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The Base Stock Model

Assumptions
Demand occurs continuously over time
Times between consecutive orders are stochastic but
independent and identically distributed (i.i.d.)
Inventory is reviewed continuously
Supply leadtime is a fixed constant L
There is no fixed cost associated with placing an order
Orders that cannot be fulfilled immediately from onhand inventory are backordered

The Base-Stock Policy


Start with an initial amount of inventory R. Each time
a new demand arrives, place a replenishment order
with the supplier.
An order placed with the supplier is delivered L units
of time after it is placed.
Because demand is stochastic, we can have multiple
orders (inventory on-order) that have been placed
but not delivered yet.

The Base-Stock Policy


The amount of demand that arrives during the
replenishment leadtime L is called the leadtime
demand.
Under a base-stock policy, leadtime demand and
inventory on order are the same.
When leadtime demand (inventory on-order) exceeds
R, we have backorders.

Notation
I: inventory level, a random variable
B: number of backorders, a random variable
X: Leadtime demand (inventory on-order), a random variable
IP: inventory position
E[I]: Expected inventory level
E[B]: Expected backorder level
E[X]: Expected leadtime demand
E[D]: average demand per unit time (demand rate)

Inventory Balance Equation


Inventory position = on-hand inventory + inventory
on-order backorder level

Inventory Balance Equation


Inventory position = on-hand inventory + inventory onorder backorder level
Under a base-stock policy with base-stock level R,
inventory position is always kept at R (Inventory position
=R)

IP = I+X - B = R

E[I] + E[X] E[B] = R

Leadtime Demand
Under a base-stock policy, the leadtime demand X
is independent of R and depends only on L and D
with E[X]= E[D]L (the textbook refers to this
quantity as ).
The distribution of X depends on the distribution
of D.

I = max[0, I B]= [I B]+


B=max[0, B-I] = [ B - I]+
Since R = I + X B, we also have
IB=RX
I = [R X]+
B =[X R]+

E[I] = R E[X] + E[B] = R E[X] + E[(X R)+]


E[B] = E[I] + E[X] R = E[(R X)+] + E[X] R
Pr(stocking out) = Pr(X R)
Pr(not stocking out) = Pr(X R-1)
Fill rate = E(D) Pr(X R-1)/E(D) = Pr(X R-1)

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Objective
Choose a value for R that minimizes the sum
of expected inventory holding cost and
expected backorder cost, Y(R)= hE[I] +
bE[B], where h is the unit holding cost per
unit time and b is the backorder cost per unit
per unit time.

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The Cost Function


Y (R ) hE [ I ] bE [ B ]
h ( R E[ X ] E [ B ]) bE [ B ]
h ( R E[ X ]) ( h b) E[ B ]
h ( R E[ D ]L) ( h b) E ([ X R ] )
h ( R E[ D ]L) ( h b) x R ( x R ) Pr( X x )

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The Optimal Base-Stock Level

The optimal value of R is the smallest integer that


satisfies
Y (R 1) Y ( R ) 0.

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Y ( R 1) - Y ( R ) h R 1 E[ D ]L ( h b) x R 1 ( x R 1) Pr( X x )

h R E [ D ]L (h b) x R ( x R ) Pr( X x )

h (h b) x R 1 ( x R 1) ( x R ) Pr( X x )

h ( h b) x R 1 Pr( X x )

h ( h b) Pr( X R 1)
h ( h b) 1 Pr( X R )
b (h b) Pr( X R )

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Y ( R 1) - Y ( R ) 0
b ( h b) Pr( X R ) 0
b
Pr( X R )
bh

Choosing the smallest integer R that satisfies Y(R+1)


Y(R) 0 is equivalent to choosing the smallest integer
R that satisfies
b
Pr( X R )
bh
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Example 1
Demand arrives one unit at a time according to a
Poisson process with mean . If D(t) denotes the
amount of demand that arrives in the interval of time
of length t, then
( t ) x e t
Pr( D ( t ) x )
, x 0.
x!

Leadtime demand, X, can be shown in this case to


x L
(

L
)
e
also
have
the
Poisson
Pr( X x )
, distribution
E[ X ] L, with
and Var ( X ) L.
x!
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The Normal Approximation


If X can be approximated by a normal distribution,
then:
R* E ( D ) L zb /( b h ) Var ( X )

Y ( R*) ( h b) Var ( X ) ( zb /( b h ) )

In the case where X has the Poisson distribution


with mean LR* L z
L
b /( b h )

Y ( R*) ( h b) L ( zb /( b h ) )
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Example
2
If X has the geometric distribution with parameter , 0
1
P ( X x ) x (1 ).

E[ X ]
1
Pr( X x ) x
Pr( X x ) 1 x 1

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Example 2 (Continued)
The optimal base-stock level is the smallest integer
R* that satisfies
Pr( X R * )
1

R* 1

b
bh

R*
bh

b
]
b h 1
ln[ ]

ln[

b
ln[
]
bh

ln[ ]

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Computing Expected
Backorders
It is sometimes easier to first compute (for a given
R
R),
E [ I ] x 0 ( R x ) Pr( X x )
and then obtain E[B]=E[I] + E[X] R.
For the case where leadtime demand has the
Poisson distribution (with mean = E(D)L), the
following relationship (for a fixed R) applies
E[B]= Pr(X=R)+(-R)[1-Pr(X R)]
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