi Mu Zhihong Shen Maged Dessouky∗

yenmingl@usc.edu smu@usc.edu zhihong.shen@gmail.com maged@usc.edu

Daniel J. Epstein Department of Industrial and Systems Engineering

University of Southern California
3715 McClintock Avenue, Los Angeles, CA 90089

October 23, 2009

Abstract

We study a perishable inventory system that requires to maintain a fresh and large quantity of
inventory at all times. For example, certain pharmaceuticals are kept for emergency preparedness
and response operations. We aim to maximize the profit by optimizing the joint problem of the
ordering and issuing policies while maintaining a minimum amount of perishable inventory. First,
we consider a linear price model such that the primary and secondary market price functions are
linearly decreasing in age. We present the optimal issuing policy if the ordering policy is given and
fixed. We then consider optimizing the joint problem of the ordering and issuing policies. We first
derive the revenue functions when the FIFO (first-in, first-out) or LIFO (last-in, first-out) issuing
policies are used and the optimality condition is presented. Next, we consider a problem with
stepwise (2-step) price functions. For the problem with given order quantity, the optimal issuing
policy is sensitive to all parameters of the primary and secondary market price functions, and the
revenue function is non-convex and non-differentiable. Thus a heuristic issuing policy is proposed.
Some characteristics of the optimal policy are discussed and the properties of the FIFO, LIFO, and
heuristic policies are presented. We then present results for the joint problem of the ordering and
issuing policies and show that some of the analytical results from the problem with given order
quantity still hold.

Keywords: Perishable Inventory Management, Economic Manufacturing Quantity, Emergency Re-

sponse, Issuing Policy
∗
Corresponding author

1
1 Introduction

Perishable stock items cannot be stored indefinitely to satisfy future demand. Once the perishable
items pass their lifespan, they become unsuitable for consumption. In some special inventory systems,
a minimum inventory quantity of perishable item is required to be kept at all times. The tradi-
tional Economic Manufacturing Quantity (EMQ) model could be extended to deal with the perishable
items with minimum inventory requirement by limiting the length of the EMQ cycle to guarantee the
consumption of items within its shelf-life. However, in the case where the amount of the minimum
requirement is comparable to (not significantly smaller than) the amount of the regular market demand
during the shelf-life, a simple extension of the EMQ model would no longer be applicable. An exam-
ple would be the pharmaceuticals stored by the federal government and Vendor Managed Inventory
(VMI) as part of the Strategic National Stockpile (SNS). For instance, the federal government keeps
a stockpile of 1.2 billion Cipro pills (to be ready to treat 10 million patients in a potential anthrax
attack) at any time as part of the SNS in case of a large-scale bioterrorism attack. The shelf-life of the
Cipro pills is normally 7.5 years and the annual ordinary demand, used as a common antibody for a
number of infections, is only 300 million pills.

This work is relevant to the situation as described above where a large perishable stockpile is needed
in order to respond quickly to a large-scale emergency and the stored units can also be used to satisfy
the primary (or regular) market demand. We focus on the problem where the amount of the minimum
requirement of perishable items is comparable to the amount of the primary market demand during
its limited shelf-life. The minimum inventory requirement is pre-determined and known. When an
item exceeds the shelf-life, it will be discarded directly. We assume that the primary market demand
is deterministic and the items are sold to the primary market at an age dependent price function. We
also assume that there is a secondary market with unlimited demand. The secondary market is used
to dispose of excess inventory and the price for this market is also an age dependent function. The
primary market price is greater than the secondary market price for an item of the same age. An
example of a secondary market is the overseas market for pharmaceuticals. For instance, Cipro can be
sold at 95 cents per pill in the United States while in India it can be sold at 30 cents per pill [13]. Our
objective is to maximize the profit by optimizing the ordering and issuing policies while satisfying the
minimum inventory requirement. The revenue comes from issuing items to the primary market and
disposing the remaining inventory to the secondary market. The costs consist of the inventory holding
cost, fixed setup cost, and unit purchasing cost.

The ordering (or manufacturing) policy and issuing policy along with the disposal and pricing policy
are four major researched areas in the literature of perishable inventory systems. Among the four major
areas, the ordering policy and issuing policy have attracted the most attention. The ordering policy
answers the question of when and how much to order. For perishable inventory systems, the periodic
review policies are very popular because they are easy to implement in practice. Fries [5] and Nahmias
[9] performed a detailed analysis of the m-period (lifespan equals m review periods) model with zero
replenishment lead time. Continuous review policies have also drawn the attention of researchers.

2
Weiss [14] showed the (s, S) policy is the optimal ordering policy for a process with Poisson demand
and zero lead time. Liu and Lian [8] extended Weiss’s work by considering a general renewal demand
process and they obtained a closed-form expected cost function. Recently, Berk and Gurler [1] showed
the (Q, r) policy (r < Q) is a reasonably good policy in situations of Poisson demands, constant lead
times and lost sales in the presence of non-negligible ordering cost.

The issuing policies also influence the profitability because they manage the way items are removed
from the inventory system. The issuing policy directly impacts the age distribution of items issued.
In most situations, the price of the items issued is dependent on the age of the items. An appropriate
issuing policy is needed to maximize the revenues obtained from issuing items out of the system. The
issuing policy also affects the age distribution of on-hand items. Thus the shortages and losses due to
spoilage is another factor that needs to be considered when analyzing issuing policies. Derman and
Klein [3] and Lieberman [7] were some of the earliest to discuss the optimality conditions for both
the FIFO (First-In-First-Out) policy and the LIFO (Last-In-Last-Out) policy. Their discussion was
in the domain where supply and demand were assumed known. Eilon [4] and Pierskalla [10] extended
previous works by relaxing some restrictive assumptions, e.g., single demand source, concave or convex
functions of field life, etc. Pierskalla and Roach [11] were the first to analyze the inventory systems
with random supply and demand of perishable items (a blood bank is a good example of such an
inventory system). They showed that for most of the objective functions considered, the FIFO policy
was the optimal policy. On the other hand, Cohen and Pekelman [2] showed that the LIFO policy was
the most suitable policy for some systems such as the military ammunition stockpile control in short
conflict situations. From the 1970s, the blood inventory management problem has attracted great
attention from the research community and motivated many studies of perishable inventory systems.
An overview of the theories and practices in blood inventory management were done by Prastacos [12].
Also motivated by problems in the blood inventory management, Goh et al. [6] modeled the perishable
inventory system with two stages. The first stage keeps the younger items and the second stage holds
the older items. They considered and compared two possible two-stage FIFO policies.

