Journal of Modelling in Management

Inventory model in a four-echelon integrated supply chain: Modeling and optimization

Abolfazl Gharaei, Seyed Hamid Reza Pasandideh, Alireza Arshadi Khamseh,
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Abolfazl Gharaei, Seyed Hamid Reza Pasandideh, Alireza Arshadi Khamseh, "Inventory model in a four-echelon integrated
supply chain: Modeling and optimization", Journal of Modelling in Management, https://doi.org/10.1108/JM2-07-2016-0065
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 Inventory model in a four-echelon integrated supply chain: Modeling and

optimization

Abstract

Design:
This paper designs and optimizes an integrated inventory model in a four-echelon supply chain that
contains a supplier, a producer, a wholesaler and multiple retailers. All Four levels agree with each other
to make an integrated inventory system. Products in this model have a multi-stage production process and
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the model is bounded by multiple stochastic constraints.

Purpose:
The main purpose is to minimize the total inventory cost of chain while the stochastic constraints are
satisfied. In other words, the goal is to find optimum agreed stockpiles and period length for products to
minimize the total inventory cost of the chain while the stochastic constraints are fulfilled.
Methodology/ Approach
The problem model is nonlinear and large. So, the Interior Point method as an effective algorithm is used
for solving the recent convex nonlinear model. Two numerical examples are solved to demonstrate the
application of this methodology and to evaluate the performance of the proposed approach.
Findings:
The findings showed the model is applicable for real-world supply chain problems in the cases that
echelons are going to do executive external integration. Also, the Interior Point algorithm has a
satisfactory performance and a high efficiency in terms of optimum solution for solving nonlinear and
large models.
Originality:
The authors designed and optimized the inventory cost in a four-level integrated supply chain in
stochastic conditions. The new decision variables, number of chain levels, multi-products, stochastic
constraints and multi-stage products in four-level integrated supply chain are other novelties of this paper.
The authors provided an efficient algorithm for solving a large-scale and nonlinear model in this research,
too.
Keywords: Modeling, Inventory, Supply chain, Integration, Stochastic, Optimization, Interior point, Lot
sizing, Nonlinear programming.

1
 1. Introduction and research literature

Today’s business environment is characterized as a highly competitive, dynamic and volatile market

(Kumar Sharma et al., 2014). The marketplace is presently characterized by heightened global

competition often against a backdrop of an excess of supply over demand (Christopher et al., 2006). The

intensification of global competition and the demand for better customer services have considerably

increased the need for supply chain integration between companies. Integration is defined as “the extent

to which all activities within an organization, and the activities of its suppliers, customers, and other
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supply chain members, are integrated together” (Narasimhan et al., 1998). Supply chain integration1 aims

to coordinate processes along the supply chain2 that is considered as an important determinant to

maintain a competitive advantage over competitors (Christopher et al., 2006). The basis of integration can

be characterized by interaction, collaboration, information sharing, trust, partnerships, shared technology

and a fundamental shift away from the individual management of functional processes toward

management of an integrated chain of processes (Vickery et al., 2003; Kahn, 1998). Gimenez et al. (2005)

and Stevens (1989) stated that external integration is an extension of the internal integration. The

integration of levels with multi or single stage products in SCs with the aim of design and optimization of

an integrated inventory system in order to minimize the inventory cost of the chain is one of the most

critical optimization problems in SCI. Among extensive researches conducted in the last issue, the

following recent works can be mentioned in chronological order.

Ekambaram et al. (2003) developed a relationally reinforced SCI model in their paper to supplement the

basic transactional contractual links and to release the latent energies needed for elevation of construction

industries in many countries. Yao et al. (2004) considered an integrated supply chain model in which one

vendor supplies items to multiple buyers. They explored the optimality structure of this integrated model

and asserted that the optimal cost curve was piece-wise convex. Van Donk et al. (2005) developed a

framework to investigate which level and scope of integration can be achieved in a supply chain

1
SCI
2
SC

2
 dominated by shared resources, if the type and amount of uncertainty vary for different buyers. SooWook

(2006) examined the causal linkages among SCM practice, competition capability, the level of SCI, and

firm performance. He found that, in small firms, an efficient SCI might play a more critical role for a

sustainable performance improvement, while, in large firms it might have a more significant effect on

performance improvement. Gilbert et al. (2006) introduced a generalized order policy and derived optimal

production smoothing parameters for that order policy. Their research resulting techniques produced an

order policy that uses inventory or backlog to absorb the random variation in demand, but has immediate
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response to variation in the forecast level of demand. Klein (2007) examined e-Business SCM

relationships between service providers and clients, focusing on the performance impacts of the level of

customization implemented by clients using vendor provided e-Business solutions and the subsequent real

time access achieved by operational information provided by vendors.

Edward (2008) studied the problem of setting transfer prices in a vertically ISC in which the divisions

shared technology and transaction costs. He developed a cooperative game that provided transfer prices

for the intermediate products in the SC. Cheng Hsiao (2008) investigated the integrated stochastic

inventory problem for a two-stage supply chain consisting of a single retailer and a single supplier. Jaber

et al. (2008) investigated the coordination of order quantities amongst the players in a three level supply

chain. Their model achieves coordination amongst the members in a supply chain, assuming a common

cycle time for all non-identical buyers. They developed a mathematical model to investigate whether the

cost at a level decreases as the result of coordination or not. Van Dam et al. (2009) demonstrated that

different modeling paradigms and tools were used to successfully create a model of an oil refinery SC.

Three models presented in this paper have different characteristics so that they were represented in a

different quadrant of the modeling space. Ayoub et al. (2009) proposed an optimization model and

solution approach for designing and evaluating integrated systems of bio-energy production supply

chains, i.e., supply chain at the local level.

