ENHANCING COMPETITIVENESS VIA OPTIMAL REPLENISHMENT

POLICIES FOR MULTI-ITEM INVENTORY SYSTEM SUBJECT TO

RESOURCE CONSTRAINTS UNDER TIME DISCOUNTING

Patcharaporn Yanpirat*, Jitraporn Samakachan, and Sansanee Supapa

Department of Industrial Engineering, Faculty of Engineering
Kasetsart University, Chatujuk, Bangkok 10903, Thailand.
Tel. and Fax: (6602) 5798610, E-mail: * fengppy@ku.ac.th

ABSTRACT

Under the contemporary business environment especially an increasing in global

competition and manufacturing technologies, several management techniques are
implemented by the firms to facilitate the achievement of enhancement their
competitiveness. The appropriate inventory policies can be accounted as one of the
management techniques used to reduce the cost and waste of maintaining large levels of
raw materials and unfinished product. This paper develops the deterministic non-constant
demand inventory model to propose the optimal replenishment policies for multi-item
inventory system. The effect of the time-value of money and the amount of available
capital are incorporated into the model via mix-integer linear programming technique.
The results are discussed with a case study and a sensitivity analysis of the optimal
solution with respect to the parameters of the system is carried out.

Key words: inventory policies, time-value of money, mix-integer programming, and

capital budgeting

I INTRODUCTION

Under the contemporary business environment, the primary changes are increase in global
competition, advances in manufacturing technologies, advances in information
technologies, greater focus on the customer, new forms of management organization, and
changes in the social, political, and cultural environment of business. In order to enhance
competitive advantage, several management techniques are implemented by the firms
such as just-in-time, mass customization, flexible manufacturing system, value chain,
theory of constraint, and total quality management, etc. (Blocher, 2005). Furthermore, the
appropriate inventory policies can be accounted as one of the management techniques
used to reduce the cost and waste of maintaining large levels of raw materials and
unfinished product. The studies on inventory can be classified into two folds depending
on the nature of demand. They are deterministic demand and stochastic demand. In the
first, demand is known with the certain value over the entire period of planning horizon
whereas the second is unknown until it is received which results in unavoidable stock out
or lost sales (Sobel and Zhang, 2001). For deterministic demand in multi-period, Fisher,
et al. (2001) develops the concept within the EOQ modeling framework and apply it to
the dynamic lot-sizing problem. They find if demand in each period equals the long-run
average demand rate, an optimal replenishment policy over the short horizon coincides
with the long-run optimal replenishment policy. However, the concept of time-value of
money is not taken into consideration. The reason to be claimed is that optimizing the
average cycle cost will yield the same result as obtained by optimizing the discounted
cost when interest rates are low and the planning horizon is short. Invalidity of such claim
is demonstrated by Chung (1996) and Chung, et al. (1998). They propose optimal
inventory policies for infinite time span taking into account of time-value of money, the
result indicates an inventory policy derived from discounted cost differs substantially
from that given by undiscounted inventory analysis. Bose, et al. (1995) develops the EOQ
inventory model for deteriorating items. Their model considers the time-value of money
and different inflation rates for various costs where demand is deterministic with linear
trend. However, available capital invested in inventory at each time period, which effects
on the liquidity of the firm (Riggs, 2004), is not taken into account.

In this paper, the multi-item inventory model is developed to propose the optimal
replenishment policies which the effect of the time-value of money and the amount of
available capital are incorporated into the model via mix-integer linear programming
technique. The mathematical model is illustrated in Section II. The results are discussed
with a case study and a sensitivity analysis of the optimal solution with respect to the
parameters of the system is carried out in Section III. Finally, the conclusions are drawn
in Section IV.

II MATHEMATICAL MODEL

A deterministic inventory model with non-constant demand is developed with the

following notations and assumptions:
1. Planning horizon is divided into multiple periods and finite.
2. Demand rate for each period is assumed constant but varied over time
3. There are constraints on cost of capital, and capital invested in inventories.
4. Multiple items are taken into account.
5. Shortage is not taken into consideration.
6. No quantity discounts either on the unit purchase cost or the unit transportation
cost are assumed.
7. All relevant costs are assumed constant with equal amounts for each period over
the planning horizon.
8. No benefits from joint replenishment are assumed.

