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1. Introduction chain (PSC) can be defined as ‘‘the integration of all activities asso-
ciated with the flow and transformation of drugs from raw materi-
Research into supply chain and inventory management has als through to the end user, as well as associated information flows,
been extensive in the field of health care. The main goal of this re- through improved supply chain relationships to achieve a sus-
search is to reduce health care costs without sacrificing customer tainable competitive advantage’’ [4]. The PSC comprises three ma-
service. Pharmaceuticals represent a significant part of health care jor players: producers, purchasers, and pharmaceutical providers.
costs, account for approximately 10% of annual health care expen- Producers consist of pharmaceutical companies, medical surgical
diture in the USA and about $600 billion globally in 2009 [1]. Phar- product companies, device manufacturers, and manufacturers of
maceutical products can be expensive to purchase and distribute, capital equipment and information systems. Purchasers include
but shortages of essential medicines, improper use of medicines, grouped purchasing organizations (GPOs), pharmaceutical whole-
and spending on unnecessary or low-quality medicines also have a salers, medical surgical distributors, independent contracted dis-
high costs in terms of wasted resources and preventable illness and tributors, and product representatives. Providers include hospitals,
death. Almarsdóttir and Traulsen identified a number of reasons hospital systems, integrated delivery networks (IDNs), and alterna-
why pharmaceutical deserve special consideration in the control of tive site facilities [5].
inventory [2]. In the current economic crisis, increasing attention The PSC is very complex and carries high responsibility in en-
is being focused on the rising costs of health care and specifically suring that the right drug reaches the right people at the right time
pharmaceuticals. and in the right condition to fight against disease and suffering. It is
Careful management of pharmaceutical is directly related to a a highly sensitive supply chain in which anything less than a cus-
country’s ability to address public health concerns. Aptel and Pour- tomer service level (CSL) of 100% is unacceptable because of the
jalali stated that management of pharmaceutical supplies is one of direct impact on health and safety. The solution adopted by many
the most important managerial issues in health care industries [3].
pharmaceutical industries is to carry a huge inventory in the sup-
However, many health care industries experience difficulty in
ply chain to ensure a fill rate close to 100%. However, ensuring 100%
managing their pharmaceutical products. A pharmaceutical supply
product availability at an optimal cost represents a huge challenge
unless the supply chain processes are streamlined towards cus-
∗ Corresponding author. Tel.: +91 451 2452371; fax: +91 451 2453071. tomer needs and demands. Product perishability is another critical
E-mail addresses: uthayagri@gmail.com (R. Uthayakumar), PSC issue. Outdated or expired items may be overlooked and dis-
jaisilpriyan@gmail.com (S. Priyan). pensed to patients, which could have potentially disastrous effects
2211-6923/$ – see front matter © 2013 Elsevier Ltd. All rights reserved.
http://dx.doi.org/10.1016/j.orhc.2013.08.001
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on both patient care and public relations. In a 2003 survey, the es- developed a simple inventory rule for joint ordering in a univer-
timated cost for expiration of branded products in supermarkets sity hospital, but they ignored capacity constraints [16]. Kelle et al.
and drug stores was over 500 million dollars [6]. Apart from this provided decision support tools that improve operational, tactical,
perishability issue, health care managers are challenged with de- and strategic decision-making in PSC and inventory management
veloping inventory policies given changing demands, limited space under an inventory policy that involves periodic review [17]. The
capacity, CSL, patient safety, and regulations affecting supply. inventory models mentioned above are single-echelon models that
In considering a PSC, health care managers have to decide or- consider a constant lead time, which is not a controllable factor un-
der quantities and purchasing dates and the inventory level they der a periodic review environment.
carry to effectively serve their customers. They also have to manage Outsourcing is allocation of specific business processes to an
their interactions with pharmaceutical companies to minimize the external specialist service provider and can yield organizational
integrated total cost for PSC and inventory management without flexibility. Although outsourcing has a variety of organizational
sacrificing CSL. Therefore, PSCs require effective inventory man- benefits, it can also pose difficulties if a suitable service provider
agement policies and coordination among producers, purchasers, is not identified. As in other industries, outsourcing has become
and providers. PSC decisions are significant because a shortage of an important strategy for pharmaceutical companies owing to in-
medicines and improper use of pharmaceutical products lead to fi- creasing competitive pressures to reduce costs and the time to
nancial losses and have a significant impact on patients. Therefore, market. Regardless of the specific product, partnerships among
PSC decision-makers require expert knowledge to make the best suppliers and distributors to combine services have generated ben-
use of their organizational resources and improve customer satis- efits for health care providers [18]–[20]. However, outsourcing
faction without negatively affecting public health, patient safety, leads to longer and more complex PSCs and reduces their trans-
or relations with PSC members. parency. Nicholson et al. developed analytical models to study and
Unlike many industries, hospital administrators and pharmacy analyze the impact of outsourcing of inventory management de-
managers have to manage very complicated distribution networks cisions in health care to a third-party provider [19]. They com-
and inventory management problems without proper guidance on pared inventory costs and service levels for non-critical inventory
efficient practices. This is because most hospital administrators items of an in-house three-echelon distribution network to an out-
and pharmacy managers are doctors with expert knowledge in sourced two-echelon distribution network. According to Veral and
medicine, and are not supply chain professionals [7]. Hence, given Rosen, a long-term benefit of outsourcing is the ability to reduce
the high costs, coordination, constraints, and perishability of phar- the number of suppliers in the system, which will eventually lower
maceuticals, more study is necessary to help health care managers procurement costs for downstream members of the supply chain
in setting optimal PSC and inventory management policies. Oper- [20]. Chasin et al. investigated medical errors arising from out-
ations research (OR) provides a wide range of methodologies that sourcing of laboratory and radiology services [21]. As for any com-
can help hospitals and other health care systems to significantly plicated area of study, the limitations of an investigation must be
improve their operations. A number of studies have considered considered. The lack of outsourcing is a limitation of this study.