Anderson et al. (2010) investigated the equilibrium behavior of competing supply chains, in which similar

products were sold in the same market and competed on price. Arora et al. (2010) proposed a quaternary

3
 policy system towards integrated logistics and inventory aspect of the SC. A system of multi retailers and

distributors, with a unique policy that each distributor follows, was analyzed. Mohammadi Bidhandi et al.

(2011) were developed an integrated model in the design of multi-commodity, single-period SC network

problems under uncertainty. In this model, the operational costs, the customer demand, and the capacity

of the facilities were stochastic parameters with a known joint distribution. Junfang et al. (2011) studied

an integrated inventory model in an SC which is involved procurement, production and delivery activities.

The model was studied in an environment where products experience a continuous price decrease and the
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planning was performed in an infinite time horizon. Laı´nez et al. (2012) described the enlarged scope

presently attributed to SCM, which departed from classical approaches focused on operations to a more

integrated conception. Matsui (2012) examined the economic role of transfer pricing for a vertically ISC

when a risk-averse production-division manager faced uncertainty on the outcomes from research and

development3 investment. Kedar Joshi et al. (2012) provided a paper to demonstrate a newly developed

integrated multi-criteria decision method4 with two-sided preferences or selection scenario in build-to-

order supply chains to explore the future applications like supplier parks.

Sarkar et al. (2013) published a paper which dealt with an integrated vendor–buyer SC model. Two

models were constructed based on the probability distribution of the lead time demand. The aim of their

model was to reduce the total system cost by considering the setup cost reduction of the vendor. Elimam

et al. (2013) formulated an ISC as a project network5 with activities covering: sending and receiving

orders, processing these orders as well as sending and receiving of shipments and their precedence. Das et

al. (2013) developed an integrated production inventory model of supplier and retailer in which a delay in

payment was offered by the supplier to the retailer for a constant deteriorating item and shortage was not

allowed. Khan et al. (2014) provided a simple but integrated mathematical model for determining an

optimal vendor–buyer inventory policy by accounting for quality inspection errors at the buyer’s end and

learning in production at the vendor’s end. The objective was to minimize the joint annual cost incurred in

3
R&D
4
MCDM
5
PN

4
 the SC .Diabat et al. (2014) developed a nonlinear mixed integer program that minimized the cost of a

stochastic two-echelon SC. The results of their paper indicated a significant increase in costs proportional

to the size of the SC. Dong-Ping et al. (2014) formulated the integrated inventory management policy for

raw material procurement and production control by using the stochastic dynamic programming

approach. Alfalla-Luque et al. (2015) examined the relationship between employee commitment and SCI

dimensions to explain several performance measures, such as flexibility, delivery, quality, inventory, and

customer satisfaction. Their paper focused on the interrelationships between the different dimensions of
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SCI. Khalifehzadeh et al. (2015) aimed at designing a four-echelon supply chain structure, including

multiple suppliers, multiple producers, multiple distributors, and multiple customers. Mohd Saleh et al.

(2015) proposed a framework to investigate the influence of supply chain relational capital on the

execution of SCI by adopting relational capital theory. Zhao et al. (2016) considered an integrated

production-inventory-distribution planning problem faced by a multinational corporation managing a

multi-stage supply chain over an infinite time horizon. Lemmens et al. (2016) reviewed the literature on

model-based supply chain network design in order to identify the applicability of these models to the key

issues of the design of a vaccine supply chain. Diabat et al. (2016) developed a capacitated multi-echelon

joint location-inventory model, according to which a single product is distributed from a manufacturer to

retailers through a set of warehouses, the locations of which were determined by the model. They

developed a genetic algorithm6 based heuristic to solve the problem and the GA was validated on small

size problems. Najmi et al. (2016) addressed a model for an advanced hydrocarbon biofuel supply chain

integrated with existing petroleum refineries. This model simultaneously optimized the supply chain

design and found the equilibrium quantity of feed stocks, crude oil and final products in the integrated

supply chain. Samaranayake et al. (2016) provided a paper that its purpose was to develop a conceptual

framework of integrated supply chain model that could be used to measure, evaluate and monitor

operational performance under dynamic and uncertain conditions.

6
GA

5
 In this paper, an integrated inventory system in four-echelon supply chain is modeled under stochastic

condition. Products order quantity has a normal distribution with a known mean and variance. In other

words, to make the model more applicable to real-world supply chains, multiple stochastic constraints on

production time capacity, space and setup costs, lot sizes, number of orders, total procurement and

production costs are considered. It is noted, products in this chain are multi-stage. The aims are to

determine the agreed optimum lot size and the agreed optimum period length for each product to

minimize total cost of integrated inventory system in the chain. As the mathematical formulation of the
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problem becomes nonlinear with a large size, the Interior Point algorithm as an effective algorithm helps

us find the optimum solution in the recent large-scale nonlinear problem. The remainder of this paper

organized as follows:

The problem along with its assumptions is described in section 2. Mathematical formulation of this model is

provided in section 3. Section 4 is devoted to the Interior Point algorithm. Numerical examples are solved in

section 5 to demonstrate the applicability of the proposed algorithm along with assessing the performance of

the solution method. Finally, a sensitivity analysis and the conclusion are given in sections 6 and 7,

respectively.

2. Problem definition and assumptions

The four-echelon supply chain under stochastic condition involves several multi-stage products with the order

quantities following normal distributions with known means and variances in each level. Thus, the lot sizes,

production time capacity, total procurement and production costs, space and setup costs and number of

orders, all are assumed stochastic. The goal is to minimize the total cost of the integrated inventory model in

supply chain while the stochastic constraints are fulfilled. The following assumptions are used for

formulating of the problem:

1. There are
items for each product on supplier level and there are "n" products in each level of

producer, wholesaler and retailers.

6
 2. Order quantity of product i in each level has a normal distribution with a known mean μ and a

known variance σ .

