LEAD-TIME VARIABILITY IN A CONTINUOUS-REVIEW INVENTORY SYSTEM

WITH AN UNRELIABLE SUPPLIER

Esmail Mohebbi
Department of Industrial & Management Systems Engineering
University of Nebraska-Lincoln, Lincoln, NE 68588-0518, emohebbi2@unl.edu

Abstract: We consider a continuous-review inventory system with compound Poisson demand, hyper-exponentially
distributed lead time, and lost sales where the supply process may be randomly disrupted depending on the
availability of a supplier. Assuming that the supplier’s availability can be modeled as a two-dimensional continuous-
time Markov chain, we present an exact formulation of the long-run average cost rate function based on deriving the
stationary distribution of the on-hand inventory, and provide some numerical results.

INTODUCTION

The success of most modern firms operating in today’s intensely competitive market is closely linked to efficient
management of “pipeline” inventories as the main enabling factor to ensure cost efficiency while maintaining a
high level of customer satisfaction. Hence, inventory managers are often faced with the challenge of incorporating
the issue of suppliers’ reliability into their stocking decisions. Clearly, the term “reliability” in connection to a
supplier may refer to a number of attributes ranging from availability in responding to replenishment orders, when
needed, to variability in delivery lead times as well as the quality of the delivered products. In particular, the
availability of a supplier can be negatively impacted by a variety of factors including equipment breakdowns,
material shortages, capacity constraints, price inflations, strikes, embargos, and political crises thereby disrupting the
supply process. (See Weiss and Rosenthal (1992), Parlar and Perry (1996), and Parlar (2000), among others, for
examples of such damaging impact for several cases in automotive and computer industries.)

The analysis of supply disruptions within the context of production/inventory control models has received much
attention in the literature in recent years. The existing research in the area can be mostly classified under two major
categories: The first group consists of those studies that examine the supply disruption problem in a production-
storage setting comprised of a failure-prone production facility that supplies a single product at a constant known
rate, while operating, into an immediate storage facility which faces a deterministic or stochastic demand process.
The inter-failure (on) and repair (off) time periods are considered to be either both random or constitute some
combination of constant and random cases under a threshold or two-bin production control policy. An early work in
this category is Meyer, Rothkopf, and Smith (1979), followed by Sharafali (1984), Akella and Kumar (1986),
Parthasarathy and Sharafali (1987), Posner and Berg (1989), Hopp, Pati and Jones (1989), Hu, Vakili and Yu
(1994), Hu (1995), Berg, Posner and Zhao (1994), Moinzadeh and Aggarwal (1997), and Liu and Cao (1999),
among others. We refer the reader to Abboud (2001) for an extensive review of the literature in this category and
note in passing that these models primarily assume that the production output is added to the inventory either
continuously and uniformly or on a one-for-one basis during the course of production (i.e., no batch replenishment
of stock is considered). Therefore, they are mainly prevalent in continuous processing and/or capital-intensive
industries conducive to such replenishment routines. In many real life inventory control systems, however,
replenishments occur in economical lot sizes (or batches), either instantaneously or after a lead time. As such,
addressing the issue of supply disruption for such inventory systems is of particular importance.

Accordingly, the second group of studies, which is particularly relevant to this work, includes those that focus on an
inventory system with an unreliable supplier whose status alternates randomly between two possible “available”
(on) and “unavailable” (off) states. When the supplier is on, the system functions similar to a regular inventory
system with a fully reliable supplier who is capable of accepting replenishment orders as soon as they are triggered
according to an adopted control policy. Once the supplier switches to the off state, it cannot accept new orders for
the duration of the off period, but continues to deliver the outstanding orders accepted prior to the switching epoch.
A substantial portion of research work in this category corresponds to incorporating the supply disruption
phenomenon into classical EOQ-type inventory models (i.e., deterministic demand, zero lead time, and
instantaneous replenishment) under various characterizations of the probability distributions describing the on/off
periods (Parlar and Berkin (1991), Weiss and Rosenthal (1992), Parlar and Perry (1995, 1996), Gurler and Parlar
(1997), and Parlar (2000), among others). Several studies have considered the randomness of the demand process in