problems related to health care using OR techniques [8–11]. Here All steps from the supply of raw materials to the finished prod-
ucts can be included in a supply chain connecting raw mate-
we develop an OR model for PSC and inventory management for a
rial suppliers, manufacturers, retailers, and the customer/hospital.
pharmaceutical company and a hospital. The next section reviews
Multi-echelon inventory management is the management of in-
the literature on supply chain management issues from the per-
ventory and coordination of the distribution process at more than
spective of health care industries.
one level of a supply chain network. Multi-echelon inventory mod-
els have attracted much attention and the integrated approach has
2. Literature review been extensively studied. This approach was first implemented in
retail and manufacturing industries, but has since spread to health
Management of the procurement, storage, and distribution of care industries. Kim presented an explanation of an integrated
pharmaceutical supplies is crucial for hospitals and pharmaceuti- supply chain management system developed to specifically ad-
cal companies from economic and organizational points of view. dress issues related to pharmaceuticals in the health care sector
PSC issues have been addressed by several authors from differ- [22]. Meijboom and Obel addressed supply chain coordination for
ent point of views. Norris investigated cost reductions for hospi- a pharmaceutical company with a multi-location and multi-stage
tals by considering the total delivered cost of a product rather than operations structure [23]. Amir et al. developed a generalized net-
just the unit cost [12]. This involves quantifying every cost asso- work oligopoly model for PSC competition that takes into account
ciated with a product, including the unit cost and costs related to product perishability, brand differentiation, and discard costs [24].
ordering, inventory, distribution, preparation and use, and paper- Their generalized network-based framework captures competition
work. Lapierre and Ruiz presented a strategy for improving hospi- among firms in the various supply chain activities of manufactur-
tal logistics by focusing on scheduling decisions and a supply chain ing, storage, and distribution.
approach rather than the more common multi-echelon inventory Lead time is an essential factor in any supply chain and inven-
management [13]. They placed an emphasis on scheduling deci- tory management system. Pharmaceutical manufacturers typically
sions, such as when to buy a product, when to deliver to each care set a specific time for delivery products to customers that consid-
unit, when each employee should work, and what task should be ers factors such as labor strikes and natural disasters. This time is
done. Scott and Graham proposed that implementation of an off- called the inventory lead time and comprises components such as
site warehouse to pool resources would result in a great savings for order preparation, order transit, supplier lead time, delivery time,
hospital supply chains [14]. The savings would be achieved as a re- and set-up time [25]. In many practical situations, lead times can be
sult of dramatic reductions in inventory holding costs and on-hand reduced by paying an additional crash cost. According to Hsu and
inventory. Lee, crash costs could be expenditure on equipment improvement,
Bevilacqua et al. compared two different management ap- information technology, order expedition, or special shipping and
proaches for procurement of medical items by hospitals in a region handling [26]. Using this viewpoint, Liao and Shyu devised a prob-
of central Italy [15]. They focused on a selected range of medical abilistic inventory model in which lead time was considered as a
supplies according to their prevalence in three separate hospital decision variable [27]. Several researchers extended this approach
budgets. Comparisons were made for parameters such as buffer in integrated production–inventory models for lead time reduction
stock, the reorder point, and relative costs. Dellaert and Van de Poel in a single-vendor, single-buyer supply chain [28–30].
