European Journal of Operational Research 174 (2006) 861–873

www.elsevier.com/locate/ejor

Production, Manufacturing and Logistics

Two-warehouse inventory model with deterioration

under FIFO dispatching policy
Chun Chen Lee *

Department of Accounting, Soochow University, 56, Sec. 1, Kuei-Yang Street, Taipei 100, Taiwan

Received 3 November 2004; accepted 21 March 2005

Available online 3 January 2006

Abstract

In most of the literatures on two-warehouse inventory decision models, the last-in-first-out (LIFO) dispatching pol-
icy has always been assumed. This presumption, however, is not in line with the actual practice of most business entities.
To enhance the freshness of merchandise or goods, businesses commonly follow the first-in-first-out procedure (FIFO).
This inconsistency forms the base and main motivation for our research. In this paper, Pakkala and Achary’s two-ware-
house LIFO model is first modified and then a FIFO dispatching two-warehouse model with deterioration is proposed.
Comparison of the two models indicated that the FIFO model is less expensive to operate than LIFO, if the mixed
effects of deterioration and holding cost in RW are less than that of OW. Finally, numerical examples are provided
to investigate and examine the impact that various parameters have on policy choice.
Ó 2005 Published by Elsevier B.V.

Keywords: Inventory; Deterioration; Two-warehouse; FIFO; LIFO

1. Introduction

The classical economic order quantity (EOQ) model is formulated by considering three inventory costs
to achieve a minimum system cost. These costs are the procurement cost, carrying cost and shortage cost.
One of the unrealistic assumptions is that items are not perishable while in storage. However, there are
items such as highly volatile substances, radioactive materials, fresh goods, etc., in which the rate of dete-
rioration is higher. Loss from deterioration should not be ignored. Ghare and Schrader [4] were the first to

*
Tel.: +886 2225 38244.
E-mail address: cclee@scu.edu.tw

0377-2217/$ - see front matter Ó 2005 Published by Elsevier B.V.

doi:10.1016/j.ejor.2005.03.027
862 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873

consider issues regarding on-going deterioration of inventory. Since then, research for deterioration of
inventory has been extensively examined by many researchers from time to time. Raafat [14] and Goyal
and Giri [6] have made excellent reviews of these models.
In various situations, the degree of deterioration depends on the preservation of inventory in the facility
and its environmental conditions which are available in the warehouse. An interesting research topic incor-
porating deterioration effect in inventory decision involves the situations in which there are two storage
facilities. Sarma [15] is the first to discuss the two-warehouse inventory model with deterioration. In his
model, a single inventory item is first stored in the owned warehouse (OW), with limited capacity, and
any additional quantity to be stored in the rented warehouse (RW). An infinite replenishment rate is
considered in this model with uniform scheduling period and shortage allowance. Other authors, e.g.
Benkherouf [2], Bhunia and Maiti [3], Goswami and Ghaudhuri [5], and Lee and Ma [8] proposed the
two-warehouse models when demand is a function of time either with or without the consideration of
deterioration. Pakkala and Achary [10] extended Sarma’s model to the case of finite replenishment rate with
shortage. All of the above mentioned research models are commonly referred to as continue release model,
assuming that inventory is to be released directly and continuously in each warehouse. Murdeshwar and
Sathe [9], Pakkala and Achary [11] considered bulk release model which inventory in RW must first be
transferred to OW before its release to the customer.
It is generally assumed that the RW offers better preserving facilities than the OW, therefore it charges a
higher holding cost. The two-warehouse models discussed above naturally adopt the LIFO (last-in-first-
out) inventory flow. Under such circumstances, inventories are first stored in OW with overflows going
to RW. But when retrieving for consumption, it is always from RW when available before retrieving from
OW. However, we believe such rule needs to be further investigated when applying to a real world situation.
First, in the RW, particular in a public warehouse, a professional vendor who specializes in the warehous-
ing operation would carry a lower operating cost due to well equipped set ups, learning effect of trained
worker, and the economics of scale from high volume. Second, as competition increases between warehouse
facilities in real world, their ability to offer valued added service with completive lower price is becoming
more and more necessary. Many businesses have gotten into or expanded their use of public warehouse
because of cheap shipping or other financial reasons (Anonymous, [1]). Finally, a critical point of inventory
decision for perishable products, to allow later stored inventory in RW to be dispatched last means a
greater risk of deterioration of inventory. The cost of deteriorated inventory and related opportunity cost
may far exceed the cost saving benefit derived from the warehouse rent. In the real world, maintaining a
FIFO rule of inventory flow has been the common practice of most managers. In fact, Pierskalla and Roach
[12] have shown that a FIFO issuing policy is optimal for perishable and deteriorating inventories in a sin-
gle warehouse setting with unlimited capacity.
In this paper, Pakkala and Achary’s [10] LIFO model with finite replenishment rate will be reconsidered.
We propose a FIFO two-warehouse model that inventory in OW, which is stored first, will be consumed
before those in RW based on the above considerations that the true holding cost in RW is not necessarily
higher than in OW. Before making comparisons between the two models, in Section 3.1, we made a mod-
ification to Pakkala and Achary’s model to allow their model to be more complete. Furthermore, the pro-
posed assumption of a predetermined cycle time will also be relaxed to a more general approach which is to
let cycle time be part of decision and to determine both order level and backorder level simultaneously. In
the final section, various parameter analyses are implemented to examine the impact on policy choice.