3. The demand rate for products in levels is known, deterministic and dependent.

4. Shortage and discount are not allowed.

5. The products in different levels of the chain share unique period length and lot size.

6. Products in producer level have a multi-stage production process and each product is made up from

"
"Items.
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7. Holding costs of the products or items per unit per time unit vary among different levels of the chain.

8. The planning horizon in this four-echelon supply chain is infinite.

9. The total procurement cost of the products or items in each level is constrained with a probability

greater than a specified value.

10. Number of orders for products or items in each level is limited with a probability greater than a

certain value.

11. The space cost required for the products or items in each level is limited to a probability greater than

a specified value.

12. The total number of products ordered by levels is limited to a probability greater than a certain value.

13. Maximum production time capacity for producing the products is constrained by a probability

greater than a specified value.

14. Maximum setup cost for producing the products is limited to a probability greater than a specified

value.

3. Mathematical formulation

3.1. Notations

Parameters


: The mean of the order quantity of product or item i in the supplier level

σ
: The variance of the order quantity of product or item i in the supplier level

7
 
: The probability of violating each of the stochastic constraints related to the supplier

Z∝ : The critical point of the standard normal value for 


: Fixed ordering cost related to items of ith product for supplier

ℎ
: Holding cost of jth item from ith product for supplier


: Demand rate of ith product of supplier


: Maximum number of stockpile for supplier’s products


: The cost per unit of space for ith supplier’s product
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: Maximum space cost for supplier


: Supply cost per unit of product i that supplied by supplier


: Maximum supply cost for supplier


: Maximum number of orders for supplier

  : The mean of the order quantity of product i in the producer level

σ  : The variance of the order quantity of product i in the producer level

 : The probability of violating each of the stochastic constraints related to the producer

∝ : The critical point of the standard normal value for 

  : Fixed ordering cost per order of ith product of producer

ℎ  : Holding cost of jth item from ith product of producer

ℎ  : Holding cost of ith product of producer

  : Demand rate of ith product of producer

  : Fixed ordering cost per order of jth item from ith product of producer

 : Maximum number of stockpile for producer’s products

  : The cost per unit of space for ith producer’s product

 : Maximum space cost for producer

8
   : Production cost per unit of product i for producer

 
: Setup cost per unit of ith product in stage “s”

 
: Production time capacity per unit of ith product in stage “s”

 
: The expense per unit of production time capacity for unit of ith product in stage “s”

 : Maximum production cost for producer

 : Maximum production time capacity for producing the products in producer level

 : Maximum setup cost for producing the products in producer level

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 : Maximum number of orders for producer

 : The mean of the order quantity of product i in wholesaler level

σ : The variance of the order quantity of product i in wholesaler level

 : The probability of violating each of the stochastic constraints related to the wholesaler

∝ : The critical point of the standard normal value for 

 : Fixed ordering cost per order of ith product of wholesaler

ℎ : Holding cost of ith product of wholesaler

 : Demand rate of ith product of wholesaler

 : Maximum number of stockpile for wholesaler’s products

 : The cost per unit of space for ith wholesaler’s product

 : Maximum space cost for wholesaler

 : Procurement cost per unit of product i for wholesaler

 : Maximum procurement cost for wholesaler

 : Maximum number of orders for wholesaler

!: Number of retailers

 "# : The mean of the order quantity of product i in the kth retailer level

σ "# : The variance of the order quantity of product i in the kth retailer level

9
 "# : The probability of violating each of the stochastic constraints related to the kth retailer

∝"# : The critical point of the standard normal value for "#

 "# : Fixed ordering cost per order of ith product of kth retailer

ℎ "# : Holding cost of ith product of kth retailer

 "# : Demand rate of ith product of kth retailer

 "# : The cost per unit of space for ith product of kth retailer

"# : Maximum space cost for kth retailer

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 "# : Procurement cost of per unit of product i for kth retailer

"# : Maximum procurement cost for kth retailer

"# : Maximum number of orders for kth retailer

Variables and unknowns


: Number of optimum stockpile of ith product for supplier

$
: The optimum period length of ith product for supplier

  : Number of optimum stockpile of ith product for producer

$  : The optimum period length of ith product for producer

 : Number of optimum stockpile of ith product for wholesaler

$ : The optimum period length of ith product for wholesaler

$ "# : The optimum period length of ith product for kth retailer

 : Number of optimum stockpile of ith product for the levels

$ : The optimum period length of ith product for the levels

Related Parameters to levels

%: Number of products

: Number of items which make up ith product

10
 s: Number of stages for producing the products which can be varied from one product to another

& : Consumption rate of jth item in ith product

 : Space occupied by each unit of product i

$
: Total inventory cost of supplier

$ : Total inventory cost of producer

$" : Total inventory cost of retailers

$ : Total inventory cost of wholesaler

$' : Total inventory cost of integrated four-echelon integrated supply chain

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3.2. Design of integrated inventory model in four-echelon supply chain

The supplier at the first level of the four-echelon ISC provides the required items to produce the products

at the producer level. The total inventory cost of the supplier, including the ordering and holding costs, is

obtained by Eq. (1).

4 4 0

1
$
= ) * + ) *)(ℎ
& )3 
$
(
− 1)   3 (1)

   $
2
12 12 12

The total inventory cost of the producer, including the ordering cost in the first term, holding cost of

produced products in the second term, holding cost of items in the third term, setup cost in the fourth term

and production time capacity costs for producing the products in the fifth term is regarded as Eq. (2):

  + (∑012   )
4 4
1
$ = ) + ) ℎ    $  7  − 18
   $  2
12 12

4 0 4

1
+ ) *)(ℎ  & )3   $  7  − 18 + ) 9)7 
8:   $ 
2
12 12 12
12

+ ) 9)7 
 
8:   $  (2)
12
12

11
 The wholesaler at the third level buys the produced products from the producer and sells them to multiple

retailers. The total inventory cost of the wholesaler, including the ordering and the holding costs are

obtained using Eq. (3).