Author's personal copy
In practice, a periodic-review inventory policy is not applicable n: Total number of lots of M products delivered by the phar-
for health care inventory management because customer demands maceutical company to the hospital in one production cycle, a
and patient arrivals are uncertain. Thus, efficient management of positive integer
health care inventory systems requires a different approach than a Other parameters for the hospital
periodic-review reorder point model. According to Woosley, there Di : Average demand for the ith product per year
are at least three limitations for use of the continuous replenish- di : Expiry rate for the ith product
ment model in the context of health care supply systems [7]. The hbi : Holding cost per unit per year excluding interest charges for
model does not account for limited human resources or physical the ith product
storage capacity, CSL which is critical in most hospitals, and deci- Ai : Ordering cost per order for the ith product
sions are based only on costs and do not consider inventory control tc : Common trade credit period for all products offered by the
activities and restricted capacity. Because of the above-mentioned pharmaceutical company in years
limitations in health care industries, a continuous-review inven- Id : Common deposit interest rate for all products per year
tory policy is more suitable than a periodic review approach in Ic : Interest charge paid per $ in stock to the bank for all products
health care inventory management. per year
Multi-echelon inventory problems for perishable products have pi : Purchase price per unit for the ith product
been widely studied for general applications. However, existing si : Selling price per unit for the ith product
inventory models are not applicable to pharmaceutical products ri : Reorder point for the ith product
for several reasons. Pharmaceutical products can be more expen- Xi : Lead time demand for the ith product, which follows a nor-
sive than other products to purchase and distribute, and short- mal √ distribution with finite mean Di L and standard deviation
ages and improper use of essential medicines can have a high cost σi L, where σi is the standard deviation for the demand per
in terms of wasted resources and preventable illness and death. unit time for the ith product
Therefore, special care should be taken in pharmaceutical inven- E (Xi − ri )+ : Expected demand shortage for the ith product at
tory decisions to ensure 100% product availability at the right time, the end of a cycle
at the right cost, and in good condition to the right customers. The θi : Fraction of demand for the ith product that is not met from
quality of health care industries strongly depends on the availabil- stock, so 1 − θi is the service level
ity of pharmaceuticals on time. If a shortage occurs at a hospital, F : Fixed transportation cost for all products per delivery
an emergency delivery is necessary, which is very costly and can fi : Storage space for the ith product
be implications for patient health. Inventory management strate- W : Total space available for the M products
gies that are unsuitable for health care industries may lead to large Other parameters for the pharmaceutical company
financial losses and a significant impact on patients. Hence, inven- hv i : Holding cost per unit time for the ith finished product
tory strategies for pharmaceutical products are more critical than Si : Set-up cost for the ith finished product
those for other products. Thus, a specific inventory model is nec- Pi : Production rate for the ith finished product
essary for control of pharmaceutical products to save patient lives Iv : Interest rate for calculating the opportunity interest loss for
and reduce unnecessary inventory costs. the pharmaceutical company due to delayed payment per year
Here we investigate a two-echelon supply chain inventory dci : Expiration rate for the ith finished product
model for multiple pharmaceutical products under realistic prob- Cdci : Cost of expiry for the ith finished product
lems in health care industries. These include effective inventory
Qwi : Replenishment quantity for the ith raw material for pro-
policies and decisions, constraints and limitations, customer sat-
duction in each production cycle
isfaction, permissible payment delays, inventory lead time, and a
Awi : Ordering cost for the ith raw material
minimum expected total inventory cost. We present a continuous-
hwi : Holding cost per unit time for the ith raw material
review integrated production–distribution inventory model for
Fw : Fixed transportation cost for all raw materials
supply chain involving a pharmaceutical company and a hospi-
vwi : Labor cost for order handling and receipt for the ith raw
tal. We consider multiple pharmaceutical products, a variable lead
material
time that can be controlled via crash cost, permissible payments
αi : Defect rate for the ith raw material in an order lot, αi ∈
delays, and realistic constraints such as space availability and CSL.
[0, 1), a random variable
We develop a procedure for determining the optimal solutions for
sci : Screening cost per unit time for the ith raw material
inventory lot size, lead time and the total number of deliveries from
rsi : Screening rate per unit time for the ith raw material
the pharmaceutical company to the hospital to achieve the target
IETC (.): PSC integrated expected total cost for all products
hospital CSL at a minimum supply chain cost.
The remainder of the paper is organized as follows. Section 3
provides the notations and assumptions used. Derivation of the OR 3.2. Assumptions
model is described in Section 4 and the solution procedure is pre-
sented in Section 5. A numerical example is provided in Section 6. 1. The supply chain consist of a single pharmaceutical company
Section 7 concludes. and a single hospital and they deal with multiple (M) pharma-
ceutical products. For the ith product, the hospital orders a lot
3. Notations and assumptions of size Qi (i = 1, 2, 3, . . . , M) and the pharmaceutical company
produces nQi units at a finite production rate of Pi (Pi > Di ) per
We develop an OR model using the notations and assumptions unit time in one production cycle, but ships in quantity Qi to the
listed below. Additional notations and assumptions are provided hospital n times. All products for the hospital are in shortage and
when required. completely backordered.
2. For the ith raw material, all orders are delivered to the pharma-
3.1. Notations ceutical company in one shipment by an external supplier. In
other words, the quantity of the ith raw material required for
M: Number of products controlled in the supply chain production in each production cycle is instantaneous.
Decision variables 3. All expired pharmaceutical products held in inventory by
Qi : Order quantity for the ith product (i = 1, 2, 3, . . . , M) the pharmaceutical company are a constant fraction of the
L: Lead time (days) for all products accumulated inventory.
Author's personal copy
4. The hospital uses a continuous-review inventory policy for all To accommodate a more realistic inventory situation, we add
products and the order quantity Qi for the ith product is placed the effects of trade credit finance. In real life, business via share
when its inventory level falls to the reorder point ri . marketing, trade credit finance, or permissible payment delays
5. The reorder point for the ith product is ri = expected demand can improve sales in health care industries. Many pharmaceutical
for product i during the lead time (Di L)+ safety stock of i (ssi ), companies offer hospitals an interest-free credit period to promote
where ssi = ki x (standard deviation for the lead time demand market competition and improve health policy, patient safety,
for i), that is, and public health. Before the end of the trade credit period, the
√ hospital can sell the goods and accumulate revenue and earn
ri = Di L + ki σi L, (1) interest. However, higher interest is charged if the payment is not
settled by the end of the trade credit period. Therefore, it makes
where ki is the safety factor for product i and satisfies Pr (Xi >
economic sense for the hospital to delay payment to the end of the
ri ) = qi , and qi is the allowable stock-out probability for i during
permissible delay period allowed by the pharmaceutical company.
