European Journal of Operational Research 142 (2002) 497508

www.elsevier.com/locate/dsw

Production, Manufacturing and Logistics

Quality improvement and setup reduction in the joint

economic lot size model
John F. Asco *, M. Javad Paknejad, Farrokh Nasri
Department of BCIS/QM, Frank G. Zarb School of Business, Hofstra University, Hempstead, NY 11549-1340, USA
Received 13 April 2001; accepted 9 August 2001

Abstract
The co-maker concept has become accepted practice in many successful global business organizations. This fact
has resulted in a class of inventory models known as joint economic lot size (JELS) models. Heretofore such models
assumed perfect quality production on the part of the vendor. This paper relaxes this assumption and proposes a
quality-adjusted JELS model. In addition, classical optimization methods are used to derive models for the cases of
setup cost reduction, quality improvement, and simultaneous setup cost reduction and quality improvement for the
quality-adjusted JELS. Numerical results are presented for each of these models. Comparisons are made to the basic
quality-adjusted model. Results indicate that all three policies exhibit signicantly reduced total cost. However, the
simultaneous model results in the lowest cost overall and the smallest lot size. This suggests a synergistic impact of
continuous improvement programs that focus on both setup and quality improvement of the vendors production
process. Sensitivity analysis indicates that the simultaneous model is robust and representative of practice.
2002 Elsevier Science B.V. All rights reserved.
Keywords: Inventory; Quality; Joint economic lot size models

1. Introduction
The co-maker concept has become accepted
practice in many successful global business organizations. The basic tenet of this philosophy is that
vendor (supplier) and purchaser are value chain
partners in manufacturing and delivering a high
quality product to the purchasers customers. This
viewpoint has led to the development of a class of

Corresponding author. Tel.: +1-516-463-5362; fax: +1-516463-4834.

E-mail address: acsjfa@hofstra.edu (J.F. Asco).

inventory models known as integrated or joint

economic lot size (JELS) models. These models
consist of lot size formulas based on the joint optimization of vendor and purchaser costs.
This idea of the joint optimization of vendor
and purchaser costs was rst initiated by Goyal
(1977). In this work Goyal developed a model for
an integrated lot size in which the suppliers lot
size is an integer multiple of the customers order
quantity. Trial and error is used to arrive at this
integer value. This approach to integrated lot sizing was revisited by Banerjee, among others.
The term JELS was coined by Banerjee (1986)
who used classical optimization to derive the JELS

0377-2217/02/$ - see front matter 2002 Elsevier Science B.V. All rights reserved.
PII: S 0 3 7 7 - 2 2 1 7 ( 0 1 ) 0 0 3 0 8 - 3

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J.F. Asco et al. / European Journal of Operational Research 142 (2002) 497508

formula which is a function of demand, the annual

inventory carrying charge, the vendors annual
production rate, setup cost, and unit production
cost, and the purchasers order cost and unit purchase cost. The JELS, in general, is not the optimal
lot size for either the purchaser or vendor operating independently. Thus, some cost is involved on
both parties part to operate at this mutually
benecial level. Banerjee investigates the costtradeos involved in adopting the JELS from both
the purchasers and vendors points of view. Essentially, one party will be at a disadvantage if the
JELS is adopted. This situation can be ameliorated
by the advantaged party oering some price concession to the other party. The JELS model presented in Banerjee (1986) assumes that the vendor
produces on a lot-for-lot basis in response to orders from a single purchaser, demand is deterministic, and the vendor is the sole supplier.
This initial work by Banerjee motivated other
researchers to more deeply investigate the JELS
concept. One JELS research thrust revolves around
relaxing Banerjees lot-for-lot assumption. Goyal
(1988) developed a joint total relevant cost model
for a single-vendorsingle-buyer production inventory system assuming that the vendors lot size
is an integer multiple of the purchasers order size.
Goyals model was derived based on the implied
assumption that the vendor can supply to the
purchaser only after completing the entire lot. Lu
(1995) relaxed Goyals assumption and assumed
that the vendor can supply the purchaser even
before completing the entire lot. That is, Lus work
allows lot splitting. Further, the article considers
the case of multiple buyers from a single vendor.
As to the applicability of Lus model, the author
states our new model will be suitable when the
vendor has an advantage over the buyer in the
purchasing negotiation. This situation is not unusual when the vendor is the sole supplier of an
item, and the buyer lacks the economic power to
demand a price discount.
Goyal (1995) presents an improved solution
methodology for the model proposed in Lu (1995).
Hill (1997) generalizes the model presented in Lu
(1995) and modied in Goyal (1995). Lus model,
in addition to developing heuristics for the singlevendormultiple-buyer problem, gave an optimal