Shen [13] considered a perishable inventory system with a large minimum inventory constraint.
Shen [13] proposed a modified EMQ model and formulated a non-convex non-smooth cost function
of maintaining the proposed model. An efficient exact algorithm was developed to minimize the cost
function. Shen’s [13] work assumed uniform primary and secondary market prices and focused on the
ordering policy only. Though there is a rich literature on issuing policies for perishable items, to the
best of our knowledge, there is no prior work in the issuing policy which considers a requirement of
a significant minimum inventory level. This research considers a situation where a large perishable
stockpile is needed to respond quickly to a large-scale emergency and the stored units can also be used
to satisfy the primary market demand. We study the problem that is based on Shen’s [13] modified
EMQ model and take the issuing policy of the perishable items into consideration. This work addresses
this gap by first looking at the issuing policies assuming an ordering policy is given and then trying to
optimize the joint problem of the ordering and issuing policies.

The rest of the paper is organized as follows. Section 2 gives a brief introduction of the modified

3
EMQ model in Shen [13]. Section 3 discusses the scenario that the price of an item is a linearly
decreasing function of its age. In this section, the revenue functions for the FIFO policy and the LIFO
policy are derived and a joint optimal ordering and issuing policy is proposed. The problem becomes
much more complicated in Section 4 when we consider stepwise primary and secondary market price
functions. A heuristic issuing policy has been developed to compare with FIFO and LIFO policies. We
conclude this paper in Section 5.

2 Modified EMQ Model

We study the joint ordering and issuing problem using the modified EMQ model developed by Shen
[13] for perishable items with a minimum inventory quantity constraint. In this section, we give a brief
introduction of the modified EMQ model on which our work is based.

There are two types of demand that need to be considered, a primary market demand and a
minimum inventory requirement, called Imin , which must be kept in the system at all times. The
secondary market demand is used to dispose of excess inventory. In the case that the minimum
inventory requirement is significantly smaller than the primary market demand, a tighter limit on
the EMQ cycle is enough to guarantee the freshness of the minimum inventory. However, when the
minimum inventory requirement is in a scale comparable with the primary market demand, a trivial
extension to any current perishable inventory policy is no longer adequate. Hence, we need a new
inventory model for the problem. Since there are two types of demand, we can formulate the problem
into two different inventory models. One is a single inventory system that combines the two types
of demand and the other one is a standard model which runs the two parts separately. From Shen’s
numerical experiments, the combined system saves about 30% of the cost to a standard model. Thus,
our issuing model is based on the combined system which is called the modified EMQ model.

Assume that the primary market demand is known with a priori constant rate D per year. The
production can start at any time at a constant rate P , which is greater than D. Let Tinv denote
the inventory cycle as the minimum length of time (in years) that an inventory pattern repeats. The
idea of the model is that, in a Tinv cycle, we produce the amount of products to satisfy the primary
market demand and Imin for the next cycle. Fig. 1 shows an illustration of a typical inventory plot
of the modified EMQ model. For any given Q, we initially run a regular production cycle (underlying
Q
regular production cycles with the cycle length T , where T = D) and we may need to make some
adjustment near the end of the inventory cycle to meet the minimum inventory requirement (an
additional production cycle). To maintain a fresh inventory in the system, every Tinv , an Imin amount
is either consumed by the primary or secondary markets and another Imin amount is produced. At the
end of each Tinv , we sell/dispose all the inventory above the Imin level (not consumed by the primary
market demand) to a secondary market so that we have an exact Imin at the beginning of the next
Tinv cycle. We assume an unlimited demand for the secondary market.

In this model, we have the following constraint on the minimum inventory quantity to guarantee

4
 Figure 1: Illustration of the Modified EMQ Model

the system to refresh the entire minimum inventory quantity within each Tinv .

D · Tinv < Imin ≤ P · Tinv

In order to produce an Imin amount within Tinv while satisfying the constraint, an additional
production cycle may be required to produce the amount to be disposed at the end of an inventory
cycle (if there is no emergency response event). If an additional production cycle exists, it may start
at any time of an underlying regular production cycle and thus form a partial regular production
cycle. In other words, within each inventory cycle Tinv , the inventory model possibly consists of three
different parts: 1) N full regular production cycles (for example, in Fig 1, N = 2); 2) a partial regular
production cycle; 3) an additional production cycle. Where the inventory cycle ends relative to a
regular underlying production cycle affects the production plan. It may end in the production period
(the uphill region) or in the non-production period (the downhill region).

With the different additional production cycle and Tinv scenarios, there are a total of 5 different
possible cases. Fig 2 provides illustrative inventory plots for all 5 cases. Cases 3, 4 and 5 show that
an additional production cycle is needed while regular production models are sufficient in Cases 1 and
2. In Cases 2 and 4, Tinv ends in the production period of a regular underlying production cycle;
otherwise in Cases 1, 3, and 5, Tinv ends in the non-production period. Furthermore, Cases 3, 4 and 5
are further classified according to where the additional production cycle starts. If it starts at the same
non-production period as it ends, it is Case 5; if it starts at some earlier regular production cycle, we
have Cases 3 and 4.

As an exemplary case, we next show the total cost, T RC(Q), as a function of the order quantity,
Q, for Case 1. The total costs within a single inventory cycle is composed of 3 parts: inventory holding

5
 Figure 2: All 5 Cases of Possible Scenarios

cost, fixed setup cost, and unit purchasing cost. After some simplifying steps, Shen [13] shows that
the T RC(Q) becomes

Q Q
T RC(Q) = A(N + 1) + ( − Tinv + N ) · Dv
D D
1 Q2 D Q Q
+ h[(N + 1) (1 − ) − D( − Tinv + N )2 ] (1)
2 D P D D

where,

A: fixed setup cost per production run

h: inventory holding cost per unit per year
v: purchasing cost per unit
N: number of complete regular production cycles in one Tinv cycle

We extend the work of Shen [13] to consider an age dependent sale price of items sold to the primary
and secondary markets. With consideration of the primary and secondary market prices, our objective
now is to maximize profit. From equation (1), it is easy to see that the cost portion of the profit model
is independent of the issuing policy. However, the revenue portion of the profit model is influenced by
both the issuing and ordering policies.

6
3 Linear Price Function

In this section, we are interested in the problem that both the primary and secondary market price
functions decrease linearly with the age of the product. We want to determine a policy to issue products
to the primary market and to dispose the remaining products to the secondary market.

Unlike Shen’s [13] model, where the primary and secondary market price functions are independent
of the age of the item, now we assume both the market prices are linearly decreasing in age. It is
a reasonable assumption for some perishable products because customers may not be willing to pay
the same price for less fresh products. Assume the shelf-life of the inventory is Ts . Let fM (t) be the
primary market price function and fS (t) be the secondary market price function, where t represents the
age of an item. Throughout this section we assume fM (t) and fS (t) are linearly decreasing functions:
a b
fM (t) = a − Ts t and fS (t) = b − Ts t. We define a as the full primary market price and b as the full
secondary market price. The functions are shown in Fig. 3.

Figure 3: Linear market price functions

3.1 Problem with Given Order Quantity

We first introduce the problem where the ordering policy is given and fixed. Since we know when
and how much to order and we assume the purchasing cost, inventory holding cost, and setup cost
are all age independent, the cost portion of the model is a constant. Thus, we only need to consider
the objective of maximizing the revenue. Since the primary market price is decreasing by age, it is
intuitive to think that if we can always issue the items with younger ages to the primary market, we
might receive larger revenue. Next we prove this intuition and state the optimality condition.