the lead time. We assume that the pharmaceutical company offers a common
6. The pharmaceutical company offers a certain trade credit pe- trade credit period for all products to attract hospital cooperation
riod (permissible payment delay) for all products to cooperate in our integrated strategy.
with the hospital in an integrated strategy. Thus, the hospital Let tc be the common credit period for all products and let hbi be
does not have to pay immediately on receipt of products. the unit stock-holding cost per unit time excluding interest charges
7. The credit period tc is less than the reorder interval for each for stock financing.
product, which means that the credit period cannot be longer
√ The expected inventory for product i over the
cycle is 2i + ki σi L, where 2i is the expected cycle stock. Therefore,
Q Q
than the time at which another order is placed. This is in hbi Qi
agreement with usual practice in health care industries. the holding cost per unit time for the cycle stock of i is . A safety
√ 2
8. The hospital deposits sales income in a bank with an annual stock of ki σi L is held throughout the cycle. Therefore, according
interest rate of Id before payment is due. At the time of to the trade credit policy, the pharmaceutical company charges
payment, the hospital pays the pharmaceutical company for interest at rate Ic for this portion of the stock and the hospital must
products purchased. The hospital has a loan from a bank for pay the corresponding holding cost. Hence, the total cost of the
unpaid purchase costs for unsold units. During the payment safety stock per unit time√is the sum of the holding cost and interest
delay period, the pharmaceutical company has an opportunity charged: (hbi + pi Ic )ki σi L.
interest loss at an annual rate of Iv , where Iv = Id . The credit period tc is less than the reorder interval for each
9. Crash costs increase as an approximate exponential function of product. This is a reasonable assumption because previous orders
the lead time. Therefore, the lead-time crash cost R(L) per order should be paid for before another order is placed. Therefore, the
for all products is assumed to be an exponential function of L hospital can sell products and earn interest at the common rate of
and is defined as Id up to the end of the credit period. Hence, the interest earned by
si Id Di
tc D2i tc2 si Id
L = L0 , the hospital per unit time for product i is Di tdt = .
0 0
R(L) =
Qi 2Qi
eC / L Lb ≤ L < Lb −1 , The expected shortage for i, E (Xi − ri ) , is completely backlogged
+
according to Eq. (1). The expected net inventory level√immediately Accordingly, the expected total cost per unit time for product i
after arrival of procurement quantity Qi is Qi + ki σi L. Hence, the is
expected on-hand inventory over the cycle is Max. on hand 2+ Min. on hand
√ √ √ Di (Qi − Di tc )2 pi Ic
= (Qi +ki σi L)+ki σi L
= Qi
+ ki σi L. ETChi (Qi , L) = (Ai + F + R(L)) +
2 2 Qi 2Qi
Author's personal copy
hbi Qi √
+ + (hbi + pi Ic )ki σi L + Di (di Cdi (L) + vi ) According to Assumption 3, the total number of expired prod-
2 ucts held by the pharmaceutical company is
D2i tc2 si Id si tc Id Di
Qi Qi
n2 Qi2
− − E (Xi − ri )+ . = dci nQi + (n − 1) − .
2Qi Qi Pi Di 2Pi
The expected total cost per unit time for all (M ) products is then Therefore, the expiration cost per unit time
M M
Di Di nDi
ETCh (Q , L) = [ETChi (Qi , L)] = (Ai + F + R(L)) = dci Qi Cdci + (n − 1) − .
i=1 i=1
Qi Pi 2Pi
(Qi − Di tc ) pi Ic 2
hbi Qi √ Consequently, the total production cost is Pi T1i Pci (Qi ), where
+ + + (hbi + pi Ic )ki σi L nQ
T1i = P i is the production cycle for product i. The unit production
2Qi 2 i
cost Pci (Qi ) is a linear function of the order quantity Qi , that is,
D2i tc2 si Id
si tc Id Di Pci (Qi ) = δi + δoi Qi , where δi is the fixed cost per unit finished
+ Di (di Cdi (L) + vi ) − − E (Xi − ri )+ (2)
2Qi Qi product and δoi Qi is the tool/die cost per unit finished product,
where Q = (Q1 , Q2 , Q3 , . . . , QM ). which is proportional to the lot size Qi . Hence, the total production
cost per unit time for product i is Di Pci (Qi ). Since Si is the set-up
cost and the production quantity for a lot is nQi units, the expected
4.2. Inventory model for the pharmaceutical company
set-up cost per unit time is given by nQ
Si Di
i
.