56
inventory systems with unreliable suppliers and zero lead times (Parlar, Wang, and Gerchak (1995), Arreola and
DeCroix (1998), and Ozekici and Parlar (1999)). To the best of our knowledge, there are only two studies that
address the supply disruption problem within the context of an inventory system with stochastic demand and non-
zero lead time: Gupta (1996) presented an exact analytical cost-minimization treatment of a continuous-review lost-
sales (s,Q) inventory system with Poisson demand and constant lead time in which the supplier’s on/off periods are
exponentially distributed, and the number of outstanding orders at any time is at most one. Gupta’s work also
included an exact analysis of a case involving zero lead time with no limitation imposed on the number of orders
(each of size Q) that can be placed at any time. Parlar (1997) developed a heuristic cost-minimization model for the
supply disruption problem in a continuous review (s,Q) inventory system with random demand, random lead time,
and backorders where the duration of the on period follows an Erlang distribution and the off period is general. The
model is basically an extension of the well known Hadley and Whitin (1963, p.162) heuristic for stochastic (s,Q)
inventory systems with backorders and no more than a single order outstanding at any time in order to account for
disruptions in the supply process. However, despite its generality, the model is merely an approximation that is
proven to be effective only when the durations of stockout periods can be neglected. More specifically, the heuristic
can result in overly inflated cost values when the lead time is highly variable.

Our primary objective in this work is to incorporate the issue of lead-time variability into the supply disruption
problem thereby addressing the concept of supplier’s reliability in a more general sense. In this regard, we consider
a lost-sales continuous-review inventory system with an unreliable supplier where demand is Compound Poisson,
lead time is hyperexponentially distributed, and the supplier is in the either on or off state at any point in time
according to a two-dimensional continuous-time Markov chain. For this system, we present an exact analytical
model for establishing the long-run average cost rate function based on deriving the stationary distribution of the
inventor level (stock-on-hand) under an (s,Q)-type control policy. Some numerical results are also provided.

The contribution of this research is twofold: First, analytical treatment of lost-sales inventory systems despite their
pertinence in highly competitive environments is generally regarded as a difficult task (see Hadley and Within
(1963) for a detailed discussion). This work advances the existing research findings in stochastic lost-sales
inventory systems with non-zero lead time and supply disruptions to a case involving non-unit-size demands and
random lead times. Second, by allowing for lead times to follow a probability distribution whose coefficient of
variation exceeds unity, it presents an exact analytical model for an inventory system where lead-time variability, in
addition to the “availability” of the supplier at order placing epochs, can highly influence the supplier’s reliability
in responding to replenishment orders.

THE INVENTORY MODEL

Model Description

Demands in a continuous-review inventory system with an unreliable supplier are generated according to a
compound Poisson process with occurrence rate l. Demand sizes are independent identically distributed (iid)
random variables with mean m-1 whose probability density and distribution functions are denoted by g (.) and G (.),
respectively. The supplier’s on and off periods follow a two-dimensional homogeneous Markov chain. That is, the
on and off periods are independent exponentially distributed random variables with means h-1 and u-1, respectively.
The control policy is of (s,Q)-type with at most one order outstanding at any time: A replenishment order of size Q
is triggered as soon as the inventory level drops to or below a reorder level s (0£ s<Q). The order is “accepted”
immediately, provided that the supplier is in the on state; otherwise, if the supplier is in the off state, the triggered
order will be placed on “hold” for the remainder of the off period and will not be accepted until the supplier becomes
available. Once the supplier switches back to the on state, the held order will be accepted instantaneously and
processed in a regular manner. Note that a switch to the off state only affects the acceptance of a replenishment order
in the future and will not affect the processing of the order (if any) that has already been accepted by the supplier.
All demands during the stockouts—including the excess demand when the size of a demand order is larger than the
inventory level— are considered to be lost. It should be pointed out that the form of the optimal control policy for
this class of inventory systems remains an open question. As such, our selection of the control policy in this case
mainly relies on the fact that the (s,Q)-type policies are generally simple and easy to implement, thus, popular in
practice, and provide analytical facility in the adopted modeling approach. Finally, we assume that the
replenishment lead time, L, follows a hyperexponential distribution with parameters pj and sj, j=1,…,R. That is,

57
 −σ j y
Pr( L ≤ x) = ∫ 0 ∑ Rj=1 p j σ j e dy, x ≥ 0, p j > 0, ∑ Rj=1 p j = 1. Figure 1 depicts a typical tracing of the inventory
x

process.

Inventory
Level

s+Q

0
Time
off on off on off on off on off

ƒ‚ ‚ ‚ ƒ‚ ‚

L L L L L

‚: Order Accepted ƒ: Order Placed On Hold L: Lead Time

Figure 1. A typical tracing of the inventory level.