4 4
 1
$ = ) * + ) ℎ  $ ( − 1)3 (3)
 $ 2
12 12

In Eq. (3), the first term is the ordering cost and the second term is the holding cost of the wholesaler.

Note that the ordering and the holding cost depends on the number of stockpiles for wholesaler's products.
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Retailers at the fourth level buy the products from the wholesaler and sell them to customers. The total

inventory cost of the the retailers, including the ordering and the holding cost are determined using Eq.

(4).
< 4
 "# ℎ "#
$" = ) ) +  $ (4)
$ "# 2 "# "#
#12 12

The stochastic constraints of this model have been stated in Section 2, where the problem was defined and

the assumptions were stated. Mentioned stochastic constraints are regarded as Eqs (5) to (21).
4

>() 
?
≤ 
) ≥ 
(5)
12

>()   ?  ≤  ) ≥  (6)
12

>()  ? ≤  ) ≥  (7)
12

>()  "# ? "# ≤ "# ) ≥ "# EF G = 1, 2, … , ! (8)

12

4


>() ≤ 
) ≥ 
(9)
?

12

4
 
>() ≤  ) ≥  (10)
? 
12

12
 4

>() ≤  ) ≥  (11)
?

12

4
 "#
>() ≤ "# ) ≥ "# EF G = 1, 2, … , ! (12)
? "#
12

>() 
 ?
≤ 
) ≥ 
(13)
12

>()    ?  ≤  ) ≥  (14)
12
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>()   ? ≤  ) ≥  (15)
12

>()  "#  ? "# ≤ "# ) ≥ "# EF G = 1, 2, … , ! (16)

12

>() ?

≤ 
) ≥ 
(17)
12

>() ?    ≤  ) ≥  (18)
12

>() ?  ≤  ) ≥  (19)
12

>() 9)7 
8: ?  ≤  ) ≥  (20)
12
12

>() 9)7 
8: ?  ≤  ) ≥  (21)
12
12

Stochastic constraints (5) to (8) guarantee procurement and production cost limitation for supplier,

producer, wholesaler and retailers, respectively. Stochastic constraints (9) to (12) guarantee number of

orders limitation for supplier, producer, wholesaler and retailers, respectively. Stochastic constraints (13)

to (16) guarantee space costs limitation for supplier, producer, wholesaler and retailers, respectively.

13
 Stochastic constraints (17) to (19) guarantee limitation of number of stockpile for supplier, producer and

wholesaler, respectively. Stochastic constraints (20) and (21) guarantee limitation of production time

capacity and setup cost for producing the products in producer level, respectively.

As stated earlier, four levels of mentioned chain interacted and agreed with each other on having the same

period length and the same number of stockpile for each product in order to provide an integrated

inventory system to optimize total cost of supply chain inventory. Based on this cooperation and

agreement between levels, we will have:


=   =  =  and, $
= $  =$ =$
=$ "# = $
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Accordingly, by replacing λ and T parameters in Eqs (1) to (21), the mathematical formulation of the

problem becomes:

OP% $' = ) $
+ $ + $ + $"

  + (∑012   )
4 4 0 4

1
= ) * Q + ) *)(ℎ
& )3 
$ ( − 1) 3 + )
 $ 2  $
12 12 12 12

4 4 0
1 1
+ ) ℎ    $ ( − 1) + ) *)(ℎ  & )3   $ ( − 1)
2 2
12 12 12

4
4

+ ) 9)7 
8:   $ + ) 9)7 
 
8:   $
12
12 12
12

4 4 < 4
 1  "# ℎ "#
+ )* + ) ℎ  $ ( − 1)3 + ) ) +  $ (22)
 $ 2 $ 2 "#
12 12 #12 12

Subject to:

4 4 4

) 
$ 
≤ ∝
. S) T
 
+ ) 
. 
(23)


12 12 12

4 4 4

)   $   ≤ ∝ . S) T     + )   .   (24)


12 12 12

14
 4 4 4

)  $  ≤ ∝ . S) T   + )  .  (25)


12 12 12

4 4 4

)  "# $  "# ≤ ∝"# . S) T "#   "# + )  "# .  "# EF G = 1, 2, … , ! (26)



12 12 12

4 4 4
1 
 1
) ≤ ∝
. S)  + ) .  (27)
$ T


12 12 12
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4 4 4
1    1
) ≤ ∝ . S)  + ) .  (28)
$ T    
12 12 12

4 4 4
1  
1
) ≤ ∝ . S) +) .  (29)
$ T  
12 12 12

4 4 4
1  "#  1
) ≤ ∝"# . S) +) .  EF G = 1, 2, … , ! (30)
$ T "#   "# "#
12 12 12

4 4 4

) 
 $ 
≤ ∝
. S) T
 
  + ) 
. 
.  (31)


12 12 12

4 4 4

)    $   ≤ ∝ . S) T       + )   .   .  (32)


12 12 12

4 4 4

)   $  ≤ ∝ . S) T     + )  .  .  (33)


12 12 12

4 4 4

)  "#  $  "# ≤ ∝"# . S) T "#   "#   + )  "# .  "# .  EF G = 1, 2, … , ! (34)



12 12 12

15
 4 4 4

) $ 
 ≤ ∝
. S) T
  + ) 
.  (35)


12 12 12

4 4 4

) $    ≤ ∝ . S) T    + )   .  (36)


12 12 12

4 4 4

) $   ≤ ∝ . S) T   + )  .  (37)


12 12 12
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4
4
4

) 9)7 
8: $   ≤ ∝ . S) ) T   .  
 + ) )   .  
(38)
12
12 12
12 12
12

4
4
4

) 9)7 
8: $   ≤ ∝ . S) ) T   .  
 + ) )   .  
(39)
12
12 12
12 12
12

Note in equations (22) to (39) that Z∝ , Z∝U , Z∝V and Z∝WX are the upper α-percentile of the standard

normal distribution. The formulas given in (22) to (39) are based on the stochastic nonlinear-

programming model.