Proposition 3.1 If a ≥ b, it is optimal to issue the youngest items to the primary market demand
when we have a linearly decreasing price function.

7
Proof. Before we prove the argument for the non-continuous production problem, we prove it for a
simplified special case first. Let us consider a problem that has a continuous production plan with
disposal, i.e., without the downhill no-production periods in Fig. 1 or in a EMQ model.

We define the initial-age as the time from being produced until the beginning of the next Tinv
cycle. For a discrete time case, the possible value of the initial-age is an integer between [1, Tinv ].
Since the ordering policy is known, we have all the initial-age information of the production before
every Tinv cycle. Let set S be a set of the initial-age of the items produced from the previous Tinv
cycle, i.e., S = {1, ..., 1, 2, ..., 2, ...., Tinv , ..., Tinv }. Since it is a continuous production case, S contains
every integer in [1, Tinv ] and each distinct value has P elements in S.

To find the optimal issuing policy of this continuous production problem, we formulate the problem
as a mixed integer programming (MIP) model. The variables are defined as follows:

• Xit : initial-age of ith item issued at time t to the primary market

• Yj : initial-age of jth item disposed to the secondary market

• Zitk : binary variables representing whether Xit equals to k, where

(
1 if Xit = k
Zitk =
0 if Xit 6= k

• Wjk : binary variables representing whether Yj equals to k, where

(
1 if Yj = k
Wjk =
0 if Yj 6= k

The objective is to maximize the revenue from all sales. The objective function can be written as

(P −D)Tinv
X−1 X
Tinv D
a X b
max [a − (Xit + t)] + [b − (Yj + Tinv )]
Ts Ts
t=0 i=1 j=1

Rearranging the objective function and removing the constant terms. We have the MIP model as
follows:
(P −D)Tinv
X−1 X
Tinv D X
min a Xit + b Yj
t=0 i=1 j=1
(P −D)Tinv
X−1 X
Tinv D X
s.t. Zitk + Wjk = P ∀k (2)
t=0 i=1 j=1
X
Zitk = 1 ∀ i, t (3)
k
X
Wjk = 1 ∀ j (4)
k

8
 X
k · Zitk = Xit ∀ i, t (5)
k
X
k · Wjk = Yj ∀j (6)
k
Xit ∈ {1, ..., Tinv }, Yj ∈ {1, ..., Tinv }
Zitk ∈ {0, 1}, Wjk ∈ {0, 1}
i = 1, ..., D, j = 1, ..., (P − D)Tinv
t = 0, ..., Tinv − 1, k = 1, ..., Tinv

Constraint (2) guarantees that there are exactly P items with initial age k issued to either the
primary or the secondary market over one Tinv cycle. Constraints (3) and (4) state that each item
issued to either the primary or the secondary market has a unique initial age. The relationships
between the binary variables and integer variables are established in constraints (5) and (6).

Let X̂ be the set of initial-age of the items issued to the primary market by using the issuing policy
that assigns the youngest items to the primary market and Ŷ be the set of initial-age of the remaining
items disposed to the secondary market. Similarly, let X 0 and Y 0 be the sets of initial-age by using
any other issuing policy for the primary and secondary market, respectively. Note that X̂ ∪ Ŷ = S and
XX XX
X 0 ∪ Y 0 = S. Assume X̂it = m and Xit0 = n. We can see that m ≤ n. Since X̂ ∪ Ŷ = S
t i t i XX X
and X 0 ∪ Y 0 = S, let c be the sum of all the elements in S and we have X̂it + Ŷj = c and
t i j
XX X
Xit0 + Yj0 = c. That is,
t i j

XX X
a X̂it + b Ŷj = ma + (c − m)b (7)
t i j

XX X
a Xit0 + b Yj0 = na + (c − n)b (8)
t i j

Because m ≤ n, we have (8) − (7) = (n − m)(a − b) ≥ 0 if a ≥ b. Thus if a ≥ b, we can guarantee that

by issuing the youngest items to the primary market demand, we will obtain the optimal value for the
continuous production problem.

Now consider the non-continuous production problem (as in Fig. 1). Among a Tinv cycle, there
will be some time segments without production. The set S now no longer contains every integer
between [1, Tinv ], e.g., S = {1, ..., 1, 2, ..., 2, ..., 5, ..., 5, 10, 10, ..., 10, ..., Tinv }. Except for the difference
in the parameter S, the rest of the previous MIP model can be used for the non-continuous production
problem and we can then claim the above proof is still valid. Also, without loss of generality, the result
still holds when we consider a continuous time case.

Since the objective value is not affected by the sequence of issuing, for the optimal result, it does
not matter what sequence we use as long as we issue the youngest items to the primary market.

9
3.2 Joint Revenue And Cost Problem

In the previous subsection, we need to only maximize the revenue since with a given ordering policy
the cost is fixed. Now we consider the joint problem to maximize the profit by optimizing the ordering
and issuing policies. In this subsection, we first derive the revenue as a function of order quantity Q
for the FIFO and LIFO issuing policies. We then present an optimal solution for the joint revenue and
cost problem based on the results in Section 3.1.

3.2.1 FIFO Issuing Model

A detailed process to develop the revenue function for Case 1 is provided. Similar logic follows for the
other cases and the details are shown in the Appendix 1.

Figure 4: Graph illustration for Case 1 under FIFO

The revenue function can be decomposed into: Revenue(Q) = Revenue from primary market(Q)
+ Revenue from secondary market(Q). First the revenue from the primary market for a given Q in
Case 1 is developed (see Fig. 4). Assume with FIFO, the product issued at time t is produced at time
t0 ; thus the age of the product issued at time t is Tinv + t − t0 . We can also see that t0 P = tD since the
products we consumed in the current cycle are produced from the previous cycle in a FIFO manner.
Hence the age of the product issued at time t is Tinv + t − t D
P , which is a function of t. For a regular
production cycle, we can derive the revenue function of satisfying the primary market demand from
time 0 to time T as Z T
tD a
[a − (Tinv + t − ) ]D dt (9)
0 P Ts
The revenue of satisfying the demand from time T to time 2T would be the same as (9) and can be
generalized to the case where there are N complete production cycles in Tinv . The same idea is also
used to find the revenue from time N T to Tinv and it would be the same as that from 0 to Tinv − N T .

