Exact Time Discounting and Heuristics for the EOQ Model with Random Yield

Abstract

In inventory management, the warehousing cost, in addition to the financial cost, which reflects the economic cost of money tied up in the inventory, make up the inventory holding cost. Accurate estimation for this holding cost is important, especially in non-conventional settings, such as systems with random yield, where the uncertainty in the supply process complicates the analysis. In this research, we develop an exact time discounting formulation for the Economic Order Quantity (EOQ) model with many random yield variants, such as the “stochastically proportional” and the binomial processes. We also propose heuristics, based on the undiscounted cost framework, aimed at obtaining near-optimal ordering policies with simple closed-form variations of the base EOQ. Our numerical results indicate significant cost reduction from using exact time discounting over the classical undiscounted cost approach, which bases the financing cost solely on the amount of received inventory in an order. However, some of our heuristics, especially one based on an “average cost” that inflates the unit cost to account for the wasted supply, perform very well, albeit with a little added complexity with respect to the classical approach.