Most production–distribution inventory models assume that The hospital has a loan from a bank for unsold products. There-
the total cost for the manufacturer comprises holding, set-up, and fore, during the trade credit period, the pharmaceutical company
production costs for finished goods. However, this total cost is has an opportunity interest loss at an annual rate of Iv , where
not suitable for real-life production situations because a manufac- Iv = Id . Hence, the expected opportunity interest loss per unit time
turing company generally procures raw materials from external for product i is Iv pi tc Di .
suppliers and holds them in inventory before starting production. Let ETCfi (n, Qi ) denote the expected total cost per unit time for
Therefore, the inventory for a manufacturing company should in- finished product i for the pharmaceutical company, which equals
clude raw materials and associated costs such ordering, purchas- the sum of set-up, holding, production, and product expiry costs
ing, and holding costs. Here we assume that the pharmaceutical and opportunity interest losses for product i. That is,
company procures multiple raw materials from supplier and pro- Si Di hv i Qi Di 2Di
duces multiple finished products. Therefore, we derive expected ETCfi (Qi , n) = + n 1− −1+
nQi 2 Pi Pi
total costs for both finished products and raw materials.
+ Di Pci (Qi ) + Iv pi tc Di
4.2.1. Finished products Di nDi
+ Qi dci Cdci + (n − 1) − .
In our integrated inventory system, the pharmaceutical com- Pi 2Pi
pany begins production once the hospital orders l products of lot The expected total cost per unit time for all finished products is
size Ql , where the production rate is Pi (i = 1, 2, 3, . . . , M ) and then
a constant number of units are added to the inventory until the M
production run has been completed. The pharmaceutical company
ETCf (Q , n) = ETCfi (n, Qi )
produces product i in lot size nQi in each production cycle of length i =1
nQi
Di
, and the hospital receives the product in n lots each of size M
Si Di hv i Qi Di 2Di
Qi (i = 1, 2, 3, . . . , M). The first lot of size Qi is ready for ship-
= + n 1− −1+
ment after time Qi /Pi and then the pharmaceutical company con- i =1
nQi 2 Pi Pi
tinues to the deliver the product on average every Qi /Di units of + Di Pci (Qi ) + Iv pi tc Di
time until the inventory level falls to zero. Hence, the expected
on-hand inventory of product i for the pharmaceutical company Di nDi
+ Qi dci Cdci + (n − 1) − . (3)
is evaluated as the difference in accumulated inventory between Pi 2Pi
the pharmaceutical company and the hospital. According to Fig. 1,
the inventory of product i for the pharmaceutical company is
n2 Q 2 4.2.2. Raw materials
nQi
Qi
Pi
+ (n − 1) DQii − 2Pii units and the accumulated inventory Under Assumption 2, replenishment quantity Qwi for raw
Q2 material i is received instantaneously at the beginning of each cycle
for the hospital is Di (1 + 2 + 3 +· · ·+(n − 1)) units. Hence, the ex- nQ
i time D i . Hence, the expected order cost per unit time is given by
pected inventory per unit time for the pharmaceutical company is i
Aw i D i
2 nQi
. For a practical perspective, we assume that each quantity Qwi
n2 Qi
Qi Qi
nQi + (n − 1) − contains defective raw materials at a rate of αi , which is a random
Pi Di 2Pi variable. Therefore, raw materials lots are screened at a rate of rsi
Qi2 to separate perfect and imperfect raw material. At the end of the
Di
− (1 + 2 + 3 + · · · + (n − 1)) screening process, imperfect raw materials are sold as a single lot at
Di nQi
the lowest sales price per unit item to the external supplier. Thus,
nQi2 Qi n(n − 1)
2
Di nDi Di s Q D
the screening cost is ci nQwi i and the revenue from imperfect raw
= + (n − 1) − − i
Di Pi 2Pi 2Di nQi i wi i s αQ D
materials per unit time is di nQ .
i
Qi Di 2Di Without loss of generality, we assume that (1 − αi )Qwi = Pi T1i ,
= n 1− −1+ . nQ
2 Pi Pi where T1i = P i . In other words, the replenishment quantity is
i
Therefore, theholding cost
per unit time
for the pharmaceutical nQi
∀i = 1, 2, 3, . . . , M .
hv i Qi Di 2Di Qwi = (4)
company is n 1− −1+ .
2 Pi Pi (1 − αi )
Author's personal copy
Fig. 1. Inventory pattern for a supply chain between a pharmaceutical company and a hospital.
That is, We assume that the lead time demand Xi follows a normal prob-
IETC (Q , L, n) = ETCh (Q , L) + ETCp (Q , n) ability distribution
√ function (p.d.f.) f (xi ) with mean
√Di L, standard
deviation σi L, and reorder point ri = Di L + ki σi L, where ki is
Di (Ai + F + R(L)) Di (Awi + Fw + Si )
M
the safety factor for product i.
IETC (Q , L, n) = +
Qi nQi For product i, shortages occur when Xi > ri . Therefore, the
i=1
expected shortage at the end of the cycle time for the hospital is
(Qi − Di tc ) pi Ic2 √ hbi Qi given by
+ + (hbi + pi Ic )ki σi L+
2Qi 2 ∝
√
+ Di [di Cdi (L) + vi + Pci (Qi ) + hwi ] E (Xi − ri )+ = (xi − ri )f (xi )dxi = σi LΨ (ki ), (12)
D2i tc 2 si Id ri
hv i Qi Di 2Di
+ n 1− −1+ − + Iv pi tc Di
2 Pi Pi 2Qi where Ψ (ki ) = ϕ(ki ) − ki [1 − Φ (ki )] > 0 and ϕ, Φ are the
standard normal p.d.f. and cumulative distribution function (c.d.f),
si tc Id Di Di nDi
− E (Xi − ri )+ + Qi dci Cdci + (n − 1) − respectively, for product i.