solution to the single-vendorsingle-buyer problem based on the assumption that a single batch
can be split into an integral number of equal
shipments. Goyal showed that an alternative
policy involving successive shipments within a production batch, increasing by a factor equal to the
production rate divided by the demand rate, generates lower total joint relevant costs. Hills paper
shows that neither of these policies is optimal.
They can be thought of as limiting extremes of a
more general class of policy for which successive
shipments within a production batch increase by a
xed factor.
Of greater signicance to this present work is
research that investigates the impact of reduced lot
sizes resulting from investment in setup cost reduction on the JELS. Asco et al. (1988) integrate
the concepts of JELS and vendor setup cost reduction. For the case of a single vendor and purchaser and assuming a logarithmic investment
function, they derive relationships for the optimal
JELS, optimal vendors setup cost, and the optimal joint total cost per year. Results of a numerical example indicate that signicant savings in
joint total cost can accrue from investing in decreased setup costs on the part of the vendor. As in
the case of the JELS with constant setup cost,
adoption of the joint economic lot size including
investment results in one of the parties being at a
cost disadvantage and a major question is the
method by which joint cost savings may be equitably distributed. Further work by Asco et al.
(1991) extends this approach to the case of onevendor and many-nonidentical-purchasers. Much
the same results are achieved as in the single vendor and purchaser case.
Nasri et al. (1991) investigated the impact of
simultaneous investment in setup cost and order
cost reduction on Banerjees JELS model. Results
indicate that signicant savings in joint total cost
can accrue from such simultaneous investment.
Further, both the vendor and purchaser realize
signicant savings when compared to the basic
JELS model.
After reviewing the state of the JELS literature,
Joglekar and Tharthare (1990) built a more realistic model, the rened JELS model, by relaxing
the lot-for-lot assumption, and separating the

J.F. Asco et al. / European Journal of Operational Research 142 (2002) 497508

traditional setup cost into two independent costs.

The rst is the standard manufacturing setup cost
per production run, and the second is the vendors
cost of handling and processing an order from a
purchaser. Based on these changes, they develop a
rened JELS model for both the one-vendor,
many-identical-purchasers and the more general
one-vendor, many-nonidentical-purchasers situations.
Finally, Asco et al. (1993b) investigated the
one-vendor, many-nonidentical-purchasers JELS
model with vendor setup cost reduction and purchaser order cost reduction. The results indicate
that there are signicant cost savings for the JELS
over independent optimization when such investments are made. This suggests that when an environment of cooperation between the parties has
been established the JELS is a superior policy.
The impact of quality on lot sizing decisions is
another major thread of inventory research. A
number of authors have investigated the eect of
quality on lot size for the case of independent
optimization for the vendor. Rosenblatt and Lee
(1986) investigated the eect of process quality on
lot size in the classical economic manufacturing
quantity (EMQ) model. Porteus (1986) introduced
a modied EMQ model that indicates a signicant
relationship between quality and lot size. In both
of these works, the optimal lot size is shown to be
smaller than that of the EMQ model. Paknejad
et al. (1995) extend this work to consider stochastic
demand and constant lead time in the continuous
review s; Q model.
Cheng (1991) develops a model that integrates
quality considerations with the EPQ. The author
assumes that unit production cost increases with
increases in process capability and quality assurance expenses. Classical optimization results in
closed forms for the optimal lot size and optimal
expected fraction acceptable. The optimal lot size is
intuitively appealing since it indicates an inverse
relationship between lot size and process capability.
It should be noted that a good survey of the
literature on integrating lot size and quality control policies is given in Goyal et al. (1993).
Schonberger (1982, 1986) presents some basic
foundations of JIT purchasing as expressed in the
co-maker concept. They include, among others:

499

1. Reduce suppliers (vendors) for an item to a few,

and in some cases only one.
2. Establish long-term relationships with such suppliers. In order to improve the viability and reliability of such long-term relationships, engage
in a supplier development program aimed at improving supplier performance by assisting them
in improving the quality of their processes, and
ultimately their products.
3. Work to decrease lot sizes because smaller lot
sizes lead to improved manufacturing performance.
Therefore, it is obvious that quality is a crucial
issue for a successful co-maker relationship. In
fact, the big three US automobile makers require
that all suppliers achieve QS-9000 quality certication. Further, suppliers are continuously monitored to assure that they maintain practices that
are consistent with this level of quality.
Given this importance of quality to the comaker concept, it is evident that the next phase in
the development of JELS models is to investigate
the impact of quality on their performance.
2. The basic models
We begin our investigation of this new thread of
JELS research with the seminal work of Banerjee.
Consider a system in which a single vendor produces on a lot-for-lot basis in response to orders
from a single purchaser, demand is deterministic,
and the vendor is the sole supplier. Under these
conditions the JELS may be obtained by minimizing the joint total relevant cost given by
Banerjee (1986) as
JTRCQ D=QS A
Q=2rD=RCv Cp ;

where
D annual demand or usage of the item,
R vendors annual production rate for this
item,
A purchasers ordering cost per order,
S vendors setup cost per setup,
r annual inventory carrying charge, expressed
as fraction of dollar value,

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J.F. Asco et al. / European Journal of Operational Research 142 (2002) 497508

Cv unit production cost incurred by the vendor,

Cp unit purchase cost paid by the purchaser,
Q order or production lot size in units,
and R P D, Cv 6 Cp .
The result of classical optimization yields the following formula for the JELS:
q
Qj 2DS A=rD=RCv Cp :
2
Implicit in this derivation is that all units produced
by the vendor, in response to the purchasers order, are of acceptable quality. Now, assume that
this is not the case.
Let us look at a situation where the vendor
operates a process that is in statistical control.
That is, the process generates a known, constant
proportion of defectives, p. (Such an assumption
has been made previously in the literature by
Cheng (1991).) The vendor ships on a lot-for-lot
basis to the purchaser. Under these circumstances
on receiving the parts from the vendor, Deming
(1981) (also detailed in Gitlow et al. (1995) and
Papadakis (1985)) proves that the purchaser
should consider only two inspection policies zero
inspection or 100% inspection. Full inspection is
preferred when the cost of inspecting an incoming
item is small when compared to the cost of a defective item being released to the purchasers production process. We assume this to be the situation
for the present research. To be consistent with
Demings ideas, we further assume that the purchasers inspection process is perfect, and that all
rejected parts are replaced by the vendor at his
expense. Of course, it is likely that the vendor will
recover some of these costs from the purchaser
either directly or indirectly.
Based on this scenario, we now adjust the JELS
model for the quality factor. The joint total relevant cost including quality may be written as
JTRCp Q; 
p DS A=
pQ Q=2prC
D=
p1  
pCM CN ;

where

p 1  p the proportion of good items produced by the vendors process,
C D=RCv Cp ,

CM vendors cost of repair and replacement of

defective items per unit,
CN purchasers cost of inspection per unit.
Implicit in the structure of the cost function (3) is
the fact that defective units are detected before
they go into the purchasers inventory and are
immediately returned to the vendor. The result of
classical optimization yields the following formula
for the quality-adjusted JELS:
p
Qjp 2DS A=rCp2 :
4
Note that in Eq. (4), if p 1 then quality is perfect
and the quality-adjusted JELS simply reduces to
the basic JELS expressed as Eq. (2). Also note that
Qjp is inversely related to p. This is intuitively evident because the required joint lot size will be
smaller if more items are acceptable in the lot.

