• Leadtimes are zero; that is, an order arrives as soon as it is placed.

• Allorderinganddemandoccursatthestartoftheperiod.Inventoryischarged

on the amount on hand at the end of the period.

The problem is to decide how much to order in each period so that demands are met without backlogging and
the total cost, including the cost of ordering and holding inventory, is minimized. This basic model was first
analyzed by Wagner and Whitin (1958) and has now been called the Wagner-Whitin Model.

In this model, it is clear that the total variable order cost incurred will be fixed and independent of the schedule
of orders, and thus this cost can be ignored. Let yt be the amount ordered in period t, and It be the amount of
product in inventory at the end of period t. Using these variables, the problem can be formulated as follows:

(10.1) (10.2) (10.3)

ProblemWW : Min s.t.

Kδ(yt)+hIt
It 􏰄It−1 +yt −dt,

T t􏰄1

t 􏰄1,2,...,T It,yt ≥ 0, t 􏰄 1,2,...,T.

I0 􏰄 0

Here constraints (10.1) are called the inventory-balance constraints, while (10.2) simply specifies initial
t
inventory. Note that the inventory can also be rewritten as: It 􏰄 i􏰄1(yi − di) and therefore the It variables can be
eliminated from the formulation.

Wagner and Whitin made the following important observation.

Theorem10.1.1 Anyoptimalpolicyisazero-inventoryorderingpolicy,thatis,a policy in which

ytIt−1 􏰄 0, for t 􏰄 1,2,...,T.

Proof. The proof is quite simple. By contradiction, assume there is an optimal policy in which an order is placed
in period t even though the inventory level at the beginning of the period (It−1) is positive. We will demonstrate
the existence of another policy with lower total cost. Evidently, the It−1 items of inventory were ordered in
various periods prior to t . Thus, if we instead order these items in period t, we save all the holding cost incurred
from the time they were each ordered.

Thus, ordering only occurs when inventory is zero. A simple corollary is that in an optimal policy an order is of
size equal to satisfy demands for an integer number of subsequent periods.

Using the above property, Wagner and Whitin developed a dynamic program- ming algorithm to determine
those periods when ordering takes place. By con- structingasimpleacyclicnetworkwithnodesV
􏰄{1,2,...,T+1},wecanview the problem of determining a policy as a shortest path problem. Formally, let lij ,

the length of arc (i, j ) in this network, be the cost of ordering in period i to satisfy the demands in periods i, i +
1, . . . , j − 1, for all 1 ≤ i < j ≤ T + 1. That is,

j−1

k􏰄i
Allotherarcshavelij 􏰄+∞.Thelengthoftheshortestpathfromnode1tonode T + 1 in this acyclic network is the
minimal cost of satisfying the demands for periods 1 through T . The optimal policy, that is, a specification of
the periods in which an order is placed, can be easily reconstructed from the shortest path itself. This procedure
is clearly O(T 2).

Most of the assumptions made above can be relaxed without changing the basic solution methodology. For
example, one can consider problem data that are period dependent (e.g., ct , ht or Kt ). The assumption of zero
leadtimes can be relaxed if one assumes the leadtimes are known in advance and deterministic. In that case, if an
order is required in period t , then it is ordered in period t − L, where L is the leadtime.

Researchers have also considered order costs that are general concave functions of the amount ordered, that is, ct
(y). The problem can be formulated as a network flow problem with concave arc costs. This was the approach of
Zangwill (1966) who also extended the model to handle backlogging, although the solution method is only
computationally attractive for small size problems.

The Wagner-Whitin model can also be useful if demands during periods well into the future are not known. This
idea is embodied in the following theorem.

Theorem10.1.2 Lettbethelastperiodaset-upoccursintheoptimalorderpolicy associated with a T period problem.

Then for any problem of length T ∗ > T it is necessary to consider only periods {j : t ≤ j ≤ T ∗} as candidates
for the last set-up. Furthermore, if t 􏰄 T , the optimal solution to a T ∗ period problem has yt >0.