10
Thus, the revenue of satisfying the primary market demand in the Tinv cycle is
Z T Z Tinv −N T
tD a tD a
N [a − (Tinv + t − ) ]D dt + [a − (Tinv + t − ) ]D dt (10)
0 P Ts 0 P Ts

Next, we derive the revenue for the items disposed to the secondary market for a given Q. Let Idis
denote the amount of disposal. Note that without loss of generality we assume an unlimited demand
for the items disposed to the secondary market. In this case, Idis = ((N + 1)T − Tinv )D. Assume
the units which are to be disposed are produced in the time period from t1 to t2 , where t2 is the last
production time in the previous cycle. Let T1 be the production time in one regular production cycle
and we have
D
t2 − t1 = T1 − (Tinv − N T )
P
Let s be the time from t1 to the end of the Tinv cycle. We have

s = Tinv − N T − T1 + (t2 − t1 )

Thus, the first disposed unit has the age

1
Tinv + s = Tinv + (Tinv − N T − T1 + t2 − t1 − )
P

To generalize the age function, the ith unit disposed has the age

i
Tinv + (Tinv − N T − T1 + t2 − t1 − )
P

And the last unit disposed has the age

Tinv + (Tinv − N T − T1 )

Thus the revenue from salvaging the excess items is

Idis
X Idis x b
[b − (2Tinv − N T − T1 + − ) ] (11)
P P Ts
x=1

Combining the revenue from both the primary and secondary markets (equation (10) and (11)), we
have
Z T Z Tinv −N T
tD a tD a
Revenue(Q) = N [a − (Tinv + t − ) ]D dt + [a − (Tinv + t − ) ]D dt
0 P Ts 0 P Ts
Idis
X Idis x b
+ [b − (2Tinv − N T − T1 + − ) ] (12)
P P Ts
x=1

where Idis = ((N + 1)T − Tinv )D.

11
3.2.2 LIFO Issuing Model

The revenue functions have to be rewritten for each case under the LIFO policy. Again, a detailed
process to develop the revenue function for Case 1 is provided and the details for the other cases are
shown in the Appendix 2.

Figure 5: Graph illustration for Case 1 under LIFO

Assume under the LIFO policy the item issued at time s1 is produced at time s01 (see Fig. 5); thus
the age of this product is t1 + t01 + (Tinv − 2T − T1 ), where T1 denotes the production time in one
regular production cycle. And we can also see that t1 D = t01 P since the products we consumed in the
current cycle are produced from the previous cycle in a LIFO manner. Thus the revenue for satisfying
the primary market demand in time period [0, T ] is
Z T
t1 D a
[a − (t1 + + Tinv − 2T − T1 ) ]D dt1
0 P Ts

Now assume the products issued at s2 are produced at time s02 and have the age of t2 + t02 + (Tinv −
2T − T1 ) + 2T , where t2 D = t02 P . The revenue from satisfying the primary market demand in time
period [T, 2T ] is
Z T
t2 D a
[a − (t2 + + Tinv − T1 ) ]D dt2
0 P Ts
Generalizing this to the case where there are N complete production cycles in [0, Tinv ], we have the
revenue for period [0, N T ] as below

N −1 Z T 
X tD a
[a − (t + + Tinv − N T − T1 + 2nT ) ]D dt (13)
0 P Ts
n=0

12
 Similarly, for the time period [2T, Tinv ] in this case, the revenue is
Z Tinv −2T
tD a
[a − (t + + Tinv − T1 + 2T ) ]D dt
0 P Ts

which can be generalized to:

Z Tinv −N T
tD a
[a − (t + + Tinv − T1 + N T ) ]D dt (14)
0 P Ts

Next, we derive the revenue for the items disposed to the secondary market for a given Q. Let
Idis denote the amount of disposal. In this case, Idis = ((N + 1)T − Tinv )D. Assume the first item of
disposal will be produced at time s3 and the last item of disposal will be produced at s03 . We can see
that Idis = t3 P . The ith item of disposal will have age

(i − 1)
Tinv + Tinv − t3 +
P

Thus the revenue from disposal can be written as

Idis
X x b
[b − (2Tinv − ) ] (15)
P Ts
x=1

Now, we are ready to write the whole expression for revenue by combining the revenue from both
markets (equation (13), (14), and (15)).

N −1 Z T 
X tD a
Revenue(Q) = [a − (t + + Tinv − N T − T1 + 2nT ) ]D dt
0 P Ts
n=0
Z Tinv −N T
tD a
+ [a − (t + + Tinv − T1 + N T ) ]D dt
0 P Ts
Idis
X x b
+ [b − (2Tinv − ) ] (16)
P Ts
x=1

where Idis = ((N + 1)T − Tinv )D.

3.2.3 The Optimal Policy

By Proposition 3.1, it implies that, for any order quantity Q, the revenue of the LIFO policy is larger
than that of the FIFO policy. We denote it as

RevenueLIF O (Q) ≥ RevenueF IF O (Q) (17)

13
Since the cost is not a function of the issuing policy (CostLIF O (Q) = CostF IF O (Q)), we have

ProfitLIF O (Q) ≥ ProfitF IF O (Q) (18)

where the profit functions can be obtained by subtracting the cost functions from the revenue function.
For example, for Case 1:

ProfitF IF O (Q) = equation(12) − equation(1)

ProfitLIF O (Q) = equation(16) − equation(1)

Let Q∗F IF O and Q∗LIF O denote the optimal order quantities that generate the maximal profit
under the FIFO and LIFO policies, respectively. That is, Q∗F IF O is the maximum of the function
ProfitF IF O (Q) and Q∗LIF O is the maximum of the function ProfitLIF O (Q). The revenue functions
of the FIFO and LIFO policies in terms of Q are nonlinear, non-continuous, and non-differentiable;
making it unlikely that an optimal solution can be identified by a polynomial algorithm. Thus one
way to locate Q∗F IF O and Q∗LIF O is by enumeration. For any problem, the possible quantity of Q is
upper-bounded by P Tinv so Q∗F IF O and Q∗LIF O must be integers between [0, P Tinv ]. The profit of each
possible quantity Q can be calculated and then the global maximum can be determined.

By substituting Q with Q∗F IF O in equation (18), we have

ProfitLIF O (Q∗F IF O ) ≥ ProfitF IF O (Q∗F IF O ) (19)

Since Q∗LIF O is the optimal order quantity under the LIFO policy, we have

ProfitLIF O (Q∗LIF O ) ≥ ProfitLIF O (Q∗F IF O ) (20)

By equation (19) and (20), we know that

ProfitLIF O (Q∗LIF O ) ≥ ProfitF IF O (Q∗F IF O ) (21)

Hence, we can conclude that the maximal profit under the LIFO policy is no less than that under the
FIFO policy. Next, we show the optimal production batch size and the issuing policy for the joint
problem.

Theorem 3.2 (Q∗LIF O , LIF O) is an optimal policy for the joint problem.

Proof. Assume there is an optimal issuing policy A with optimal ordering quantity Q, called (Q,
PolicyA ), for the joint problem. By Proposition 3.1, for the same Q and varying the issuing policy,
(Q, LIF O) is also the optimal policy. By optimality, for the fixed issuing policy LIFO, (Q∗LIF O , LIFO)
is also an optimal policy.