3. Quality improvement
In this section we consider the option of investing to improve the quality of the vendors
production process. Quality at the source is a basic
plank of any co-maker relationship. Supplier development programs that aim to improve the
quality of supplier processes, and therefore products, are prevalent in most industries. In the auto
industry, for example, manufacturers work closely
with suppliers to improve their production processes. The ultimate aim being supplier certication according to widely accepted standards such
as QS 9000. Generally, one result of such certication is that purchasers are able to eliminate
incoming inspection. This results in improved quality, increased throughput, and lower costs.
We now consider p to be a decision variable and
pursue the objective of minimizing the sum of the
investment cost for increasing p and the qualityadjusted joint total relevant cost. Specically, we
seek to minimize
f Q; p iap p JTRCp Q; p

subject to
p0 < p 6 1;

where i is the cost of capital, p0 1  p0 is the

original proportion of good units produced by the

J.F. Asco et al. / European Journal of Operational Research 142 (2002) 497508

vendors process, ap p is a convex and strictly

increasing function of 
p, JTRCp Q; 
p is the joint
total relevant cost given by Eq. (3), and 
p0 is the
original proportion of good items before any investment is made.
To obtain the JELS including investment in
quality improvement we minimize (5) over Q and p
by classical optimization techniques. Of course, if
the optimal quality proportion does not satisfy the
restriction (6), we should not make any investment, and the results of (4) hold.

501

where
p0 original proportion of good parts before
investment;
pI CM CN D=ia;

10

Qjp 2DS A=rCp2 1=2 ;

11

QjpI 2DS A=rC1=2 ia=CM CN D:

12

(c) The resulting optimal total cost per unit time

is given by

3.1. The logarithmic investment function case

f Q ; p minfJTRCp Qjp ; JTRCIQjpI ; pI g;

We seek to improve quality by investing to increase, 

p, the proportion of good units produced
by the vendors production process. We use the
following exponential growth function of investment:

where


p
p0 e

Dap

subject to

p 6 1;
p0 < 

where 
p0 is the original proportion of good units
and D is the percentage increase in 
p per dollar
increase in ap . The restriction (8) induces a companion restriction on the admissible amount of
investment,
0 6 ap 6 ln1=
p0 =D:
Taking log on both sides of (7) gives
ap a ln 
p b;

where a 1=D and b  ln 

p0 =D.
We are now ready to prove Theorem 1 when
ap 
p as represented by (9) is used in (5).
Theorem 1. If 0 6 
p0 < 1 and D is strictly positive,
then the following hold:
(a) f Q; 
p is strictly convex if 2DS Aia > 0.
(b) The optimal proportion of good parts produced by the vendors process and optimal JELS are
given by



p

maxf
p0 ; 
pI g;

Q minfQjp ; QjpI g;

JTRCp Qjp DS A=pQjp 

Qjp prC=2
D=p1  pCM CN 
and

13

Qjp

is given by Eq. (11),

h
i
JTRCIQjpI ; pI i a ln pI b DS A=pI QjpI
QjpI pI rC=2
h
i
D=pI 1  pI CM CN
and QjpI is given by Eq. (12), pI is given by Eq. (10).
Proof. (a) Let f Q; p iap p JTRCp Q; p for
0 6 p0 < 1, where JTRCp Q; p is given by Eq. (3).
f Q; p is strictly convex if the principal minors of
its Hessian determinant are strictly positive. We
proceed by computing the principal minors
jH11 j 2DS A=pQ3 > 0;
jH22 j 2DS Aia > 0:
It is clear that both principal minors are strictly
positive. Hence, part (a) holds.
(b) The optimal values of the decision variables
may be found by solving the two simultaneous
equations given by
of =oQ of =op 0:
The solution to these equations yields Eqs. (10)
and (12). The stationary point QjpI ; pI is a relative minimum if it satises the convexity condition

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J.F. Asco et al. / European Journal of Operational Research 142 (2002) 497508

of part (a). Beginning with Eq. (12) and after some

algebraic manipulation it can be shown that
i
h
2 2
Q2
jpI rCCM CN D =ia 2DS Aia:
Therefore,
QjpI > 0:
Since all variables that compose QjpI are strictly
positive, this condition is satised and we have a
local minimum at QjpI ; pI , and part (b) holds.
(c) The proof of this part results from substituting the optimal values QjpI and 
pI into the appropriate joint relevant cost function. 