Qi Pi 2Pi Hence, using Eqs. (11) and (12), the CSL constraint for product i
hwi E (αi )nQi Di can be written as
+ √
rsi (1 − E (αi ))2 σi LΨ (ki )
≤ θi , L ∈ [Lj , Lj−1 ].
Di (sci + vwi − sdi E (αi ))
Qi
+ , L ∈ [Lj , Lj−1 ]. (9)
(1 − E (αi )) The CSL constraint for all products is then given by
M M √
4.3. Constraints
θi Qi ≥ σi LΨ (ki ), L ∈ [Lj , Lj−1 ]. (13)
i =1 i=1
In practice, when a hospital carries inventory it may face
limitations such as the availability of floor space, total investment Our problem involves finding the optimal Qi , lead time L, and
in inventory, the total number of orders to be placed per year, the total number of deliveries n for all products in a production cycle
number of deliveries that can be accepted, the delivery size that that minimize the integrated expected total cost expressed by
can be handled, and CSL maintenance. Specifically, most hospitals Eq. (9) and satisfy both the floor space constraint expressed by
have an undersized central area for pharmacy storage that can Eq. (10) and the CSL constraint expressed by Eq. (13):
hold very limited quantities of the numerous products required. In
Di (Ai + F + R(L))
M
addition, the health care industry is service-oriented, and customer
Min IETC (Q , L, n) =
service and satisfaction are paramount. Therefore, segmentation i=1
Qi
by market or customer is a very important step in developing
an appropriate supply chain strategy for the target customer. Di (Awi + Fw + Si ) (Qi − Di tc )2 pi Ic √
+ + + (hbi + pi Ic )ki σi L
Therefore, we consider hospital issues in relation to floor space and nQi 2Qi
CSL constraints. hbi Qi
Consider first a case in which the hospital floor space is limited + + Di [di Cdi (L) + vi + Pci (Qi ) + hwi ]
2
to W square feet and one unit of inventory product i occupies fi
D2 tc 2 si Id
square feet. If Qi is the lot size, then the floor space constraint hv i Qi Di 2Di
+ n 1− −1+ − i
means that 2 Pi Pi 2Qi
si tc Id Di √
M Di
+ Iv pi tc Di − σi LΨ (ki ) + Qi dci Cdci + (n − 1)
fi Qi ≤ W . (10) Qi Pi
i =1
hwi E (αi )nQi Di Di (sci + vwi − sdi E (αi ))
nDi
For the CSL constraint, certain goals are defined and CSL is the − + +
percentage that should be achieved for each goal. This is used in 2Pi rsi (1 − E (αi ))2 (1 − E (αi ))
supply chain and inventory management to measure the perfor- M
mance of inventory replenishment policies. Service levels θi are
subject to fi Qi ≤ W ,
associated with products according to the number of occasions of i =1
M M
(14)
shortage that managers are willing to accept during a period of √
time. If a hospital pharmacy is out of a product, it can place an θi Qi ≥ σi LΨ (ki ),
emergency order with the pharmaceutical company to replenish i =1 i =1
this product. However, hospitals would like to avoid these emer- where Q = (Q1 , Q2 , Q3 , . . . , QM ), L ∈ [Lj , Lj−1 ] and Ψ (ki ) =
gency orders if possible because they are very costly [7]. We con- ϕ(ki ) − ki [1 − Φ (ki )] > 0.
sider the service level θi for each item separately. We assume that
the hospital has set a target service level in terms of the fill rate cor-
responding to the proportion of all product demands to be satisfied 5. Solution
directly from available stock. Therefore, the CSL constraint imposes
a limit on the proportion of demands that are not met from stock. The solution to Eq. (14) is complex because of the number of
For product i this can be expressed as variables and constraints in this nonlinear problem. Therefore, we
apply a Lagrangian multiplier algorithmic approach. The solution
Expected demand shortages of product i at the end of the cycle for a given safety factor
is discussed in detail for the following cases.
Quantity of product i available to satisfy the demand per cycle
≤ θi .
Case 1. M
In this case, we temporarily ignore the constraints i=1 fi Qi
That is, √
θi Qi ≥ σi LΨ (ki ) and then determine the
M M
≤ W and i =1 i=1
E (Xi − ri )+ Qi , L, and n that minimize the integrated expected total cost
≤ θi . (11) IETC (Q , L, n).
Qi
Author's personal copy
Initially, for fixed Qi and L ∈ [Lj , Lj−1 ], we can prove that and
IETC (Q , L, n) is a convex function of n. Hence, the search for an
∂ 2 IETC (Q , L, n) 2Di CeC /L D i C 2 eC / L
M
optimal number of lots, n∗ , is reduced to finding a local minimum. = +
∂ L2 i=1
Qi L3 Qi L4
Property 1. For fixed Qi and L, IETC (Q , L, n) is conv ex in n σi (si tc Id Di Ψ (ki ) − ki (hbi + pi Ic ))
+ 3/2
> 0,
Proof. Taking the first and second partial derivatives of IETC (Q , L, 4L
n) with respect to n, we have respectively, when si tc Id Di Ψ (ki ) > ki (hbi + pi Ic ).