Model Formulation

Let TCR (s,Q) represent the total cost rate function comprised of the long-run average sum of ordering, holding, and
shortage costs per unit time for the inventory system described above. Note that under the stated set of assumptions,
the supplier’s availability constitutes an alternating Poisson process. Hence, from renewal theory and utilizing the
memoryless property of the exponential distribution, we can write:

ηTCR {T =τ + L} ( s, Q) + υTCR {T = L} ( s, Q)
TCR ( s, Q ) = , (1)
η +υ
where t is an exponential random variable with mean u-1, and TCR {T } (.) is the total cost rate function for an
inventory system which operates under a similar set of assumptions, but orders from a fully reliable supplier with
lead time T. For brevity, in what follows we focus our attention on TCR{T=t+L} (.). Let W{T=t+L} (t) denote the
inventory level at time t for the newly described inventory system. It can be verified that W{T=t+L} (t) is a
regenerative process, and hence, there exists a limiting distribution characterizing the steady state behavior of
W {T =τ + L} = lim t → ∞ W {T =τ + L} (t ) (in distribution). Let F and f mark the stationary distribution and density functions
of the inventory level, respectively. Then, letting G (.) = 1 − G (.) and utilizing the PASTA (Wolff (1982) property, it
follows that
s +Q s +Q s +Q ∞
TCR {T =τ + L} ( s, Q) = λK ∫ G ( w − s)dF ( w) + h ∫ wdF ( w) + λπ ∫ ∫ xg ( w + x)dxdF ( w), (2)
w= s w=0 w= 0 x =0

where K, h, and p, respectively, denote and the fixed ordering cost, the inventory carrying cost per unit per unit
time, and shortage cost per unit of the lost sales. It should be noted that while the second integral term in the above
equation characterizes the average inventory level, the first and third integral terms represent the probability of
placing a replenishment order and the average amount of lost sales, respectively, at a demand occurrence epoch.
Thus, our primary task in forming Eq. (2) is to derive the stationary distribution of the inventory level. To
accomplish this task, we use a system-point level-crossing methodology (Brill and Posner (1977)). In this regard,
we partition the sample path tracing of W{T=t+L} into W0{T=t+L}, W10{T=t+L}, and W1j{T=t+L}, j=1,…,R, representing,
respectively, those portions of the sample path in which there is no order, or one order in stage t, or one order in

58
phase j, j=1,..,R, outstanding. The stationary density f and distribution function F are also partitioned accordingly
( f 0 , f 10 , f 1 j , F0 , F10 , F1 j , j = 1, L , R), and the following level-crossing balance relations are established:
s +Q R w
λ ∫ [G (α − w) −G (α − Q)] f 0 (α )dα + ∑ σ j F1 j ( w − Q) = λ ∫ G (α − Q)dF0 (α ), w ∈ [Q, s + Q), (3)
α =w j =1 α =Q
s +Q w
λ ∫ [G (α − w) −G (α − s)]dF (α ) = λ ∫ G (α − s) f
α =w
0
α =s
0 (α ) dα , w ∈ ( s, Q), (4)

s s +Q
λ ∫ G (α − w) f 10 (α )dα + λ ∫ G (α − w)dF0 (α ) = υF10 ( w), w ∈ [0, s ], (5)
α =w α =s
s
λ ∫ G (α − w) f1 j (α )dα + υp j F10 ( w) = σ j F1 j ( w), j = 1, L R w ∈ [0, s ]. (6)
α =w
Solving the above system of equations along with the normalizing condition
F0 ( s + Q) + F10 ( s) + ∑ Rj =1 F1 j ( s) = 1 (7)
will provide the unique stationary distribution of W{T=t+L}. Clearly, an efficient solution procedure, in general, will
require utilization of numerical means of solution as the solution structure, depending on the form of G (.), can be
exceedingly complex, and consequently, of limited practical utility. However, for the special case where demand
sizes are exponentially distributed (i.e., G(x) = 1- e-ìx , x 0), these equations can be readily solved to obtain the
following functional forms for the stationary density f:

Ra0 − ∑ Rj =1b1 j eγ
| j µ ( w −Q)
− b10 H R e βµ ( w− Q) , w ∈ (Q, s + Q),
f 0 ( w) = S a (8)
|
T 0, w ∈ ( s, Q),

f 10 ( w) = b10e βµw , w ∈ (0, s], (9)

γ j µw
f 1 j ( w) = b10δ j p j e βµw + b j e , w ∈ (0, s], j = 1,L R, (10)

where H R = ∑ Rj =1 p j δ$ j , δ$ j = 1 + δ j , δ j = υ / (σ j − υ ), γ j = σ j / ( λ + σ j ), j = 1,L , R , β = υ / ( λ + υ ),
and a0 , b10 , b1 j , j = 1,L R, are constant coefficients. In addition to above, the following point mass probabilities
exist:
b H R b1 j b H R b1 j
Pr(W {T =τ + L} = 0) = 10 R + ∑ , and Pr(W {T =τ + L} = Q) = 10 R + ∑ ,
βµ j =1γ j µ βµ j =1γ j µ

where β = 1 − β , and γ j = 1 − γ j , j = 1,L , R. Finally, the unique solution to the set of R+2 linearly independent
relations comprised of
( β −γ j ) µs
βb1 j + γ j δ j p j e = 0, j = 1,..., R − 1, (11)

b10e βµs − βa 0 = 0, (12)