14
 Proposition 3.2 can then be re-written as

ProfitLIF O (Q∗LIF O ) ≥ ProfitAnyP olicy (Q∗AnyP olicy )

4 2-Step Price Function

Now we consider the problem with stepwise primary and secondary market price functions. First we
study the problem with given order quantity and a heuristic issuing policy is proposed. We also discuss
the relations of the FIFO, LIFO, and heuristic policies theoretically and numerically. We then study
the joint revenue and cost problem to see whether the analytical results from the problem with given
order quantity still hold.

We use the same parameter notation as in Section 3. Throughout this section we assume a 2-step
primary and secondary market price functions. The idea is similar to the linearly decreasing price
function that in real life the customers may not be willing to pay the full price for less fresh products.
If an item has aged for a threshold time, it can only be sold at a discount price. Fig. 6 illustrates the
functions. The 2-step primary market price function is
(
a1 if t ≤ Ta
fM (t) =
a2 if Ta < t ≤ Ts

where a1 is the full primary market price, a2 is the discount primary market price, and Ta is the
threshold time for the discount primary market price. Similarly, the secondary market price function
is (
b1 if t ≤ Tb
fS (t) =
b2 if Tb < t ≤ Ts
where b1 is the full secondary market price, b2 is the discount secondary market price, and Tb is the
threshold time for the discount secondary market price.

Figure 6: 2-Step market price functions

15
4.1 Problem with Given Order Quantity

Consider the modified EMQ model when the order quantity is known. Recall that when we have linear
price functions, it is optimal to issue the youngest items to the primary market demand. However,
issuing the youngest items to the primary market demand might not be optimal anymore when we
have a 2-step price function. We use the following example to illustrate this statement (see Fig. 7):

P = 3, D = 1, Tinv = 6, Ta = 5, Tb = 8,

Set of initial-age = {1, 1, 1, 2, 2, 2, 5, 5, 5}

In the left hand side of Fig. 7, we pair up the first column (the time we issue an item) with the second
column (the initial-age of an item). The ages of issued items are shown on the right hand side. If we
issue the youngest items to the primary market, the best revenue we can obtain is 5a1 + a2 + 3b2 . If

Figure 7: Issuing results if assign the youngest DTinv items to the primary market

we do not restrict ourselves to issue the youngest items to the primary market, the best we can do is
5a1 + a2 + b1 + 2b2 > 5a1 + a2 + 3b2 (see Fig. 8 for illustration). Thus, issuing the youngest items to
the primary market demand is no longer the optimal policy.

It is intuitive to think that it is optimal to sell as many items as we can to the primary market at
the full price a1 . However, we might sell more items to the secondary market at the full price b1 if we
sacrifice one item at price a1 . In such a case, the price parameters a1 , a2 , b1 , and b2 affect the optimal
decision. In the latter section, we will show that the price structure also matters. The optimal policy
also depends on the Ta and Tb parameters.

4.1.1 Heuristic Policy

For the problem with given order quantity, the optimal issuing policy is sensitive to all the parameters
of the primary and secondary market price functions. Since Ta , Tb , a1 , a2 , b1 , and b2 are all influencing

16
 Figure 8: An optimal issuing policy for the example

factors to the optimal policy, we may enumerate all the possible conditions among these parameters
to identify an optimal solution. From the example of Fig. 7 and Fig. 8, we can see that the set
of initial-age (the production plan) is also crucial when issuing items. There are five different cases
for the inventory model and the (non-continuous) production plan changes as long as P , D, or Tinv
change, and the possible combinations explode exponentially. Hence, we propose a heuristic policy to
approximate the optimal solution.

Our heuristic is based on the idea that we want to sell as many items as we can at the full primary
market price. We start from time Tinv −1 and scan time backwards until we can find a matched (latest)
time for issuing the youngest items such that those items can still be sold at full primary market price.
Since the youngest items should start with initial-age = 1, the first matched time is Ta − 1. After time
Ta − 1 has been satisfied, we scan time backwards again from Ta − 1 to a nearer time that can match
with the youngest items remaining in the production set such that they can still be sold at the full
primary market price. If we can’t find any time that can be matched with the youngest items at full
price, we are done issuing those items at the full primary market price. Then we issue the oldest unsold
items (items with the largest initial-age) for the unsatisfied primary market demand at the next price
level a2 . We want to leave these younger items for disposal to the secondary market since we also have
a stepwise secondary market price function. Detail algorithm steps are shown in Appendix 3. The
time complexity of the algorithm is O((P + D)Tinv ).

Fig. 9 gives an illustrative example of the heuristic policy. Consider the following example:

P = 3, D = 1, Tinv = 12, Ta = 8, Tb = 22,

Set of initial-age = {1, 1, 1, 5, 5, 5, 9, 9, 9, 10, 10, 10, 11, 11, 12, 12, 12}

First, we scan time backwards from Tinv = 11 and issue the item with initial-age=1 to time = Ta −1 = 7.
We continue issuing items for time = 6, 5, 3, 2, and 1. Note that at time = 4 and 0, there is no item
that can be assigned at price a1 so we leave it un-issued for now. Second, we issue the items with

17
 Figure 9: Illustration of heuristic policy

the largest initial-age to the rest of the primary market demand at price a2 . At the end of the Tinv
(time = 12), we issue the remaining un-issued items to the secondary market, which gives the total
revenue of 6a1 + 6a2 + 3b1 + 3b2 . If we use the FIFO and LIFO policies, the revenues are 12a2 +6b1
and 4a1 + 8a2 + 6b2 , respectively. Thus, one feature of the heuristic is that more items are sold at full
primary market price, a1 .

4.1.2 Analytical Study of The Optimal Policy

Throughout this subsection, we assume the ordering policy is known and fixed, i.e., with a given fixed
Q. We discuss the relations of the FIFO, LIFO, and heuristic policies. We also examine the conditions
that guarantee optimality or dominance over the other policies.

When the production cycle (Tinv ) is relatively short, even if the production period is non-continuous,
it is possible to save an older item to the end and still get the full price a1 . For this case, we might
want to issue the oldest items to the primary market and earn extra revenue from the sales to the
secondary market. Thus, the FIFO policy is a better policy than the LIFO policy in this case. Let T2
be the machine idle time in one regular production cycle. Proposition 4.1 states the conditions that
the FIFO policy is optimal.

Proposition 4.1 For a given Q, if Tinv + x < Ta , then FIFO is an optimal policy. For Cases 1, 2,
and 5, x = T2 = (1 − D
P )T . For Cases 3 and 4, x = max{ Imin −DT
P
inv
, T2 }.

Proof. In each case, x is chosen that if Tinv + x < Ta , then every product sold to the primary market

18
under the FIFO policy gets the full price a1 . The most we can get from the secondary market is achieved
by disposing the youngest items. By using FIFO, the revenue from the primary market is maximized
because every item is sold at price a1 . Also, the revenue from the secondary market is maximized
because the disposed items are the youngest batch and the price function is decreasing with age. Thus
FIFO is an optimal policy.