For fixed n and L ∈ [Lj , Lj−1 ], we obtain optimal Qi (see Eq. (17)
∂ IETC (Q , L, n) M
Di (Awi + Fw + Si )
= − given in Box I) by setting Eq. (16) to zero.
∂n i=1
n2 Qi Thus, for fixed n and L ∈ [Lj , Lj−1 ], when all the constraints
hv i Qi
Di
Di
are ignored, Eq. (17) gives an optimal value of Qi such that the
+ 1− + dci Qi Ccdi 1 − integrated expected total cost is minimum. Using the convexity
2 Pi 2Pi behavior of the objective function with respect to the decision
hwi E (αi )Qi Di variables, we propose the following algorithm to find optimal
+ (15) values of Qi , L, and n.
rsi (1 − E (αi ))2
and Algorithm 1. Step 1. Set n = 1.
Step 2. For each Lj , j = 0, 1, . . . , b, perform (2.1) and (2.2).
∂ IETC (Q , L, n)
2 M
2Di (Awi + Fw + Si )
= > 0. Step 2.1. Compute Qi (i = 1, 2, . . . , M ) from Eq. (17).
∂ n2 i =1
n3 Qi Step 2.2. Compute the corresponding IETC (Q , Lj , n), where
Q = Q1 , Q2 , . . . , QM , by putting Qi in Eq. (9).
Therefore, for fixed Qi and L, IETC (Q , L, n) is convex in n. Step 3. Find Minj=0,1,...,b IETC (Q , Lj , n).
This completes the proof of Property 1. Step 4. Set IETC (Q • , L• , n) = Minj=0,1,...,b IETC (Q , Lj , n). Then the
For fixed n, we take the first partial derivative of IETC (Q , L, n) set (Q • , L• ) is the optimal solution for fixed n.
with respect to Qi and L ∈ [Lj , Lj−1 ], respectively, to obtain Step 5. Set n = n+1 and repeat steps 2–4 to obtain IETC (Q • , L• , n).
Step 6. If IETC (Q • , L• , n) ≤ IETC (Q • , L• , n − 1), then go to step 5;
∂ IETC (Q , L, n) Di (Ai + F + R(L)) Di (Awi + Fw + Si ) otherwise go to step 7.
=− − Step 7. Set (Q ∗ , L∗ , n∗ ) = (Q • , L• , n − 1). Then set (Q ∗ , L∗ , n∗ ) is
∂ Qi Qi2 nQi2
the set of optimal solutions.
p i Ic D2i tc2 (pi Ic − si Id ) hbi
+ − + + Di δ0i Case 2. In this case, we consider the floor space constraint and
2 2Qi2 2
√ ignore CSL constraint. To solve this problem, we optimize the
si tc Id Di σi LΨ (ki )
hv i Di 2Di following function by adding a Lagrange multiplier β :
+ n 1− −1+ +
2 Pi Pi Qi2
Di (Ai + F + R(L))
M
hwi E (αi )nDi Min IETC (Q , L, n, β) =
Di nDi
+ dci Cdci + (n − 1) − + (16) i=1
Qi
Pi 2Pi rsi (1 − E (αi ))2
Di (Awi + Fw + Si ) (Qi − Di tc )2 pi Ic √
and + + + (hbi + pi Ic )ki σi L
nQi 2Qi
∂ IETC (Q , L, n) Di CeC /L ki σi (hbi + pi Ic )
M
hbi Qi
= − + √ + + Di [di Cdi (L) + vi + Pci (Qi ) + hwi ]
∂L i=1
Q i L 2
2 L 2
D2 tc 2 si Id
hv i Qi Di 2Di
si tc Id Di σi Ψ (ki )
+ n 1− −1+ − i
− √ + Di di Γ0i . 2 Pi Pi 2Qi
2Qi L
si tc Id Di √
By examining the second-order sufficient conditions (SOSC) for + Iv pi tc Di − σi LΨ (ki )
Q
fixed n, it can be verified that IETC (Q , L, n) is a convex function i
hwi E (αi )nQi Di
Di nDi
of Qi and L ∈ [Lj , Lj−1 ] because the second partial derivatives of + Qi dci Cdci + (n − 1) − +
IETC (Q , L, n) with respect to Qi and L ∈ [Lj , Lj−1 ] are Pi 2Pi rsi (1 − E (αi ))2
Di (sci + vwi − sdi E (αi ))
∂ 2 IETC (Q , L, n) 2Di (Ai + F + R(L)) 2Di (Awi + Fw + Si ) + + β [fi Qi − W ] . (18)
= + (1 − E (αi ))
∂ Qi2
Q 3
nQ 3
i √ i In this case, for fixed n and L ∈ [Lj , Lj−1 ], the optimal Qi can be
Di tc Di tc pi Ic − si Id Di tc + 2σ LΨ (ki ) determined by solving m + 1 equations in m + 1 unknown variables
+ >0 ∂ IETC (Q ,L,n,β)
3
Qi given by ∂Q i
= 0 and ∂ IETC (∂β
Q ,L,n,β)
= 0.