2. Notations and assumptions

The two-warehouse inventory models proposed in this research are based on the following notations and
assumptions:
 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873 863

D demand rate which is a constant

P constant production rate, P > D
C1 cost of a deteriorated item
C2 shortage cost per unit inventory per unit of time in shortage
C3 unit set up cost
Ti time period in a production cycle of stage i, i = 1, . . . , 6
Ii(t) inventory level at time t during time period Ti
F, H holding cost held in the RW and OW respectively
b, a deteriorating rates in RW and OW respectively, 0 < b, a < 1
W capacity of the OW
R maximum inventory level in RW
B maximum shortages allowed

The following assumptions are adopted in this study:

1. Lead time is zero and shortages are allowed.

2. The rented warehouse RW has unlimited capacity.
3. Inventory items are stored in RW only after OW is fully utilized. Once stored, these items are assumed
not to be relocated.

For convenience to differentiate between the models, each time stage Ti under LIFO and FIFO policy is
further denoted by P TLi and TFi, i = 1,
P. . . , 6. Denote TL and TF as total production cycle time for the two
policies, then T L ¼ i T Li , and T F ¼ i T Fi . Also, inventory level during each stage i for the two models are
set as ILi(t) and IFi(t).

3. The models

3.1. Modified LIFO inventory model

The inventory in a production system with LIFO dispatching policy is depicted in Fig. 2. The inventory
cycle can be divided into six parts, named TLi, i = 1, . . . , 6. Initially, BL units of backorders are carried over

Inventory level

RL

Time

BL

Fig. 1. Inventory level of Pakkala and Achary’s two-warehouse LIFO model.

864 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873

Inventory level

RL
IL4(t) IL5(t)

W
IL3(t)
IL6(t)

IL2(t) IL7(t)
Time

TL1 TL2 TL3 TL4 TL5 TL6

IL1(t) IL8(t)
BL

Fig. 2. Inventory level of modified two-warehouse LIFO model.