Figure 10: Graph illustration for Cases 1, 2, and 5

In Cases 1, 2, and 5, the items sold at the point denoted by x have the oldest age (see Fig. 10
for illustrative examples). The oldest age is Tinv + T2 for each case. Thus for Cases 1, 2, and 5, if
Ta > Tinv + T2 , then every item sold to the primary market will get full price a1 .

Figure 11: Graph illustration for Cases 3 and 4

In Cases 3 and 4, the last items sold to the primary market might have the oldest age (see Fig. 11 for
illustrative examples). Suppose the item sold at x is produced at y. Thus the age is Tinv + Imin −DT
P
inv
.

19
 Figure 12: A special situation of Case 4

Imin −DTinv
A special situation of Case 4 is shown in Fig. 12. In this case, we might have T2 > P .
Hence items sold at x0 might be older than the items sold at x. Thus, for Cases 3 and 4, the oldest age
of the products is Tinv + max{T2 , Imin −DT
P
inv
} If Ta > Tinv + max{T2 , Imin −DT
P
inv
}, every item sold to
the primary market will get full price a1 .

Next we show that if the Tinv cycle is relatively long, the LIFO policy is a better choice than the
FIFO policy.

Proposition 4.2 For a given Q, if Ta < Tinv and Tb < Tinv , ProfitLIFO ≥ ProfitFIFO .

Proof. If Ta < Tinv , under a FIFO policy, all products will be sold to the primary market at a2
whereas some products might be sold at price a1 under a LIFO policy. When Tb < Tinv , the revenue
from sales to the secondary market are the same for both policies since all will be disposed at price b2 .
Thus, ProfitLIFO ≥ ProfitFIFO .

The idea behind the heuristic policy is to sell as many items as we can to the primary market at the
full price. By comparing to the FIFO policy, the heuristic policy tends to issue the youngest items to
the primary market first. Thus, it is closer to the idea of the LIFO policy. The LIFO policy issues the
youngest item to the most recent time. It has less complexity for issuing; however, we might lose some
opportunities to sell more a1 price items. Next we show that our heuristic policy always dominates
the LIFO policy in terms of profit.

Proposition 4.3 For a given Q, ProfitHEUR is no worse than ProfitLIFO .

Proof. Recall that the initial-age is the time from being produced until the beginning of the next
Tinv cycle. Also recall that the heuristic policy finds the latest time for issuing the youngest item such
that it can still be sold at the full primary market price. In Fig. 13, assume the item produced at ta
is assigned to the demand at time tb under the heuristic and the time between ta and tb is Ta . After
the first assignment, the heuristic continues assigning the un-issued youngest item, which is produced
just before point ta to the demand at the time just before point tb .

For the LIFO policy, it always assigns the youngest item first. This is shown in Fig. 13 where the
LIFO policy first assigns the item produced at ta to the demand at point tc . We will use the notation
the first demand point to represent the time where the first (remaining) unsatisfied demand occurs and
compare the first demand points under the heuristic and LIFO policies.

20
 After every assignment, the age of the youngest un-issued item is the same under both the heuristic
and LIFO policies, but the first demand point might not be the same. The first demand point under
the LIFO policy cannot be earlier than the first demand point under the heuristic. That is, after the
first assignment, the first demand point under the heuristic is at point tc , whereas the first demand
point under the LIFO policy is the demand following point tc . Thus it can be seen that if the LIFO
policy can assign the second youngest item to sell at the full primary market price, so can the heuristic
policy. The same reasoning can apply to the nth assignment. Even if the heuristic policy can assign
the nth youngest item to be sold at the full primary market price, it might be unable for the LIFO
policy to do so. With the heuristic policy we can get greater or equal number of items sold at the full
primary market price than those with the LIFO policy, so the heuristic policy has no less revenue from
the primary market sale.

Figure 13: Illustration of proof

Under the LIFO policy, the oldest items are for sale to the secondary market. With the heuristic
policy, we might issue the oldest items to the primary market at price a2 and leave some younger items
for the secondary market. Thus, the revenue from the secondary market using the heuristic policy is
no worse than the LIFO policy. Thus, the revenue from both the primary and secondary markets for
the heuristic policy is no worse than that for the LIFO policy.

4.1.3 Experimental Analysis

In this subsection, we conduct numerical experiments based on the parameter settings from Shen [13]
(see Table 1). We experimentally study the following two conditions that have not been covered in the
propositions.

1. Tinv ≤ Ta ≤ Tinv + x, where x is defined in Proposition 4.1.

2. Ta < Tinv , Tb ≥ Tinv

By Proposition 4.1, we know that if Ta is relatively large, the FIFO policy is better than the LIFO
policy. However, if Tinv < Ta < Tinv + x, we might sometimes have the result that the LIFO policy

21
 Table 1: Parameter settings

Parameter Unit Estimation

Imin million pills 1200
Tinv month 36
v mil $ /mil pill 0.2
D mil pill / year 300
P mil pill / year 600
A mil $ /time 2
h mil $ /mil pill/year 0.02

is better. Fig. 14 illustrates the revenue functions in terms of various Ta for the FIFO, LIFO, and
heuristic policies for the example, where Q = 300, Tb = 48, a1 = 10, a2 = 8, b1 = 7, b2 = 5, and x = 6.
In this example, we consider the first condition of Tinv ≤ Ta ≤ Tinv + x (36 ≤ Ta ≤ 42). Under the
FIFO policy, the larger the value Ta , the more items are sold at the full price. Upon Ta = Tinv + x,
we can sell all items at the full price. However, under the LIFO policy, if Ta is only slightly larger
than Tinv , we may not sell more items at the full price since the production is non-continuous. As
can be seen from the graph, the revenue of the FIFO policy increases while the revenue of the LIFO
policy remains unchanged in this example. Thus, we can not guarantee which policy dominates when
Tinv ≤ Ta ≤ Tinv + x. The plot also shows that the heuristic policy performs well under all values of
Ta .

Figure 14: Illustration for fixed Tb and varying Ta where Tinv ≤ Ta ≤ Tinv + x

For the second condition, we consider an example of fixed Ta (< Tinv ) and observe the revenue
functions of the FIFO, LIFO, and heuristic policies under Tb ≥ Tinv . Let Q = 300, Ta = 30, a1 =
10, a2 = 9, b1 = 5, and b2 = 1. We plot the revenue functions when Tb ranges from 36 to 80. As can be
seen from Fig. 15, when Ta is fixed and smaller than Tinv , whether the FIFO policy or the LIFO policy
is better depends on the Tb value. The FIFO policy is better when Tb is small but greater than Tinv

22
because most of the items are sold to the secondary market at the full secondary market price under
the FIFO policy. When Tb ≥ Tinv , the revenue of the LIFO policy starts increasing as Tb increases;
thus it becomes larger than that of the FIFO policy. When Tb becomes really large, the items sold in
the secondary market are always sold at the full price. As a result, there is no benefit to issue younger
items to the secondary market so the LIFO policy becomes a better policy than the FIFO one.