This result is useful since it shows that if an order is placed in period t , the optimal policy for periods 1, 2, . . . ,
t − 1 does not depend on demands beyond period t .

Surprisingly, even though the Wagner-Whitin solution procedure is extremely efficient, often simple
approximate, yet intuitive, heuristics may be more appeal- ing to managers. For example, this may be the reason
for the popularity of the Silver-Meal (1973) heuristic or the Part-Period Balancing heuristic of Dematteis (1968).
One important reason is the sensitivity of the optimal strategy to changes in forecasted demands dt , t 􏰄 1,
2, . . . , T . Indeed, in practice these forecasted de- mands are typically modified “on-the-fly.” These changes
typically imply changes in the optimal strategy. Some of the previously mentioned heuristics are not as sensitive
to these changes while producing optimal or near optimal strategies. For another approach, see Federgruen and
Tzur (1991).

Recently researchers have shown that it is possible to take advantage of the special cost structure in the Wagner-
Whitin model and use it to develop faster exact algorithms (i.e., O(T )). This includes the work of Aggarwal and
Park (1990), Federgruen and Tzur (1991) and Wagelmans et al. (1992).

lij 􏰄K+h

(k−i)dk.

10.1 The Wagner-Whitin Model 167

168 10. Economic Lot Size Models with Varying Demands

We sketch here the O(T) algorithm of Wagelmans et al. which is the most

intuitive of the ones proposed. It is a backwards dynamic programming approach.

j
Define dij 􏰄 t􏰄i dt for i,j 􏰄 1,2,...,T, that is, the demand from period i to

period j. To describe the algorithm, we will change slightly the way we account

for the holding cost. If an item is ordered in period i to satisfy a demand in period
 .
j ≥ i, then we are charged H 􏰄 (T −i +1)h per unit. That is, we incur the i

T
holding cost until the end of the time horizon. As long as we remember to subtract the constant h i􏰄1 d1i from
our final cost, then we are charged exactly the right amount. With this in mind, define G(i) to be cost of an
optimal solution with a planning horizon from period i to period T , for i 􏰄 1, 2, . . . , T . For convenience,
define G(T + 1) 􏰄 0. Then,

G(i)􏰄 min {K+Hidi,t−1+G(t)} i<t≤T+1

􏰄 K + min {Hidi,t−1 + G(t)}. (10.4) i<t≤T+1

T
The final cost is then G(1) − h i􏰄1 d1i . Using this recursion, which is just a reformulation of the shortest path
recursion discussed earlier, it is clear that the complexity is O(T 2). Wagelmans et al.’s O(T ) algorithm is based
on the crucial observation that with careful implementation, the total amount of time spent finding the period
that minimizes (10.4) over the entire running of the algorithm is O(T ).

Consider the calculation of G(i). It is useful to plot the points (djT ,G(j)) for j 􏰄 i + 1,i + 2,...,T + 1, where the
point (dT+1,T ,G(T + 1)) is simply the origin. Let E be the lower convex envelope of these points; then define the
function g(x) 􏰄 y if and only if (x, y) ∈ E. It is clear that g is a piecewise linear convex function on [0, di+1,T ]
with g(di+1,T ) 􏰄 G(i + 1) and g(0) 􏰄 0. See Figure 10.1.

Define the breakpoints of g to be all the points x where g changes slope in addition to the points x 􏰄 0 and x 􏰄
di+1,T . If x is a breakpoint, then x 􏰄 djT forsomeperiodj ∈{i+1,i+2,...,T +1}.Letthereber breakpointsandlet i + 1
􏰄 t(1) < t(2) < ... < t(r) 􏰄 T + 1 denote the corresponding periods. These periods are called efficient because of
the following.

Theorem 10.1.3

min {Hi di,t −1 + G(t )} 􏰄 min {Hi di,t (p)−1 + G(t (p))}. i<t≤T +1 1≤p≤r

Proof. Suppose that j (with i +1 < j < T +1) is not an efficient period and let k and l (with k < j < l) be the two
consecutive efficient periods straddling j . The slope of g on [dlT , dkT ] is equal to [G(k) − G(l)]/dk,l−1, hence