from the previous cycle. The production run starts at the beginning of TL1 and, while production and
demand happen simultaneous, backorders are made up within TL1 at the rate of P  D. During TL2, inven-
tory items in OW are built from 0 up to W units with a deterioration rate of a. Any production quantity
exceeding this level must be stored in RW. During TL3, inventory items in RW are built from 0 to RL units
but with a deterioration rate of b. Meanwhile, in OW, inventory level will be depleted because of deterio-
ration in stock with a rate of a. In (11) of Pakkala and Achary [10], the available spaces in OW released
from deteriorated inventory items during TL3 are assumed not to be reutilized (see Fig. 1). However, under
the proposed assumption that H < F, the system cost will obvious be higher if it is not reutilized, and vice
versa. This short coming will be modified in this paper before making a comparison between FIFO and
LIFO in the next section.
The production run stops at the end of TL3, and RL units of inventory items in RW are depleted in TL4.
The remaining inventory items in OW are then depleted in TL5 by demand and deterioration. Finally, BL
units of backorders are accumulated at the end of TL6 by a rare of D, which completes the production cycle.
In this system, the management seeks to find the optimal levels of both RL and BL.
The differential equations describing the inventory level at any time in the production cycle are given as
follows:
dI L1 ðtÞ=dt ¼ P  D; 0 6 t 6 T L1 ;
dI L2 ðtÞ=dt þ aI L2 ðtÞ ¼ P  D; 0 6 t 6 T L2 ;
dI L3 ðtÞ=dt ¼ 0; 0 6 t 6 T L3 ;
dI L4 ðtÞ=dt þ bI L4 ðtÞ ¼ P  D  aW ; 0 6 t 6 T L3 ;
dI L5 ðtÞ=dt þ bI L5 ðtÞ ¼ D; 0 6 t 6 T L4 ;
dI L6 ðtÞ=dt þ aI L6 ðtÞ ¼ 0; 0 6 t 6 T L4 ;
dI L7 ðtÞ=dt þ aI L7 ðtÞ ¼ D; 0 6 t 6 T L5 ;
dI L8 ðtÞ=dt ¼ D; 0 6 t 6 T L6 .
Using the boundary conditions that IL1(TL1) = 0, IL2(0) = 0, IL4(0) = 0, IL5(TL4) = 0, IL6(0) = W,
IL7(TL5) = 0, and IL8(0) = 0, the above equations can be solved respectively as follows:
I L1 ðtÞ ¼ ðP  DÞðT L1  tÞ; 0 6 t 6 T L1 ; ð1Þ
I L2 ðtÞ ¼ ðP  DÞð1  eat Þ=a; 0 6 t 6 T L2 ; ð2Þ
 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873 865

I L3 ðtÞ ¼ W ; 0 6 t 6 T L3 ; ð3Þ
bt
I L4 ðtÞ ¼ ðP  D  aW Þð1  e Þ=b; 0 6 t 6 T L3 ; ð4Þ
 
I L5 ðtÞ ¼ D ebðT L4 tÞ  1 =b; 0 6 t 6 T L4 ; ð5Þ
I L6 ðtÞ ¼ W eat ; 0 6 t 6 T L4 ; ð6Þ
 
I L7 ðtÞ ¼ D ½eaðT L5 tÞ  1 =a; 0 6 t 6 T L5 ; ð7Þ
I L8 ðtÞ ¼ Dt; 0 6 t 6 T L6 . ð8Þ
Now, the inventory items held in RW and OW for a production cycle are
Z T L3 Z T L4
G1 ¼ I L4 ðtÞdt þ I L5 ðtÞdt ¼ ½P T L3  DðT L3 þ T L4 Þ  aW T L3 =b; ð9Þ
0 0

and
Z T L2 Z T L3 Z T L4 Z T L5
G2 ¼ I L2 ðtÞdt þ I L3 dt þ I L6 ðtÞdt þ I L7 ðtÞdt
0 0 0 0

¼ ½P T L2  DðT L2 þ T L5 Þ þ aW T L3 =a. ð10Þ

Denote G3 the inventory items deteriorated per cycle, G3 = bG1 + aG2:
G3 ¼ P ðT L2 þ T L3 Þ  DðT L2 þ T L3 þ T L4 þ T L5 Þ. ð11Þ
The total amount of shortages in the production cycle is
Z 0 Z 0
 
G4 ¼ I L1 ðtÞdt þ I L8 ðtÞdt ¼ ðP  DÞT 2L1 þ DT 2L6 =2.
T L1 T L6

Denote TLB = TL1 + TL6, using IL1(0) = IL8(TL6), from (1) and (8), TL1 and TL6 can be expressed as
functions of TLB:
T L1 ¼ DT LB =P and T L6 ¼ ðP  DÞT LB =P . ð13Þ
We then have
G4 ¼ DðP  DÞT 2LB =2P .
The total system cost per unit of time for LIFO policy is
TC L ¼ ð1=T L ÞðFG1 þ HG2 þ C 1 G3 þ C 2 G4 þ C 3 Þ
¼ ð1=T L ÞfF ½P T L3  DðT L3 þ T L4 Þ  aW T L3 =b þ H ½P T L2  DðT L2 þ T L5 Þ þ aW T L3 =b
þ C 1 ½P ðT L2 þ T L3 Þ  DðT L2 þ T L3 þ T L4 þ T L5 Þ þ C 2 DðP  DÞT 2LB =ð2P Þ þ C 3 g. ð14Þ
Now that IL2(TL2) = W, TL2, which is a constant can be derived from (2):
 