4. Solution method: Optimization the integrated inventory model in four-echelon SC

The interior point methods in mathematical programming have been the largest and the most dramatic

area of research in optimization since the development of the simplex method (Freund et al., 1996).

They belong to a certain class of algorithms to solve a wide range of linear and nonlinear convex

optimization problems. The modern era of the interior point methods dates back to 1984, when

Karmarkar proposed his algorithm for linear programming (Potra et al., 2000). His idea was to approach

the optimal solution from the strict interior of the feasible region. Interior-point methods have

permanently changed the landscape of mathematical programming theory, practice and computation.

Pasandideh et al. (2015) compared the performance of this method in solving nonlinear problems with

16
 the one of an exact method titled sequential quadratic programming7, which is another efficient method

to solve nonlinear programming problems (Pasandideh et al., 2015). Moreover, Gharaei et al. (2015)

confirmed the satisfactory performance of this method to solve nonlinear optimization problems

(Gharaei et al., 2015). It is noted, efficient algorithms have superlinear convergence and superlinearly

convergent algorithms need only a couple of iterations (Potra, 2003). So, the Interior Point algorithm is

used for optimizing the recent convex nonlinear model of this paper. A typical nonlinear programming

problem can be expressed mathematically as,

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Minimize F(x)

Subject to g (x) = 0

hl ≤ h( x) ≤ hu
(40)
xl ≤ x ≤ xu

The first problem to solve is to transform the inequality constraints in Eq. (40) to some equality

constraints in Eq. (41) by introducing some slack variables.

Minimize F(x)

Subject to g (x) = 0

h( x ) + s h = hu
s h + s sh = hu − hl
(41)
x + s x = xu
x − xl ≥ 0, s h , s sh , s x ≥ 0

The next step is to treat non-negativity conditions in Eq. (41) by appending the logarithmic barrier

functions to the objective function. The primal resulting barrier problem is as follows:

n n m m
Minimize Fµ = F ( x) = µ∑ ln ( x − x ) − µ ∑ ln(sx )i − µ ∑ ln(sh ) j − µ ∑ ln(ssh ) j
l i
i =1 i =l j =l j =l

Subject to g(x) =0

7
SQP

17
 h( x) + sh = hu
sh + ssh = hu − hl (42)

x + s x = xu

Where, µ as the barrier parameter is a positive number. The Lagrangian function to solve Eq. (42) is:

Lµ = F ( x) − Y T g ( x) − yhT [hu − sh − h( x)] − yshT (hu − hl − sh − ssh ) − y xT ( xu − x − sx ) -

n n m m
µ ∑ ln( x − xl )i − µ ∑ ln(sx )i − µ ∑ ln(sh ) j − µ ∑ ln(ssh ) j (43)
i =1 i =l j =l j =l
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Where y, yh , ysh , and yx are Lagrangian multipliers. Then, the first order optimality conditions are:

∇ x Lµ = ∇F ( x) − ∇g ( x)T y + ∇h( x)T yh + y x − z = 0

∇sh Lµ = yh + ysh − µ.Sh−e1 = 0

∇ ssh Lµ = ysh − µ.S sh−1 = 0

e

∇ sx Lµ = y x − µ .S x−1e = 0

∇ y Lµ = − g ( x) = 0 (44)

∇ yh Lµ = h( x) + sh − hu = 0

∇ yx Lµ = x + s x − xu = 0

∇ ysh Lµ = sh + ssh − hu + hl = 0

( X − X l ).Z .e = µ .e

Where:

18
 e = [1,...,1] X = diag( x1 ,...., xn ), sh = diag(sh1 ,...,shn ),.
T

with superscripts indicating components of a vector and:

ssh = diag(ssh1 ,...,sshm ), X = diag( xl ,..., xn ), Yx = diag( yx1 ,..., yxm ),

Ysh = diag( ysh1 ,..., xshm ),Yh = diag( yh1 ,..., yhn ), andSx = diag(Sxl ,..., S xm )
are the matrices of constraint gradients and Z is diagonal matrice. The nonlinear Equations in (44) are to

be solved by some iterative methods such as Newton’s or predictor-corrector to determine a search

direction. The search direction is obtained from the next equations,

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 − z −1 ( x − x1 ) 0 0 0 0 0 0 −I 0 
 0 S h−1 (Ysh + Yh ) 0 0 0 I I 0 0 
 
 0 0 S x−1Yh 0 I 0 0 0 0 
 
 0 0 0 S sh−1Ysh 0 I 0 0 0 
 0 0 I 0 0 0 0 I 0 
 
 0 I 0 I 0 0 0 0 0 
 0 I 0 0 0 0 0 − ∇h 0 
 
 −I 0 0 0 I 0 − ∇hT H − ∇g T 
 − ∇g 
 0 0 0 0 0 0 0 0 

 ∆ z   − µ .Z −1e + ( X − X l ).e 
∆   
 sh   µ .S h e − (Ysh + Yh ).e 
−1

 ∆ sx   µ .S x−1 − Yx e 
   
 ∆ ssh   µ . S −1
sh
− Y sh
e 

* ∆ yx =   − x − S x + xu  (45)
   
 ∆ ysh   − S h − S sh + ( hu − hl ) 
 ∆ yh   − h ( x ) − S + h 
   h u

 ∆x   − ∇ x Lµ 
∆   
 y  g ( x) 
Where:

19
 The vector [ ∆ z , ∆ sh , ∆ sx , ∆ ssh , ∆ yx , ∆ ysh , ∆ yh , ∆ x ¸ ∆ y ] is search direction.

Along the search direction, a step size α is chosen to preserve the non-negativity conditions. The new

primal and dual variables are computed from Eq. (46).

xk = x + α P ∆ x , yk = y + α D ∆ y

S x = S x + α P ∆ sx , y x = y x + α D ∆ yx
k k
(46)

S h = S h + α P ∆ sh , y h = y h + α D ∆ yh
k k
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S sh = S sh + α P ∆ ssh , y sh = y sh + α D ∆ ysh
k k

Where:

α P
is step length in primal and α D
is step length in dual problem which are chosen according to a merit

function or a filter method to keep the slacks and Lagrange multipliers positive. It is noted that one step of

the Interior Point algorithm is as below that was extended in Eq. (46).

