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Planning for shortages? Net present value analysis for a deteriorating item with partial backlogging

Planning for shortages? Net present value analysis for a deteriorating item with partial backlogging
Planning for shortages? Net present value analysis for a deteriorating item with partial backlogging
This paper develops inventory models to help answer strategic questions concerning whether planning for shortages offers financial benefits. A production-inventory system producing a deteriorating product in batches at a finite production rate with partial backordering is considered. Customers pay a deposit when placing a backorder. Backordered items receive a discount on the sales price.
As lost sales may lead to customers not returning, the demand rate may depend on the fraction of lost sales. We develop a cash-flow based profit maximising Net Present Value (NPV) model without the inventory cost parameters commonly used in this context: unit holding cost, unit backorder cost, unit deterioration cost, and unit lost sales cost. The model finds the optimal inventory policy just like NPV models that discount the traditional parameters but has the advantage of not needing to estimate the value of the traditional parameters. It is shown that in models based on discounting the traditional parameters, the parameters are not exogenously determinable but are non-trivial functions of non-financial endogenous system parameters such as the production rate, annual demand rate, and backorder rate. Extensive numerical experiments illustrate how cash-flow NPV models provide insights into the value of planning for shortages and strategic choices about the design of the production-inventory system. It also provides insight into the classical problem of how to interpret unit backorder cost and unit lost sales cost. The study indicates that these insights cannot be reliably obtained from NPV models based on discounting unit backorder costs and unit lost sales costs.
0925-5273
1-11
Ghiami, Yousef
74bc081a-7e08-4326-8bec-b25ba4ea8ae0
Beullens, Patrick
893ad2e2-0617-47d6-910b-3d5f81964a9c
Ghiami, Yousef
74bc081a-7e08-4326-8bec-b25ba4ea8ae0
Beullens, Patrick
893ad2e2-0617-47d6-910b-3d5f81964a9c

Ghiami, Yousef and Beullens, Patrick (2016) Planning for shortages? Net present value analysis for a deteriorating item with partial backlogging. International Journal of Production Economics, 178, 1-11. (doi:10.1016/j.ijpe.2016.04.021).

Record type: Article

Abstract

This paper develops inventory models to help answer strategic questions concerning whether planning for shortages offers financial benefits. A production-inventory system producing a deteriorating product in batches at a finite production rate with partial backordering is considered. Customers pay a deposit when placing a backorder. Backordered items receive a discount on the sales price.
As lost sales may lead to customers not returning, the demand rate may depend on the fraction of lost sales. We develop a cash-flow based profit maximising Net Present Value (NPV) model without the inventory cost parameters commonly used in this context: unit holding cost, unit backorder cost, unit deterioration cost, and unit lost sales cost. The model finds the optimal inventory policy just like NPV models that discount the traditional parameters but has the advantage of not needing to estimate the value of the traditional parameters. It is shown that in models based on discounting the traditional parameters, the parameters are not exogenously determinable but are non-trivial functions of non-financial endogenous system parameters such as the production rate, annual demand rate, and backorder rate. Extensive numerical experiments illustrate how cash-flow NPV models provide insights into the value of planning for shortages and strategic choices about the design of the production-inventory system. It also provides insight into the classical problem of how to interpret unit backorder cost and unit lost sales cost. The study indicates that these insights cannot be reliably obtained from NPV models based on discounting unit backorder costs and unit lost sales costs.

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Accepted/In Press date: 26 April 2016
e-pub ahead of print date: 27 April 2016
Organisations: Operational Research

Identifiers

Local EPrints ID: 393556
URI: http://eprints.soton.ac.uk/id/eprint/393556
ISSN: 0925-5273
PURE UUID: 8691f558-499d-4e2d-b8b9-223a1373cbfb
ORCID for Patrick Beullens: ORCID iD orcid.org/0000-0001-6156-3550

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Date deposited: 29 Apr 2016 08:02
Last modified: 15 Mar 2024 05:32

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Author: Yousef Ghiami

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