In addition the following notations are used in the mathematical programming

formulation of the model. Let

Decision variables:
Xi t = order quantity for item i at the end of period t;
Ii t = inventory level for item i at the end of period t; and
Vi t = 0 when no replenishment is taken place for item i at the beginning of
period t and 1 for otherwise.
Parameters:
ui = unit price for item i;
hi = unit holding cost for item i at period t;
λ t = fixed holding cost at period t;
si = fixed ordering cost for item i per replenishment;
Di t = amount of demand for item i at period t;
Li = lead time for item i at period t;
Rt = amount of available capital at period t;
k = the weighted average cost of capital at period t which represents the
time-value of money. It is assumed constant over the entire time horizon;
T = the fixed time planning horizon;
N = the number of items to be taken into account; and
M = the positive large real value.

The two types of costs are considered in the analysis: (i) purchase cost which consists of
material cost and ordering cost; and (ii) holding cost. Since the time-value of money is
taken into consideration, the purchase cost will have an influence in the determination of
the economic order quantity (Bose et.al., 1995). The mix-integer linear programming
approach is employed to formulate the model. The objective function is the present worth
of the total costs over the entire planning horizon T as given by equation (1). The
resource constraints of inventory level constraint, capital constraint, demand during lead
time constraint, and inventory level at the beginning of the first period over the planning
horizon are incorporated into the model as given by equations (2) to (8).

Objective function:
T N
[
MinZ = ∑∑ (1+k)−t . (ui .Xit ) + (1+k)−t . (hi . Iit )
t=1 i=1
(1)
+ (1+k)−t . λt + (1+k)−t . ( si . Vit ) ]
Subject to
Ii t ≤ Ii , t-1 + Xi t - Di t ; Inventory level constraint for item i at the end of
period t (2)
N

i=1
[ −t −t −t
∑ (1+k) . (ui .Xit ) + (1+k) . (hi . Iit ) + (1+k) . λt +

(1+k)−t . ( si . Vit ) ] ≤ (1+k)−t . Rt ; Capital constraint (3)

Ii , t-1 - ( Di t . Li ) ≥ 0 ; Demand during lead time constraint (4)
I i0 - D i1 . L i = 0 ; Inventory level at the beginning of the first
period over the planning horizon (5)
Xi t - ( M . Vi t ) ≤ 0 (6)
Vi t = { 0 , 1 } (7)
X i t , Ii t ≥ 0 for i = 1, 2, …, N and t = 1, 2, …, T (8)

For the weighted average cost of capital at period t, it is given as follows (Sophon, 2002).

k =Wd K d +W ps K ps +Wcs K cs
(9)
Where
Wd = proportion of total amount of debts to total capital
K d = cost of debts
W ps = proportion of preferred stock to total capital
K ps= cost of preferred stock
Wcs = proportion of common stock to total capital
K cs = cost of common stock
For cost of preferred stock, and common stock, the dividend growth model (Apichat,
2001) is employed to estimate their costs for the particular sources as given in equations
(10) and (11). The resulted values are substituted into (9) to obtain the value of k.
Dt +1
Pj = (10)
Kj −g
Dt +1 = Dt −1 (1 + g ) (11)

Where
Pj = market price of preferred stock or common stock;
Dt+1 = dividend of preferred stock or common stock for the next period;
Kj = cost of preferred stock or common stock in other word it is a rate of return on
stocks for shareholder;
g = growth rate of dividend in preferred stock or common stock;
Dt-1 = dividend of preferred stock or common stock for the last period; and
j = preferred stocks (ps), and common stocks (cs), respectively.

The inventory policy is proposed in terms of order quantity and inventory level at each
period of time and so does total inventory cost of the system over a finite time-horizon.

III APPLICATION

In this section, the proposed model is applied to a selected toy factory to measure its
performance. In order to illustrate the effective of the time-value of money on inventory
policy, two models are investigated. The first model is the model as appears in equations
(1) to (11). For the second, the same model is implemented except the term (1+k)n is
dropped which implies the time-value of money is not taken into account. Finally, the
total costs obtained from both models are compared to illustrate the efficient inventory
policy.