4. Simultaneous quality improvement and setup cost

reduction
In this section we consider the option of simultaneous investment in vendor quality improvement and setup cost reduction. The synergistic
eects of such a policy, as part of a supplier development program, have been widely recognized
in the literature and in practice. See for example,
Schonberger (1982, 1986), Hall (1983) and Asco
et al. (1993a).
Assuming a logarithmic investment function,
Asco et al. (1988) show that the JELS including
vendor setup cost reduction is
QjSI ib i2 b2 2DArC

1=2

=rC

14

with optimal setup cost of


SjSI
i2 b2 ibi2 b2 2DArC1=2 =DrC:

15

This results from the minimization of the following

cost function:
f Q; S ia  b ln S JTRCQ;
where a ln S0 =d and b 1=d.
Of course, this again assumes that quality is
perfect. To adjust (14) and (15) for the eects of
quality, one simply is required to minimize
f Qp ; S ia  b ln S JTRCp Q; 
p:

16

h
i
1=2

2 2
2 2
=DrC:
Sj
pSI i b ibi b 2DArC

17

18

Note that in (17) when p 1, indicating perfect

quality, the quality-adjusted JELS with investment
in vendor setup cost reduction reduces to (14), the
JELS with vendor setup cost reduction. Interestingly, the optimal setup cost is the same for both
cases. That is, it is independent of the quality level.
Now we turn our attention to the simultaneous
investment case. First we dene two logarithmic
investment functions. The quality improvement
function is identical to that presented as Eq. (9).
The setup cost reduction function is
aS S a  b ln S

for 0 < S 6 S0 ;

19

where a ln S0 =d, b 1=d, and S0 is the original

setup cost.
We are now ready to prove Theorem 2 when
ap p is as represented in (9) and aS S as represented in (19) are used in the following cost
equation:
f Q; p; S ap p aS S JTRCp Q; p:

20

Theorem 2. If 0 6 p0 < 1 and D is strictly positive,

and if S0 and d are strictly positive, then the following hold:
(a) f Q; p; S is strictly convex iff D < 8S
A3 i2 b2 =S 4 rC.
(b) The optimal proportion of good parts produced by the vendors process, the optimal vendors
setup cost, and the optimal JELS are given by
n
o
p max p0 ; pII ;
n
o

S  min S0 ; Sj
pII ;
n
o
Q min Qjp ; QjpII ;
where
p0 original proportion of good parts before
investment;

This results in
h
i
1=2
QjpSI ib i2 b2 2DArC =
prC

and

pII CM CN D=ia;

J.F. Asco et al. / European Journal of Operational Research 142 (2002) 497508

S0 original vendor0 s setup cost before investment;



Sj
pII Sj
pSI ;

Qjp is as presented in Eq. (4),

QjpII 2iai2 b2 ibi2 b2 2DArC

1=2

DArC1=2 =DrCCM CN :
(c) The resulting optimal total cost per unit time
is given by
n
f Q ; 
p ; S  min JTRCp Qjp ;
o

JTRCIIQjpII ; pII ; Sj
pII ;
where
JTRCp Qjp is given as Eq: 13;



JTRCII QjpII ; 
pII ; Sj
pII
h

i

i a ln 
pII b a  b ln Sj
pII



D Sj
pII rC=2
pII QjpII QjpII 
pII A =

h

i
D=
pII
1
pII CM CN :
p iaS S
Proof. (a) Let f Q; p; S iap 
JTRCQ; 
p for 0 6 
p0 < 1 and 0 < S 6 S0 , where
JTRCQ; 
p is given by Eq. (3). f Q; 
p; S is strictly
convex i the principal minors of its Hessian determinant are strictly positive. We proceed by
computing the principal minors
jH11 j 2DS A=
pQ3 > 0;
jH22 j 2DS Aia > 0;
jH33 j 2DS A=rC

1=2

2S Aib=S 2   D > 0:

It can be seen that jH11 j and jH22 j are strictly

positive, and that jH33 j > 0 if and only if the
convexity condition of part (a) of Theorem 2
holds.
(b) The optimal values of the decision variables
may be found by solving the three simultaneous
equations
of =oQ of =o
p of =oS 0:

503


The solution to these equations yields QjpII , Sj
pII ,
and pII of part (b) of Theorem 2. To prove the

stationary point QjpII ; Sj
pII is a relative minipII ; 
mum, it is sucient to show that it satises the
convexity condition of part (a). Using the optimal
values of Q, p, and S, the convexity condition of
part (a), after some manipulation, will be reduced
to

QjpII > 2DA=ibpII

since D, A, i, b, and pII are all strictly positive, the

convexity condition is satised at point QjpII ; Sj
pII ;

pII . Therefore, part (b) follows.
(c) The proof of this part results from substi
tuting the optimal values QjpII , Sj
pII into
pII , and 
the appropriate joint relevant cost function. 