For primal problem:

k k k k
( x , S x , S h , S sh ) → ( x , S x , S h , S sh ).
For Dual problem:

k k k k
( y , y x , y h , y sh ) → ( y , y x , y h , y sh ).
k k k k
The interior point method generates a sequence { x , S x , Sh , S sh } for a sequence of positive barrier

parameters {µ} converging to zero.

The iteration procedure is terminated as the relative complementary gap. The mismatches of the first

order optimality conditions defined in Equations (47) and (48), respectively.

gup
≤ ε1 , (47)
1 + Dual _ Obj

20
 l arg est _ mismatch _ of _ KKT ≤ ε 2 , (48)

Where:

gap = ( yh + y sh )T sh + ysh S sh + y xT S x + z T ( x _ xl ),
T
(49)

Dual _ Obj = F ( x) − yT g ( x) − yhT [hu − h( x)] − yshT (hu − hl ) − yxT ( xu − x) − zT ( x − xl )

In short, the steps involved in the Interior Point method are as follows:
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1. Initialization: Choose a proper starting point such that the non-negativity conditions are satisfied

2. Compute the barrier parameter µ

3. Solve the system of Equations (45)

4. Determine the step size α and update the solution

5. Convergence test: If the solution meets the convergence criterion, the optimal solution is found,

otherwise go back to Step 2.

Numerical examples are solved in the next section to demonstrate the applicability of the provided model

and to evaluate the performance of the Interior Point method.

5. Numerical examples

In the examples presented here, there are 1 supplier, 1 producer, 1 wholesaler and 2 retailers. There are 2

products in this chain which product 1 in the producer level has a three-stage production process and

product 2 has a two-stage production process. Also, each product consists of two items which

consumption rate of 1 and 2 items in 1 product ( u[ parameter) are 2, 3 respectively. The consumption
st st st

st nd nd nd
rate of 1 item in 2 product is 1 and consumption rate of 2 item in 2 product is 2. As was stated

earlier, the order quantity of products in the numerical example follows a normal distribution with a

known mean and variance, where Z∝ , Z∝U , Z∝V and Z∝WX are assumed as 3.09 for stochastic constraints

of supplier, producer, wholesaler and retailers in numerical examples.

21
 The general data and parameters of supplier, producer, wholesaler and retailers in two numerical

examples are summarized in Tables (1)-(4), respectively. The starting point of solution method in two

numerical examples is: 2 = 2,  = 2, $2 = 0.10, $ = 0.10

[Please insert Table 1]

[Please insert Table 2]

[Please insert Table 3]

[Please insert Table 4]

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The SAS programming code developed to solve the first example is given in Appendix A, as a

representative to all SAS programming codes written to solve all problems. Table (5) shows the optimum

solution, number of iterations to achieve the optimum solution, infeasibility and optimality error obtained

from the objective function in numerical examples which are solved by the Interior Point algorithm.

[Please insert Table 5]

In Table (5), λ2 and λ are number of agreed optimum stockpile of products 1, 2 for supplier, producer

and wholesaler. Also, T2 and T are optimum agreed period length for products 1 and 2 in objective

function. The number of steps taken by the Interior Point method to achieve the optimal solution is given

in the column entitled as "number of iterations". As the computation is carried out in a finite-precision

environment, rounding errors prevent the algorithm from obtaining a solution satisfying the preceding

condition exactly (shown in infeasibility column). Instead, we terminate the algorithms at some small

threshold values which can be measured in an absolute or relative sense. The seventh column refers to the

"optimality error".

6. Sensitivity Analysis

A sensitivity analysis on change rate of the integrated objective function based on the change rate of the

agreed optimum stockpiles for products (Parameter “ ”) is performed in this section only for Example

#1 with the initial data shown in Tables (1)-(5). It involves increasing or decreasing parameter “ ” at

±10, ±20, ±30, ±40 and ±50 percents, Table (6) represents the results. Moreover, Figure 1 shows

change rate of the objective function with respect to the change rate of the agreed optimum stockpiles for

22
 products. It can be seen from Figure 1, increasing the rate of the parameter “] ” (greater than 1), leads to

increase in the objective function with less steep and decreasing the rate of the parameter “] ” (less than

1), leads to decrease in the objective function with more steep.

[Please insert Table 6]

[Please insert Figure 1]

7. Conclusions

We modeled and optimized an integrated inventory system in a four-echelon SC with “n” multi-stage
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products and stochastic constraints. The main goal is to optimize the number of agreed optimum stockpile

and period length for products between chain levels. Accordingly, the Interior Point method for solving

nonlinear and large model is utilized to optimize the research integrated objective function. The results of

the implementation of the proposed method for research large-scale numerical examples indicate low

iterations, 60 & 66 repeat to achieve the optimal solution in numerical examples 1 and 2, respectively that

shows the superlinear convergence rate of the proposed method. The optimality error of the Interior Point

method is close to zero, 7.3031058E-7 & 5.9291894E-7 in numerical examples 1 and 2, respectively, that

demonestrates high accuracy and excellent quality of Interior Point solutions. Also, Infeasibility for

examples 1 and 2 is 5.746719E-13 & 2.44509E-13 which current values are close to zero. This means that

proposed solutions from Interior Point for this research optimization problem does satisfy all stochastic

constraints. In other words, it refers to inequality stochastic constraints of research optimization problem

which are satisfied as strict inequality by the Interior Point solution process. A sensitivity analysis is

performed on the change rate of the integrated objective function versus change rate of the agreed

optimum stockpiles for products based on proposed algorithm. Sensitivity analysis revealed that

increasing the rate of the parameter “]^ ” (greater than 1) in chain levels leads to the change rate of

objective function become negative with less steep. In return, decreasing the rate of mentioned parameter

(less than 1) leads to change rate of objective function become positive with more steep compared to the

previous status. In other words, it is better to chain levels that in case of selection between low or high

stockpile compared to optimum amount, they agree with each other on the delivery of low lot size.