Being based on the existing problem of the selected toy factory, the inventory policies for
outsourcing materials, especially wooden sheets which are approximately at 400 types of
woods, is taken into consideration. The ABC technique (Winston, 1994) is employed to
classify the groups of wooden sheets and only group A is selected; 26 types of wooden
sheets. For planning horizon, annual inventory policy is investigated consisting of 12
months or periods. According to the limitation of the existing data on demands for each
type of wooden sheets, non-constant demand for the particular one at each period is
assumed and given to equal to the long-run average demand rate. This implies that
demand for the particular period is known with certain value but varied with the different
values among each time period. For relevant costs, the activity-based costing technique is
employed for cost estimates.

The optimal inventory policies resulted from both models are expressed in terms of the
optimal order quantity for each month, inventory level at the end of the month, the
relevant inventory costs for each month, and total inventory cost of the system per annum.
Two models are solved by CPLEX 90 to find out the optimal inventory policies. Finally,
the sensitivity analysis of the efficient model on (i) unit cost of material, (ii) unit holding
cost per month, (iii) ordering cost per month, (vi) cost of capital, and (v) available capital
for each month are carried out to deal with uncertainty of the cost estimates.

The results presented in this paper is limited to only the relevant inventory costs per
annum classified by each type of wooden sheets and total inventory cost of the entire
system classified by each time period as appears in Tables 1 to 4, respectively. According
to the comparison between the results obtained from both models, they reveal that
inventory policy taking time discounting and capital budgeting into consideration can
create total saving approximately at 6.45 percent or 2,239,902 baht per annum to the
policy without time discounting. Analyzing in the cost components, it reveals the saving
is incurred in material cost saving at 6.53 percent or 2,211,844 baht per annum, and total
variable holding cost saving at 15.81 percent or 11,854.60 baht per annum whereas
ordering cost is increased by 45.78 percent or 70,256 baht per annum due to the increase
in the number of replenishment from 160 to 248 times per annum. Regarding to
uncertainty of the cost estimates, the sensitivity analysis reveals that total inventory cost
is sensitive to only material cost per unit.

IV CONCLUSIONS

The proposed integrated time-discounted in inventory policy indicate that the policy
maker can generate significant inventory cost savings which will enhance their
competitiveness under the contemporary business environment. In addition it will help the
decision-maker in the firms to understand and to use the capital invested in their
inventory effectively. However the model is still limited to deterministic non-constant
demand, for stochastic demand is beyond the scope of this paper and is a topic for further
study.

ACKNOWLEDGMENTS

We would like to express our sincerest thank to the Faculty of Engineering and
Department of Industrial Engineering, Kasetsart University (Main Campus) for providing
us with financial support to public this research work.

REFERENCES

Apichat Pongsupat. (2001). Business Finance. Center of Digital Printing, Bangkok.

Blocher, C., Chen, K. H., Cokins, G., and Lin, T. W. (2005). Cost Management: A
Strategic Emphasis. Third Edition. McGraw-Hill Irwin. Singapore.
Bose S., Goswai, A., and Chaudhuri, K. S. (1995). An EOQ Model for Deteriorating
Items with Linear Time-dependent Demand Rate and Shortages Under Inflation and
Time Discounting. Journal of the Operational Research Society. Vol. 46, pp.771-782.

Chung, Kun-Jen. (1996). Optimal Ordering Time Interval Taking Account of Time Value.
Production Planning & Control. Vol.7, No.3, pp.264-267.
Chung, K., Lin S., Chu, P., and Lan, S. (1998). The Production and Inventory Systems
Taking Account of Time Value. Production Planning & Control. Vol.9, No.6, pp.580-
 584.
Fisher, M., Ramdas, K., and Zheng, Yu-Sheng. (2001). Ending Inventory Valuation in
Multiperiod Production Scheduling. Management Science. Vol.45, No.5, pp.676-692.
Riggs, H. E. (2004). Financial and Economic Analysis for Engineering and Technology
Management. Second Edition. John Wiley & Sons, Inc. New Jersey.
Sobel, M. J., and Zhang, R. Q. (2001). Inventory Policies for Systems with Stochastic and
Deterministic Demand. Operation Research. Vol.49, No.1, pp.157-162.
Sophon Fongpet. (2002). Business Finance. Pearson Education Indochina Co., Ltd.,
Bangkok.
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Edition. Wadsworth, Inc. Betmont.
APPENDIX