5. Numerical examples
Consider the case of an inventory item produced to order by a vendor on a lot-for-lot basis.
A single purchaser periodically orders and buys a
batch of this item from the vendor, who is the
buyers sole source for this item. The vendor and
purchaser have agreed to cooperate in accordance
with the results of the JELS model. The following
parameters are known: D 1000 units/year, R
3200 units/year, Cv $20/unit, Cp $25/unit, S0
$400/setup, A $100/order, r 0:2, p 0:75,
CM $12/unit, and CN $5/unit. Further, the
vendor may invest in reducing setup cost according to a logarithmic investment function with parameters i 0:10 and d 0:002. Investment may
also be made in improving the quality of the
vendors manufacturing process according to a
logarithmic investment function with i 0:10 and
D 5:75 106 .
Table 1 presents the results of calculations for
the quality-adjusted JELS (JELSp ), the qualityimproved JELS (JELSIp ), the quality-adjusted
JELS with setup cost reduction (JELSIpS ), and the
quality-adjusted JELS with simultaneous investment in quality improvement and setup cost reduction (JELSIIp ). It is interesting to note that the
quality-adjusted JELS is an upper bound for lot
size and total cost. In all cases when investment is

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J.F. Asco et al. / European Journal of Operational Research 142 (2002) 497508

Table 1
Comparative results for JELS models
Variable

Quality-adjusted
JELS (JELSp )

Quality-improved
JELS (JELSIp )

Quality-adjusted JELS
with setup reduction
(JELSIpS )

Quality-adjusted JELS
with simultaneous
investment (JELSIIp )

Q (units)
(% reduction)

461.88

409.16
(11.4)

249.41
(46.0)

191.35
(58.57)

S ($)
(% reduction)

400

400

9.35
(97.66)

9.35
(97.66)

p
(% increase)

0.75

0.9776
(30.35)

0.75

0.9776
(30.35)

Vendor replacement costs ($)

$ Savings (% savings)

4000.00

274.96
3725.04 (93.13)

4000.00

274.96
3725.04 (93.13)

Purchaser inspection costs ($)

$ Savings (% savings)

6666.67

5114.57
1552.10 (23.28)

6666.67

51114.57
1552.10 (23.28)

Quality improvement costs ($)

4606.03

4606.03

Setup reduction costs ($)

187.70

187.70

Total cost ($)

$ Savings (% savings)

13192.58

12495.56
697.02 (5.28)

12023.36
1169.22 (8.86)

11352.49
1840.09 (13.95)

p0 0:75.
S0 400, 

not warranted, the results reduce to those of this

model.
As Table 1 indicates, when a policy of investing
in quality improvement is adopted the optimal lot
size is reduced by 11.4% and the optimal process
quality is improved by 30.35%. This is accompanied by a decrease of $3725.04 or 93.13% in
vendor replacement costs, a decrease of $1552.10
or 23.28 in purchaser inspection costs, and a decrease of 5.28% in total cost. These reductions
come at the added expense of $4606.03 in quality
improvement investment costs. In the situation
where investment is made solely in setup reduction, the optimal lot size is reduced by 46% while
no impact on process quality is realized. For this
case, we experience a 97.6% reduction in setup
cost and an 8.86% decrease in total cost while
quality related costs remain the same as for
JELSp . The investment cost for setup reduction is
$187.80. Finally, when a simultaneous investment
policy is in force, the optimal lot size is reduced
by 58.57% and the optimal process quality is
improved by 30.35%. The vendor and the purchaser experience the identical quality cost savings
as in the JELSIp case and identical setup cost

savings as in the JELSIpS case. Total cost savings

of $1840.09 or 13.95% are also realized. The investment costs are the same as those for the two
independent investment models.
At this point a word about the relative amounts
of the investment costs is in order. The investment
cost for setup reduction is signicantly less than
that for quality improvement. This is wholly consistent with what is experienced in practice. Setup
reduction is essentially a localized activity. Asco
et al. (1993a) discuss how programs for setup reduction have become somewhat standardized.
Existing setup operations are closely monitored;
then internal and external activities are separated
after which as many internal activities are converted to external activities as possible. These activities are usually conducted on a single machine
or work center at a time. By way of contrast,
quality improvement programs are wide-ranging
and continuous in nature. They may include training in statistical process control, product design
and specication, scheduling, preventive maintenance, etc. Essentially all the factors that have an
impact on process quality may be part of the
program. As such, a larger and more consistent

J.F. Asco et al. / European Journal of Operational Research 142 (2002) 497508

investment is likely to be required if such a program is to be successful.