R γ j µs
βγ j a 0 − ∑ b1 j e − b10 H R e βµs = 0, (13)
j =1
and Eq. (7) will provide the values of constant coefficients ( a0 , b10 , b1 j , j = 1,L R ) involved in the above solution.
Substituting the complete solution into Eq. (2) yields an exact expression for TCR{T=t+L} (s,Q). A related level-
crossing methodology can be devised for deriving an analytical expression for TCR{T=L} (s,Q). We note, however,
that the resulting structure of the total cost rate function, TCR(s,Q), in Eq. (1), even when G(.) is exponential, turns
out to be too complex to allow for establishing convexity or unimodality results. Therefore, in order to obtain the
optimal values of the control policy parameters, the minimization of the cost function can be practically
implemented via numerical search routines, using a nonlinear optimization package.

59
 NUMERICAL RESULTS

This section contains the optimality results for several sample problems with exponentially distributed batch sizes.
We considered 14 examples and obtained the optimal values of s and Q so that TCR(s,Q) is minimized. Table 1
depicts the parameters settings for these examples. The replenishment lead time (L) in all cases was assumed to
follow a two-phase (R=2) hyperexponential distribution with the same mean time (E(L)=0.1). However, in order to
account for lead time variability in each example, three different values of the coefficient of variation (CV) of the
lead time distribution were examined: CV =1.23 (i.e., p1 = p2 = 0.5, s1 = 6.67, and s2 = 20), CV=2.46 (i.e., p1 = 0.05,
p2 = 0.95, s1 = 1.25, and s2 = 15.63), and CV=5.93 (i.e., p1 = 0.02, p2 = 0.98, s1 = 0.33, and s2 = 24.39). The results
are presented in Table 2. Observe that optimal values of the control policy parameters and the associated total cost
display sensitivity with respect to changes in lead-time variability as the long-run fraction of time in which the
supplier is available, υ /(υ + η ), varies under different parameters settings.

Table 1. Numerical examples: Parameters settings

Ex. No ë ì E(L) ç õ K h ð
1 50 0.2 0.1 1 15 200 1 50
2 50 0.2 0.1 1 2.5 200 1 50
3 100 0.2 0.1 1 15 200 1 50
4 100 0.2 0.1 1 2.5 200 1 50
5 200 0.2 0.1 1 15 200 1 50
6 200 0.2 0.1 1 2.5 200 1 50
7 100 0.2 0.1 1 15 100 1 50
8 100 0.2 0.1 1 2.5 100 1 50
9 100 0.2 0.1 1 15 400 1 50
10 100 0.2 0.1 1 2.5 400 1 50
11 100 0.2 0.1 1 15 200 1 25
12 100 0.2 0.1 1 2.5 200 1 25
13 100 0.2 0.1 1 15 200 1 100
14 100 0.2 0.1 1 2.5 200 1 100

Table 2. Numerical examples: Optimality results

CV=1.23 CV=2.47 CV=5.93

Ex. s Q TCR(s,Q) s Q TCR(s,Q) s Q TCR(s,Q)
No.
1 123.99 359.64 460.47 100.18 505.51 610.70 54.79 667.86 713.84
2 249.55 432.52 673.19 269.29 489.29 742.65 208.84 690.75 894.09
3 256.50 531.85 741.30 200.54 896.25 1106.40 96.00 1258.80 1337.20
4 532.72 687.80 1201.40 574.53 819.52 1360.40 428.60 1286.30 1702.80
5 539.85 802.59 1247.50 412.40 1657.30 2088.10 178.20 2437.70 2580.60
6 1127.00 1140.00 2227.00 1205.50 1440.9 2576.80 870.30 2470.90 3315.80
7 278.17 404.23 634.95 215.52 824.53 1049.10 97.60 1217.90 1297.70
8 569.26 573.53 1122.90 607.74 723.38 1296.40 439.60 1237.10 1664.10
9 233.32 714.27 901.12 181.80 1017.30 1209.40 93.30 1336.80 1412.50
10 488.07 859.32 1329.40 529.34 973.19 1470.05 409.40 1377.80 1776.10
11 202.14 529.19 685.96 141.46 745.42 899.16 78.69 947.13 1009.20
12 385.33 678.09 1053.30 396.75 781.72 1155.50 283.20 1053.20 1335.60

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 13 311.61 533.12 796.82 374.40 992.96 1372.40 117.00 1713.50 1811.90
14 678.54 692.52 1347.2 757.52 858.68 1576.90 575.10 1616.60 2172.60

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