Table 1 Relevant inventory costs classified by material with time discounting

Material Material Cost Holding cost per unit Number of replenishment Ordering Cost Total Cost
No. Code (Baht) (Baht) per annum (Baht) (Baht)
1 1720000004 1,524,972.15 135.17 9 3,678.60 1,528,785.92
2 1720000002 1,975,958.08 180.33 9 3,731.34 1,979,869.75
3 1107550013 1,648,619.72 7,118.26 10 4,139.09 1,659,877.08
4 1107540013 1,853,046.23 7,409.19 12 4,920.29 1,865,375.71
5 1110030010 1,313,205.88 5,522.56 12 4,920.29 1,323,648.73
6 1230530521 1,412,975.36 69.06 10 4,099.88 1,417,144.30
7 1470000022 1,877,149.08 105.93 9 3,705.13 1,880,960.14
8 1470000021 2,224,462.63 74.33 10 4,143.26 2,228,680.22
9 1804504500 2,257,623.16 4,392.34 10 4,104.00 2,266,119.51
10 1720000018 1,655,136.22 192.55 7 2,889.54 1,658,218.31
11 1410000006 1,109,271.77 113.66 9 3,678.69 1,113,064.12
12 1107530013 1,224,841.38 5,210.16 11 4,533.84 1,234,585.38
13 1229029017 996,654.33 52.75 8 3,340.98 1,000,048.06
14 1800000068 1,557,041.91 11,103.08 11 4,508.37 1,572,653.36
15 1112540010 1,106,955.74 4,681.19 12 4,920.29 1,116,557.22
16 1720000008 424,716.72 46.72 6 2,459.57 427,223.02
17 1110050013 664,080.30 3,022.42 11 4,533.84 671,636.56
18 1320000017 1,306,281.79 46.20 11 4,533.84 1,310,861.83
19 1600000001 319,873.97 17.23 4 1,657.73 321,548.93
20 1110040010 819,525.62 3,159.74 12 4,920.29 827,605.64
21 1107535013 557,245.27 2,434.76 10 4,143.26 563,823.29
22 1115030010 758,505.02 2,864.93 9 3,700.73 765,070.68
23 1720000003 1,060,615.80 108.72 9 3,722.47 1,064,446.99
24 1107530010 619,955.13 2,592.59 11 4,494.98 627,042.70
25 1720000005 838,356.41 82.66 7 2,850.99 841,290.06
26 1112530010 545,465.92 2,398.35 9 3,700.95 551,565.22
Total 31,652,535.60 63,134.87 248 102,032.26 31,817,702.74
Present Worth of Total cost excluding fixed holding cost per annum 31,817,702.74
Present Worth of Total cost 32,494,304.96

Table 2 Relevant inventory costs classified by time period with time discounting

Material Cost Holding cost Number of replenishment Ordering Cost Total Cost
Period (Baht) per unit (Baht) per annum (Baht) (Baht)
1 2,273,659.01 6,294.07 23 9,992.25 2,289,945.32
2 2,194,903.91 5,715.55 19 8,166.86 2,208,786.33
3 2,356,068.76 4,090.16 21 8,931.56 2,369,090.47
4 2,628,641.65 4,382.79 23 9,678.16 2,642,702.60
5 3,154,218.06 6,886.78 23 9,576.16 3,170,680.99
6 3,494,753.55 7,362.91 24 9,886.07 3,512,002.53
7 3,554,869.74 6,780.27 21 8,559.03 3,570,209.03
8 3,105,866.07 5,213.30 22 8,871.93 3,119,951.29
9 3,473,865.49 6,603.52 23 9,177.23 3,489,646.24
10 2,828,035.93 5,231.06 22 8,684.52 2,841,951.51
11 1,975,613.04 4,574.48 18 7,030.43 1,987,217.95
12 612,040.40 - 9 3,478.07 615,518.47
Total 31,652,535.60 63,134.87 248 102,032.26 31,817,702.74
Present Worth of Total cost excluding fixed holding cost per annum 31,817,702.74
Present Worth of Total cost 32,494,304.96
Table 3 Relevant inventory costs classified by material with no time discounting