Figure 15: Illustration for fixed Ta and varying Tb where Ta < Tinv and Tb ≥ Tinv

4.2 Joint Revenue And Cost Problem

Up to now, we have only considered the 2-step price function for a given fixed Q. Now we want to
show whether the analogue results of Propositions 4.1 - 4.3 still hold for the joint ordering and issuing
policies.

The following propositions are similar to Proposition 4.2 and Proposition 4.3, except now we do not
assume a given Q. Let Q∗F IF O , Q∗LIF O , and Q∗HEU R denote the optimal order quantities that maximize
the profit functions under the FIFO, LIFO, and heuristic policies, respectively. The revenue functions
of these policies are nonlinear, non-continuous, and non-differentiable such that the optimal solutions
can not be identified by polynomial algorithms. Thus, we use the same method that we compute
Q∗F IF O and Q∗LIF O in Section 3.2.3. By enumerating all possible order quantities (integers between
[0, P Tinv ]) and calculating the corresponding profits, we can determine the optimal order quantities.

Proposition 4.4 If Ta < Tinv and Tb < Tinv , ProfitLIFO (Q∗LIF O ) ≥ ProfitFIFO (Q∗F IF O ).

Proof. By Proposition 4.2, when Ta < Tinv , Tb < Tinv and given fixed order quantity Q∗F IF O , we have

ProfitLIFO (Q∗F IF O ) ≥ ProfitFIFO (Q∗F IF O )

23
Also, Q∗LIF O is the optimal order quantity under the LIFO policy, so we have

ProfitLIFO (Q∗LIF O ) ≥ ProfitLIFO (Q∗F IF O )

Thus ProfitLIFO (Q∗LIF O ) ≥ ProfitFIFO (Q∗F IF O ) when Ta < Tinv and Tb < Tinv .

Proposition 4.5 ProfitHEUR (Q∗HEU R ) is no worse than ProfitLIFO (Q∗LIF O ).

Proof. Since Q∗HEU R is the optimal order quantity under the heuristic policy, we have

ProfitHEUR (Q∗HEU R ) ≥ ProfitHEUR (Q∗LIF O )

Also by Proposition 4.3, we have

ProfitHEUR (Q∗LIF O ) ≥ ProfitLIFO (Q∗LIF O )

Thus we have ProfitHEUR (Q∗HEU R ) ≥ ProfitLIFO (Q∗LIF O ). The domination of the heuristic policy over
the LIFO policy has been established.

Now we examine the condition in Proposition 4.1. Consider an example with a1 = 7, a2 = 4, b1 =

0.45, b2 = 0.3, Tinv = 36, and the other parameter settings remain the same as Table 1. We can
also obtain the value x and here both the FIFO and LIFO policies have the same x = 6 value. We
fix Tb = 20. In this example, when Ta > 42, Q∗F IF O remains unchanged while Q∗LIF O changes in
terms of different values of Ta (see Fig. 16). Fig. 17 shows the resulting ProfitFIFO (Q∗F IF O ) and
ProfitLIFO (Q∗LIF O ) when we fix Tb = 20. We are interested in the profit under the condition when
Ta > Tinv + x (Ta > 42). Note that when Ta is large enough, most of the items can be issued at price
a1 under the FIFO policy. As can be seen from the graph, the FIFO policy is better than the LIFO
policy when Ta > 42. However, at this point, we are not sure about the conditions that the FIFO
policy dominates the LIFO policy for the joint revenue and cost problem. We leave this part as a
subject for future research.

5 Conclusion and Future Research

In this paper, we study a perishable inventory management system with a minimum inventory quantity
constraint in response to large-scale emergencies. To maximize the profit by optimizing the ordering
and issuing policy, we consider two different price function models based on the modified EMQ model
in Shen [13]. First, we study a problem with linear primary and secondary market price functions.
Optimal issuing policies are derived for the given order quantity and the joint problems. We also derive
the revenue functions when the FIFO or LIFO issuing policies are used. Next, we analyze the problem
with a 2-step primary and secondary market price functions. A heuristic issuing policy is proposed.
We also study the relations of the FIFO, LIFO, and heuristic policies under different conditions for
the given order quantity and the joint problems.

24
 Figure 16: Q∗F IF O and Q∗LIF O under different values of Ta

Figure 17: Illustration for Ta > Tinv + x and Tb = 20

To summarize the results, Table 2 shows the optimal policies for the problems with linear price
functions. Given Q problem refers to the problem with given order quantity that solves for the optimal
issuing policy. Joint problem refers to the joint revenue and cost problem that optimizes the ordering
and issuing policies. Table 3 summarizes the properties that hold with 2-step price functions. Let Π
denote the profit.

Table 2: Summary of problems with linear price function

Problem Optimal Policy
Given Q Problem Issue the youngest items to the primary market demand if a ≥ b
Joint Problem (Q∗LIFO , LIF O)

25
 Table 3: Summary of problems with 2-step price function
Condition Given Q Problem Joint Problem
Ta > Tinv + x ΠFIFO ≥ ΠHEUR ≥ ΠLIFO ΠHEUR (Q∗HEUR ) ≥ ΠLIFO (Q∗LIFO )
Ta < Tinv and Tb < Tinv ΠHEUR ≥ ΠLIFO ≥ ΠFIFO ΠHEUR (Q∗HEUR ) ≥ ΠLIFO (Q∗LIFO ) ≥ ΠFIFO (Q∗FIFO )
Tinv ≤ Ta ≤ Tinv + x ΠHEUR ≥ ΠLIFO ΠHEUR (Q∗HEUR ) ≥ ΠLIFO (Q∗LIFO )
Ta < Tinv and Tb ≥ Tinv ΠHEUR ≥ ΠLIFO ΠHEUR (Q∗HEUR ) ≥ ΠLIFO (Q∗LIFO )

An extension of the perishable inventory management for large-scale emergencies is to take the
pricing policy into consideration. Our current model assumes the price function is given and we
determine the ordering and issuing policies based on the price structure. Thus, we might be interested
in deciding the pricing, ordering, and issuing strategies simultaneously. Furthermore, we now assume
the problem with deterministic primary market demand. It is also of interest to study the problem
under stochastic demand.

Future research can generalize the results to a n-step price function. It is not clear whether the
proposed heuristic for the 2-step price function extends effectively for the n-step problem. For example,
we consider a 3-step primary market price function where a1 is the full price and a2 and a3 are the
discount prices (a2 > a3 ). Since the production is non-continuous, the proposed heuristic policy of
selling as many items as we can at the full price a1 may not be an effective strategy. By selling less
items at the full price a1 , we could possibly sell more items at a2 and less items at a3 . If a2 is large
enough and a3 is small, selling as many items as we can at the discount price a2 gives us a larger revenue
than the proposed heuristic policy. Thus, an efficient heuristic policy taking all the price parameters
into consideration is needed.

Acknowledgment

This research was supported by the United States Department of Homeland Security through the
Center for Risk and Economic Analysis of Terrorism Events (CREATE), grant number EMW-2004-
GR-0112. However, any opinions, findings, and conclusions or recommendations in this document
are those of the author(s) and do not necessarily reflect views of the U.S. Department of Homeland
Security.