√
2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )
, L ∈ [Lj , Lj−1 ],
Qi = (17)
h i E (αi )n
pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (w1− E (αi )) 2 + 2G1 (n )
si
where G0 (n) = n 1 − P i − 1 + P i and G1 (n) = dci Cdci ( )
D 2D Di nDi
i i Pi
+ n − 1 − 2Pi
Box I.
Author's personal copy
√
2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )
, L ∈ [Lj , Lj−1 ],
Qi = (19)
h i E (αi )n
pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (w1− E (α ))2
+ 2(G1 (n) + β fi )
si i
Box II.
√
2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )
, L ∈ [Lj , Lj−1 ],
Qi = (22)
h i E (αi )n
pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (w1− E (α ))2
+ 2( G1 (n ) + θi γ )
si i
Box III.
Author's personal copy
√
2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )
, L ∈ [Lj , Lj−1 ],
Qi = (25)
h i E (αi )n
pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (w1− E (α ))2
+ 2(G1 (n) + β fi + θi γ )
si i
where the β and γ values can be determined by solving the following equations simultaneously:
√
2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )
M
− W = 0,
fi (26)
hwi E (αi )n
i =1 pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (1−E (α ))2 + 2(G1 (n) + β fi + θi γ )
si i
√
2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )
M √
θi + σi LΨ (ki ) = 0
(27)
hwi E (αi )n
i =1 pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (1−E (α ))2 + 2(G1 (n) + β fi + θi γ )
si i
Box IV.
Author's personal copy
Table 1
Numerical parameters for the hospital.
Product (i) Di Ai hbi pi si di vi ki σi Γi Γ0i fi θi (1 − θi )
1 600 20 4 5 10 0.3 1 0.5 2 18 0.3 0.3 0.015 98.5%
2 800 25 6 15 25 0.15 0.5 0.75 5 20 0.1 1 0.01 99%
3 1100 30 3 10 20 0.4 0.8 0.25 4 15 0.2 0.5 0.05 95%
Table 4
Illustration of the solution for given parameters (lead time in days).
n L ∈ [Lj , Lj−1 ] j = 0, 1, 2, 3
j = 0, Lj = 5 j = 1, Lj = 4 j = 2, Lj = 3 j = 3, Lj = 2
Q1 Q2 Q3 IETC Q1 Q2 Q3 IETC Q1 Q2 Q3 IETC Q1 Q2 Q3 IETC
1 433 383 531 57 157 436 391 534 57 062 439 394 537 56 985 462 416 564 57 459
2 263 244 291 56 531 266 247 294 56 483 269 250 297 56 465a 294 274 324 57 351
3 195 185 207 56 601 198 187 209 56 593 201 191 213 56 627 226 215 237 57 865
a
Minimum integrated expected total cost.
The integrated expected total cost IETC (Q , L, n) is clearly lower achieves a target hospital CSL for a minimum integrated expected
for n = 2 than for n = 1 and n = 3, and the algorithm reports total cost.
this as an approximate minimum. In other words, from the above In practice, pharmaceutical companies carry a huge inventory
solution procedure we can verify that to ensure close to 100% CSL. However, ensuring 100% product
availability at an optimal cost is a huge challenge unless supply
IETC (Q1 , Q2 , Q3 , L, n = 1) > IETC (Q1 , Q2 , Q3 , L, n = 2)
chain processes are streamlined towards customer needs and
< IETC (Q1 , Q2 , Q3 , L, n = 3). demands. This paper offers decision support tools that improve
Hence, we can choose the optimal lot sizes of Q1 = 269, Q2 = operational, health policy, and strategic decision-making for PSC
250, and Q3 = 297, a lead time L = 3 and a delivery number of and inventory management. The proposed model can achieve
n = 2 when both constraints are ignored. the target CSL at minimum total PSC inventory cost. Our study
Now we consider both floor space and CSL constraints. Then improves current inventory management policy in health care and
offers managerial support via the decision support tool developed.
f1 Q1 + f2 Q2 + f3 Q3 < 500 It can be used (i) to maintain medical/pharmaceutical inventory
√
θ1 Q1 + θ2 Q2 + θ3 Q3 > L (σ1 Ψ (k1 ) + σ2 Ψ (k2 ) + σ3 Ψ (k3 )) . without overstocking or expiration and (ii) to achieve a target
CSL at a minimum PSC inventory cost. This approach can be used
Here, the optimal solutions are not affected by the constraints in health care industries, especially hospitals, to provide good
as the lot sizes of Q1 = 269, Q2 = 250, and Q3 = 297 satisfy both medical services to customers/patients at a minimum inventory
constraints. Suppose that the optimal lot sizes do not satisfy the cost.
floor space constraint and satisfy the CSL constraint and we apply
the same procedure to find the optimal solution using Algorithm 2.
Acknowledgments
Similarly, if the optimal lot sizes do not satisfy the CSL constraint
and satisfy floor space constraint, then we apply the same proce-
dure to find the optimal solution using Algorithm 3. If the optimal This research was supported by the University Grants Commis-
lot sizes do not satisfy either of the constraints, we apply the same sion (UGC-BSR Fellowship and UGC-SAP-DRSII), Government of In-
procedure to find the optimal solution using Algorithm 4. In this dia.
example, the optimal lot sizes satisfy both constraints, so the con-
straints can be ignored. References
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