Material Material Cost Holding cost per Number of Ordering Cost Total Cost
No. Code (Baht) unit (Baht) replenishment per annum (Baht) (Baht)
1 1720000004 1,662,741.52 627.25 2 878.20 1,664,246.97
2 1720000002 2,083,544.70 481.25 3 1,317.30 2,085,343.25
3 1107550013 1,748,933.88 7,530.75 10 4,391.00 1,760,855.63
4 1107540013 1,988,091.98 7,920.25 12 5,269.20 2,001,281.43
5 1110030010 1,401,617.42 5,869.00 12 5,269.20 1,412,755.62
6 1230530521 1,512,606.48 361.50 3 1,317.30 1,514,285.28
7 1470000022 2,003,736.24 755.00 2 878.20 2,005,369.44
8 1470000021 2,379,940.64 415.75 3 1,317.30 2,381,673.69
9 1804504500 2,446,511.05 4,734.50 10 4,391.00 2,455,636.55
10 1720000018 1,750,663.80 741.45 2 878.20 1,752,283.45
11 1410000006 1,195,252.50 856.25 2 878.20 1,196,986.95
12 1107530013 1,299,547.80 5,518.75 11 4,830.10 1,309,896.65
13 1229029017 1,050,178.62 331.75 2 878.20 1,051,388.57
14 1800000068 1,678,896.34 11,887.50 11 4,830.10 1,695,613.94
15 1112540010 1,191,744.00 5,442.00 11 4,830.10 1,202,016.10
16 1720000008 456,640.39 332.50 1 439.10 457,411.99
17 1110050013 712,809.72 3,558.00 10 4,391.00 720,758.72
18 1320000017 1,409,534.97 604.52 2 878.20 1,411,017.69
19 1600000001 335,846.94 89.25 1 439.10 336,375.29
20 1110040010 879,819.84 3,792.75 11 4,830.10 888,442.69
21 1107535013 590,783.76 2,566.00 10 4,391.00 597,740.76
22 1115030010 807,549.60 3,371.25 8 3,512.80 814,433.65
23 1720000003 1,123,649.28 572.75 2 878.20 1,125,100.23
24 1107530010 665,611.20 3,383.50 9 3,951.90 672,946.60
25 1720000005 915,708.64 389.75 2 878.20 916,976.59
26 1112530010 572,418.56 2,856.25 8 3,512.80 578,787.61
Total 33,864,379.87 74,989.47 160 70,256.00 34,009,625.34
Total cost excluding fixed holding cost per annum 34,009,625.34
Total cost 34,734,206.94

Table 4 Relevant inventory costs classified by time period with no time discounting

Material Cost Holding cost Number of replenishment Ordering Cost Total Cost
Period (Baht) per unit (Baht) per annum (Baht) (Baht)
1 4,122,905.73 6,613.17 23 10,099.30 4,139,618.20
2 3,715,654.00 6,582.03 15 6,586.50 3,728,822.53
3 3,714,326.48 5,213.03 13 5,708.30 3,725,247.81
4 4,127,375.45 5,656.25 15 6,586.50 4,139,618.20
5 2,833,226.81 7,988.75 13 5,708.30 2,846,923.86
6 2,780,575.71 8,550.50 13 5,708.30 2,794,834.51
7 3,880,665.27 7,952.75 14 6,147.40 3,894,765.42
8 3,251,082.17 6,634.50 14 6,147.40 3,263,864.07
9 2,140,786.92 8,352.25 13 5,708.30 2,154,847.47
10 1,375,110.05 5,955.50 10 4,391.00 1,385,456.55
11 1,400,931.13 5,490.75 12 5,269.20 1,411,691.08
12 521,740.15 - 5 2,195.50 523,935.65
Total 33,864,379.87 74,989.47 160 70,256.00 34,009,625.34
Total cost excluding fixed holding cost per annum 34,009,625.34
Total cost 34,734,206.94