26
Appendix 1: Revenue Functions of FIFO Policy - Cases 2, 3, 4, 5

In Appendix 1 and Appendix 2, we use the notation that N is the number of complete regular produc-
tion cycles in one Tinv cycle, M is the number of regular production orders in one Tinv cycle, and Imax
is the maximum inventory level in a regular production cycle. We also let T1 be the production time in
one regular production cycle, T2 be the machine idle time in one regular production cycle, Tp1 be the
time from the start of the additional production cycle to the end of the current underlying production
cycle, and Tp3 be the remainder of Tinv divided by T .

Case 2:

Figure 18: Graph Illustration for Case 2 Under FIFO

Use the same logic as in Case 1, the revenue for this case is:
Z T Z Tinv −N T
tD a tD a
Revenue(Q) = N · [a − (Tinv + t − ) ]D dt + [a − (Tinv + t − ) ]D dt
0 P Ts 0 P Ts
Idis
X Idis x b
+ [b − (Tinv + − ) ]
P P Ts
x=1

where Idis = (Tinv − N T )(P − D).

Case 3:

Figure 19: Graph Illustration for Case 3 Under FIFO

27
 Z T
tD a
Revenue(Q) = M [a − (Tinv + t − ) ]D dt
0 P Ts
Z Tinv −M T disI
tD a X Idis x b
+ [a − (Tinv + Tp1 + t − ) ]D dt + [b − (Tinv + − ) ]
0 P Ts P P Ts
x=1

where Idis = Imin − DTinv .

Case 4:

Figure 20: Graph Illustration for Case 4 Under FIFO

Z T
tD a
Revenue(Q) = M [a − (Tinv + t − ) ]D dt
0 P Ts
Z Tinv −M T disI
tD a X Idis x b
+ [a − (Tinv + Tp1 + t − ) ]D dt + [b − (Tinv + − ) ]
0 P Ts P P Ts
x=1

where Idis = Imin − DTinv .

Case 5:

Figure 21: Graph Illustration for Case 5 Under FIFO

Z T
tD a
Revenue(Q) = (M − 1) · [a − (Tinv + t − ) ]D dt
0 P Ts

28
 Z Tinv −(M −1)T
tD a
+ [a − (Tinv + t − ) ]D dt
0 P Ts
I1
X I1 x b
+ [b − (2Tinv − (M − 1)T − T1 + − ) ]
P P Ts
x=1
I2
X I2 x b
+ [b − (Tinv + − ) ]
P P Ts
x=1

where I1 = M Q − Tinv D and I2 = Imin − M Q.

Appendix 2: Revenue Functions of LIFO Policy - Cases 2, 3, 4, 5

Case 2: Similar logic gives us the following result:

Z Tf
tD a
Revenue(Q) = [a − (t + ) ]D dt
0 P Ts
N −2 Z T 
X tD a
+ [a − (Tf + Tinv − N T + T2 + 2nT + t + ) ]D dt
0 P Ts
n=0
Z Tinv −Tf −(N −1)T
tD a
+ [a − (Tf + Tinv − N T + T2 + 2(N − 1)T + t + ) ]D dt
0 P Ts
Idis
X x b
+ [b − (2Tinv − ) ]
P Ts
x=1

P
where Tf = (Tinv − N T ) D and Idis = (Tinv − N T )(P − D).

Case 3: This is a more completed case, but can be taken care of using the same ideas as in Case
1. The expressions with integral from 0 to some time denote the revenue from the primary market
and the expressions involving the summation from x = 1 to some quantity denote the revenue from
the secondary market.
Z Tf
tD a
Revenue(Q) = [a − (t + ) ]D dt
0 P Ts
L−1
X Z T 
tD a
+ [a − (Tf + Tinv − (M − 1)T − T1 + 2nT + t + ) ]D dt
0 P Ts
n=0
Z Tl
tD a
+ [a − (2Tinv − Tl − (M − 1)T − T1 + LT + t + ) ]D dt
0 P Ts
Q−T
Xl D x b
+ [b − (2Tinv − KT − ) ]
P Ts
x=1
K Q
XX x b
+ [b − (2Tinv − (n − 1)T − ) ]
P Ts
n=1 x=1

29
 j k j k
P Tinv −Tf Imin −DTinv
where Tf = (Tp1 + (N − M )T + Tp3 ) D ,L= T , Tl = Tinv − Tf − LT , and K = Q .

Case 4: The expression is exactly the same as in Case 3.

Case 5:
Z Tf
tD a
Revenue(Q) = [a − (t + ) ]D dt
0 P Ts
L−1
X Z T 
tD a
+ [a − (Tf + Tinv − N T − T1 + 2nT + t + ) ]D dt
0 P Ts
n=0
Z Tl
tD a
+ [a − (2Tinv − Tl − N T − T1 + LT + t + ) ]D dt
0 P Ts
Q−T
Xl D x b
+ [b − (2Tinv − KT − ) ]
P Ts
x=1
K Q
XX x b
+ [b − (2Tinv − (n − 1)T − ) ]
P Ts
n=1 x=1
j k
−Imax +(Tinv −N T −T1 )D+(Imin −DTinv ) Tinv −Tf
where Tf = D , L = T , Tl = Tinv − Tf − LT , and K =
j k
Imin −DTinv
Q .

Appendix 3: Heuristic Algorithm

Notation:

• S: set of the initial-age of the items produced from the previous Tinv cycle

• Nt : number of items issued at time t

• Pi : number of items issued with initial age i

• I: number of items issued so far

• U : set of the time with unsatisfied demand

• R: revenue of items sold

Algorithm:

Initialize
t = Tinv − 1
I=0
U = {0, ..., Tinv − 1}

30
 R=0
Nt = 0, for t = 0, ...Tinv − 1
Pi = 0, for i ∈ S

While t > 0 and S 6= φ and I < DTinv

i = min S
If t + i > Ta
t=t−1
Else
While t + i ≤ Ta and Nt < D
i = min S
Issue one initial age = i item to the primary market at time t with full price a1
R = R + a1
Nt = Nt + 1
Pi = Pi + 1
I =I +1
If Nt = D, U = U \{t}
If Pi = P, S = S\{i}
End
End

While U 6= φ and S 6= φ and I < DTinv

t = min U
i = min S
Issue one initial age = i item to the primary market at time t with discount price a2
R = R + a2
Nt = Nt + 1
Pi = Pi + 1
I =I +1
If Nt = D, U = U \{t}
If Pi = P, S = S\{i}
End

While S 6= φ

31
 i = min S
If Tinv + i ≤ Tb
Issue all initial age = i items to the secondary market with full price b1
R = R + (P − Pi ) × b1
Else
Issue all initial age = i items to the secondary market with discount price b2
R = R + (P − Pi ) × b2
Pi = P
S = S\{i}
End

32
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