Because, in case of low lot size selection, the inventory cost of integrated supply chain will be lower than

23
 before. However, the change rate of objective function in both cases compared with each other has less

significant changes, but mentioned less changes leads to significant changes of the objective function

value. We found that the same increase/decrease rate in “λ ” parameter leads to the same change rates of

the objective function with little differences. In general, it must be stated that there is a direct relationship

with a strong correlation between the change rate of parameter “] ” and the change rate of the integrated

inventory function. For future research, we are going to develop this model in the case of shortage and

discount is allowed as integer variables in the model. So, the future developed model is in the form of
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Mixed Integer Nonlinear Programming8. We will provide and compare developed novel methods such as

Generalized Benders Decomposition9 and Extended Cutting Plane10 solution methods for solving the

MINLP developed model in large sizes.

8
MINLP
9
GBD
10
ECP

24
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Appendix A: The SAS programming code to solve the first numerical example
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proc optmodel;
var L {1..2} >= 0;
var T {1..2} >= 0;

minimize obj =

77/(L[1]^3*T[1])+89/(L[2]^3*T[2])+1277*T[1]*(L[1]-1)*L[1]^2+
1505*T[2]*(L[2]-
1)*L[2]^2+148/(L[1]^2*T[1])+166/(L[2]^2*T[2])+2324*T[1]*(L[1]-
1)*L[1]+3559*T[2]*(L[2]-1)*L[2]+104960*T[1]+87329.5*T[2]+63/(L[1]*T[1])+
78/(L[2]*T[2])+891*T[1]*(L[1]-1)+1074*T[2]*(L[2]-1)+110/T[1]+98/T[2];

con cons1:
672*T[1]+1290*T[2]<= 274.44;
con cons2:
858*T[1]+1560*T[2]<= 363.60;
con cons3:
1057*T[1]+2148*T[2]<= 654.90;
con cons4:
2546*T[1]+4891*T[2]<= 3651.69;
con cons5:
2090*T[1]+5775*T[2]<= 3405.65;
con cons6:
(1/T[1])+(1/T[2])<= 391.89;
con cons7:
(1/T[1])+(1/T[2])<= 285.76;
con cons8:
(1/T[1])+(1/T[2])<= 246.83;
con cons9:
(1/T[1])+(1/T[2])<= 96.38;
con cons10:
(1/T[1])+(1/T[2])<= 148.89;
con cons11:
45.36*T[1]+43*T[2]<= 12.79;
con cons12:
35.39*T[1]+46.8*T[2]<= 12.63;
con cons13:
27.74*T[1]+39.38*T[2]<= 11.75;
con cons14:
10.55*T[1]+11.68*T[2]<= 10.67;
con cons15:

27
 6.19*T[1]+10.50*T[2]<= 6.71;
con cons16:
168*L[1]*T[1]+215*L[2]*T[2]<=
3.09*((9*L[1]^2+4*L[2]^2)^.5)+21*L[1]+23*L[2];
con cons17:
143*L[1]*T[1]+195*L[2]*T[2]<=
3.09*((4*L[1]^2+16*L[2]^2)^.5)+19*L[1]+18*L[2];
con cons18:
137*L[1]*T[1]+179*L[2]*T[2]<=
3.09*((9*L[1]^2+9*L[2]^2)^.5)+24*L[1]+20*L[2];
con cons19:
19877*T[1]+12675*T[2]<= 4987.17;
con cons20:
5577*T[1]+3705*T[2]<= 1419.51;
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/* starting point */
L[1] = 2;
L[2] = 2;
T[1] = .10;
T[2] = .10;

solve with IPNLP / printfreq = 4;

print L[1] L[2] T[1] T[2];
quit;

28
 Table 1. General data and parameters of supplier in two numerical examples
Level Parameters Example 1 Example 2
‫ܣ‬ଵ௦ 77 68
‫ܣ‬ଶ௦ 89 76
‫ܦ‬ଵ௦ 168 150
‫ܦ‬ଶ௦ 215 224
ܿଵ௦ 4 6
ܿଶ௦ 6 9
݂ଵ 0.45 0.52
݂ଶ 0.40 0.49
݂ଵ௦ 0.6 0.55
݂ଶ௦ 0.5 0.48
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ℎଵଵ௦ 2.5 1.9

Supplier ℎଶଵ௦ 3.4 3.7
ℎଵଶ௦ 4 3
ℎଶଶ௦ 5 6.5
ߣ௦ 8 10
ܵ௦ 5,200 6,300
‫ܥ‬௦ 41,000 38,000
ܱ௦ 19 22
ߤଵ௦ 21 19
ߤଶ௦ 23 19
ଶ
σଵ௦ 9 25
ଶ
σଶ௦ 4 25
 Table 2. General data and parameters of producer in two numerical examples
Level Parameters Example 1 Example 2
‫ܣ‬ଵ௣ 78 72
‫ܣ‬ଶ௣ 82 91
‫ܦ‬ଵ௣ 143 155
‫ܦ‬ଶ௣ 195 210
ܿଵ௣ 6 4
ܿଶ௣ 8 10
݂ଵ 0.45 0.52
݂ଶ 0.40 0.49
݂ଵ௣ 0.55 0.68
݂ଶ௣ 0.60 0.73
ℎଵ௣ 8 11
ℎଶ௣ 14 12
ℎଵଵ௣ 2.5 3.2
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ℎଶଵ௣ 6.5 4.9