The overall results indicate that, consistent with
practice, there are synergistic benets to be gained
from supplier improvement programs that emphasize process improvement including both
quality and setup elements. The total quality related cost savings for the purchaser and the vendor
is $5277.14. This is accompanied by a setup cost
savings to the vendor of $390.65. Thus, the total
system savings are $5667.79. These total savings
are achieved at a total investment cost of $4793.83,
resulting in a net saving of $873.96. The savings
are disproportionate in favor of the vendor
$4115.69 versus $1552.10. As is the case for all
joint lot size models, some negotiation between the
parties will be required to determine their relative
contribution to the improvement eorts. However,
it is not unreasonable to assume that the vendor
would be willing to make a larger immediate nancial contribution as consideration for a longterm relationship with the purchaser. In fact, this
is the basis for many existing supplier certication
programs. From the purchasers point of view
there is a signicant prospect for further savings.
The optimal solution indicates that the purchaser
pays a total of $5114.57 in inspection costs. With
the vendors process producing 97.76% good units,
it is clear that, by far, the largest amount of these
costs is devoted to the inspection of good items. At
some point in time it is likely that the quality
of the vendors process will be improved to the
point that s/he can become a certied supplier.
When this occurs, it is likely that the purchaser will
forgo all incoming inspection and eliminate related
costs. Finally, the savings discussed above are
conservative when viewed in the context of what
improved quality and setup mean to overall operations.
For example, the vendor should realize expanded eective capacity that would allow him to
seek additional work from other customers. The
purchaser should realize improved operations from
direct-to-oor shipments from the vendor made
possible by the elimination of the inspection stage.
Ultimately, Schonberger (1982) indicates such
programs should lead to increased productivity
and improved market response.

505

6. Sensitivity analysis
In this section we turn our attention to an investigation of the conditions under which simultaneous investment in quality improvement and
setup cost reduction is worthwhile. This investigation begins with the derivation of critical (indierence) points for the simultaneous investment
model. Under this scenario investment is warranted

if and only if Sj
pII < S0 , that is, the optimal setup
cost is less than the original setup cost, and
pII > p0 , that is, the optimal proportion of good
units produced by the vendors process exceeds the
original proportion. By substituting Eq. (18) for

Sj
pII
pII in the former relationship and Eq. (10) for 
in the latter relationship, we may solve for critical
points for various parameters of interest in order
to perform sensitivity analysis. These derived relationships can provide managers with a yardstick
to determine whether investment would be worthwhile.
Following the procedure outlined above, critical points for demand, interest rate, and for the
two technology coecients were developed and are
presented in Table 2. For demand, D, and interest
rate, i, two restrictions are developed, one each
based on the setup cost constraint and the quality
proportion constraint. For each of the technology
coecients, d and D, a single restriction results. At
this juncture it is worth noting that critical points
for the individual investment models, JELSIp and
JELSIpS , may be derived by working with the
corresponding single restriction on quality proportion and setup cost, respectively. The resulting
critical points are equivalent to the restrictions
developed for the simultaneous investment case.
For each of the critical points presented in
Table 2, we examine their sensitivity to a single
parameter, holding all others constant. The results
of this sensitivity analysis are given in Table 3.
These results must be analyzed in concert with the
restriction on product quality (8) and the induced
companion restriction on the admissible amount
of investment. The rst portion of Table 3 looks at
the changes in optimal quality proportion, interest
rate, and the technology coecients as a function
of changes in demand. Note that as annual demand increases from 800 to 1025, the optimal

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J.F. Asco et al. / European Journal of Operational Research 142 (2002) 497508

Table 2
Critical points for simultaneous investment model
Parameter
i

Simultaneous model
(

)
1=2
S0
DrC
CM CN D
;
< Min
ap0
b 2A S0
(

2i2 b2 A S0
iap0
;
S02 rC
CM CN

>

Max

>

1=2
i 2A S0
S0
DrC

>

ip0
CM CN D

quality proportion pII increases from 0.7821 to its

upper bound 1.00; the upper bound on the interest
rate one would be willing to pay for the investment
increases from 10.43% to 13.36%; the lower bound
on the technology coecient d for which investment in setup cost reduction is desirable decreases
from 0.0001118 to 0.0000988; and the lower bound
on the technology coecient D for which investment in quality improvement is warranted decreases from 0.0000055 to 0.0000043. In this
scenario it appears that as demand increases to

1025 units, the most eective utilization of the

$50,000 investment in quality improvement is
achieved. This suggests that in developing any
supplier development program that has a major
focus on quality improvement, the purchaser must
consider the volume of parts that will be required
from the vendor. Further, as demand increases
both technology coecients, which are in the form
of percent improvement per dollar of investment,
decrease suggesting that at higher levels of demand
the marginal percentage improvement required for
successful investment is less. This indicates that
when demand is large and more defective units are
produced generating higher quality costs, even a
relatively small improvement is desirable. This is
obviously consistent with the continuous improvement principle of Total Quality Management. The
same can be said for setup cost reduction. Finally,
the upper bound on interest rate increases from
10.43% to 13.36% with the increase in demand.
These clearly are acceptable rates in the present
day nancial environment.
The second portion of Table 3 shows that as the
original setup cost per setup increases from $100 to
$1000, the lower bound on the technology coecient d decreases from 0.000253 to 0.0000593. This
is an indication that diminishing returns exists
since when setup cost is high it is worthwhile to
invest even with a relatively smaller marginal re-

Table 3
Results of sensitivity analysis
Variables

Demand (D)
800

900

1000

1025

i
d
D

0.7821
0.1043
0.0001118
0.0000055

0.8798
0.1173
0.0001054
0.0000049

0.9776
0.1303
0.0001
0.0000044

1.0020
0.1336
0.0000988
0.0000043

Variable

Original setup cost (S0 )


pII

100

400

700

1000

0.000253

0.0001

0.0000723

0.0000593

Variable

Original proportion of good units p0

0.5

0.6

0.7

0.8

0.9

0.95

0.00000294

0.00000353

0.00000412

0.00000471

0.00000529

0.00000559

J.F. Asco et al. / European Journal of Operational Research 142 (2002) 497508

turn. At lower setup costs one must experience a

greater marginal return to invest since further
setup reduction eorts are likely to be more dicult. Much the same may be said for the quality
improvement case as is exhibited in the third
portion of Table 3. As the original quality level
increases from 0.5 to 0.95, the technology coecient D increases from 0.00000294 to 0.00000559.
Thus, as original quality approaches zero defects,
the marginal percent improvement in quality must
be greater to warrant further investment. This
again is due to the fact that there are decreasing
marginal returns. That is, the last few percent of
improvement in quality is more dicult to attain
than earlier improvements. This is, in fact, what is
experienced in practice. On balance, the results of
the simultaneous investment model must be classied as robust and representative.

7. Conclusion
This paper presents a JELS model adjusted for
the quality factor. Specically, the vendor operates
a process that is in statistical control that generates
a known constant proportion of defectives. Based
on this model we investigate the options of investing in quality improvement, investing in setup
cost reduction in the quality-adjusted model, and
simultaneously investing in quality improvement
and setup cost reduction. For all three cases, classical optimization is used to derive closed forms
for the decision variables. Results of a numerical
example indicate that a signicant reduction in
total cost over the quality-adjusted JELS is
achieved by each of the models. The simultaneous
model generates the largest cost reduction of the
three. The simultaneous investment model also
exhibits a synergistic eect on lot size as a result of
a supplier development program focused on both
quality and setup improvement. These results
suggest that a program of continuous improvement should view quality and setup improvement
to be complementary and that they should be
pursued concurrently. Additional results of sensitivity analysis show the simultaneous model to be
robust and representative of practice.

507

Acknowledgements
This research was supported by a Frank G.
Zarb School of Business Summer Research Grant.

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