ℎଵଶ௣ 3.5 4.2
ℎଶଶ௣ 9.5 10.3
ܽଵଵ௣ 28 32
ܽଶଵ௣ 42 44
ܽଵଶ௣ 37 43
ܽଶଶ௣ 47 54
‫ݏ‬ଵ௣ଵ 12 10
‫ݏ‬ଵ௣ଶ 14 12
Producer ‫ݏ‬ଵ௣ଷ 13 17
‫ݏ‬ଶ௣ଵ 7 6
‫ݏ‬ଶ௣ଶ 12 14
ܿଵ௣ଵ 63 72
ܿଵ௣ଶ 49 60
ܿଵ௣ଷ 27 32
ܿଶ௣ଵ 36 41
ܿଶ௣ଶ 29 25
݁ଵ௣ଵ 2.5 2.2
݁ଵ௣ଶ 6.5 6.8
݁ଵ௣ଷ 8 12
݁ଶ௣ଵ 7 10
݁ଶ௣ଶ 6 8
ܸ௣ 96,000 89,000
ܵ௖ 34,000 29,000
ߣ௣ 7 8
ܵ௣ 6,500 7,200
‫ܥ‬௣ 52,000 38,500
ܱ௣ 37 42
ߤଵ௣ 19 16
ߤଶ௣ 18 23
ଶ
σଵ௣ 4 9
σଶଶ௣ 16 4
 Table 3. General data and parameters of wholesaler in two numerical examples
Level Parameters Example 1 Example 2
‫ܣ‬ଵ௪ 63 57
‫ܣ‬ଶ௪ 78 84
‫ܦ‬ଵ௪ 137 121
‫ܦ‬ଶ௪ 179 185
ܿଵ௪ 11 14
ܿଶ௪ 12 10
݂ଵ 0.45 0.52
݂ଶ 0.40 0.49
݂ଵ௪ 0.45 0.53
݂ଶ௪ 0.55 0.59
Wholesaler
ℎଵ௪ 13 15
ℎଶ௪ 12 10
ߣ௪ 15 22
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ܵ௪ 9,500 10,800
‫ܥ‬௪ 89,000 92,000
ܱ௪ 37 41
ߤଵ௪ 24 20
ߤଶ௪ 20 18
ଶ
σଵ௪ 9 4
ଶ
σଶ௪ 9 9

Table 4. General data and parameters of retailers in two numerical examples

Level Parameters Example 1 Example 2
‫ܣ‬ଵ௥ଵ 55 49
‫ܣ‬ଶ௥ଵ 49 53
‫ܦ‬ଵ௥ଵ 67 62
‫ܦ‬ଶ௥ଵ 73 81
ܿଵ௥ଵ 38 35
ܿଶ௥ଵ 67 72
݂ଵ 0.45 0.52
݂ଶ 0.40 0.49
݂ଵ௥ଵ 0.35 0.41
Retailer 1 ݂ଶ௥ଵ 0.40 0.32
ℎଵ௥ଵ 7 9
ℎଶ௥ଵ 8 7
ܵ௥ଵ 8,800 9,700
‫ܥ‬௥ଵ 39,000 42,000
ܱ௥ଵ 15 11
ߤଵ௥ଵ 28 25
ߤଶ௥ଵ 27 31
ଶ
σଵ௥ଵ 16 25
σଶଶ௥ଵ 9 25
 Table 4. General data and parameters of retailers in two numerical examples
Level Parameters Example 1 Example 2
‫ܣ‬ଵ௥ଶ 55 48
‫ܣ‬ଶ௥ଶ 49 51
‫ܦ‬ଵ௥ଶ 55 64
‫ܦ‬ଶ௥ଶ 75 83
ܿଵ௥ଶ 38 29
ܿଶ௥ଶ 77 65
݂ଵ 0.45 0.52
݂ଶ 0.40 0.49
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݂ଵ௥ଶ 0.25 0.28

Retailer 2 ݂ଶ௥ଶ 0.35 042
ℎଵ௥ଶ 7 8
ℎଶ௥ଶ 7 10
ܵ௥ଶ 7,500 8,100
‫ܥ‬௥ଶ 42,000 51,000
ܱ௥ଶ 23 29
ߤଵ௥ଶ 25 28
ߤଶ௥ଶ 25 19
ଶ
σଵ௥ଶ 4 9
σଶଶ௥ଶ 4 16

Table 5. Optimal results for numerical examples

Example Objective Number of Optimality

Optimum solution Infeasibility
No function value iterations error

ߣଵ 2.4838
Example ߣଶ 2.3495
17772.156194 60 5.746719E-13 7.3031058E-7
1 ܶଵ 0.036042
ܶଶ 0.038871
ߣଵ 2.7854
Example ߣଶ 2.5104
66 2.44509E-13 5.9291894E-7
2 ܶଵ 0.0276 20815.336665
ܶଶ 0.032188
 Table 6. Effects of "ߣ௜ ” changes on the optimal results of Example #1

The rate of increase/ decrease

Objective function value of chain Change rate of objective function
parameter "ૃܑ " in chain levels
1.5 "ߣ௜ " 18362.324195 -0.03321

1.4 "ߣ௜ " 18246.959961 -0.02672

1.3 "ߣ௜ " 18130.28371 -0.02015

1.2 "ߣ௜ " 18012.264597 -0.01351

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1.1 "ߣ௜ " 17892.886052 -0.00679

0.9 "ߣ௜ " 17650.125345 0.0068664

0.8 "ߣ௜ " 17526.916295 0.013799

0.7 "ߣ௜ " 17402.778554 0.020784

0.6 "ߣ௜ " 17278.19017 0.027794

0.5 "ߣ௜ " 17154.060328 0.034779

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Figure 1: Change rate of the objective function vs. change rate of the agreed optimum stockpiles
for products