1 P D
T L2 ¼ ln . ð15Þ
a P  D  aW
Using IL4(TL3) = IL5(0), from (4) and (5), we get TL4 in terms of TL3:

1 ðP  aW Þ  ðP  D  aW ÞebT L3
T L4 ¼ ln . ð16Þ
b D
Also, using IL7(0) = IL6(TL4) from (6) and (7), TL5 can be derived as a function of TL4 (also function of
TL3):
866 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873
 
1 aW eaT L4
T L5 ¼ ln 1 þ . ð17Þ
a D

Therefore, the total cost per unit time can then be expressed explicitly in terms of TL3 and TLB. The opti-
mal value of TL3 and TLB must satisfy the following two necessary conditions: oTC/oTL3 = 0 and oTC/
oTLB = 0. After rearrangement, we can obtain
         
aF F F dT L4 H dT L5 dT L4 dT L5
W H þ ðP  DÞ C 1 þ  D C1 þ  D C1 þ  TC 1 þ þ ¼0
b b b dT L3 a dT L3 dT L3 dT L4
ð18Þ
and
C 2 DðP  DÞ
T LB  TC ¼ 0; ð19Þ
P
where
dT L4 P  D  aW
¼
dT L3 ðP  aW ÞebT L3  ðP  D  aW Þ
and
dT L5 aW ðP  D  aW ÞeaT L4
¼ .
dT L3 ðD þ aW eaT L4 Þ½ðP  aW ÞebT L3  ðP  D  aW Þ
The total system cost in (14) is a complicated nonlinear function in terms of TL3 and TLB and not easy to
solve analytically. Through an enormous amount of numerical analyses, we have found that the total cost
function shows convexity with respect to TL3 and TLB. By applying numerical subroutine DNEQNF in
IMSL, the optimal value of TL3 and TLB can be obtained from (18) and (19).
Now that IL1(0) = B, and that IL4(TL3) = RL from (1), (13) and (4),
DðP  DÞ ðP  D  aW Þð1  ebT L3 Þ
BL ¼ T LB ; RL ¼ .
P b
There the optimal production policy, i.e., BL and RL , can be easily derived after the optimal solutions T L3
and T LB are obtained.
Theorem 1. Modified LIFO two-warehouse model always has a lower cost than Pakkala and Achary’s LIFO
model if H  aF/b > 0.

Proof. Denote TCP as average total cost of Pakkala and Achary’s (11). Let TP1 = T  t1, and
TPi = ti1  ti2, for i = 2, . . . , 6. After variables and parameters transformation, Pakkala’s (11) can
expressed as
TC P ¼ ð1=T P ÞfH ½P T P2  DðT P2 þ T P5 Þ=a þ F ½P T P3  DðT P3 þ T P4 Þ=b þ C 1 ½P ðT P2  T P3 Þ
2
 DðT P2 þ T P3 þ T P4 þ T P5 Þ þ C 2 DðP  DÞðT P1 þ T P6 Þ =ð2P Þ þ C 3 g. ð20Þ
For our convenience and without loss of generality, assuming that TPi = TLi for i = 1, . . . , 6. From (14) and
(20), cost difference between modified LIFO and Pakkala and Achary’s LIFO model is given by
T C L  T C P ¼ W T L3 ðH  aF bÞ.
Since WTL3 > 0, if a is not significantly less than b, modified LIFO model will have a lower cost than Pak-
kala and Achary’s LIFO model under their assumption that H < F. h
 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873 867

3.2. FIFO model

In a system with FIFO dispatching policy, inventory items in OW that is stored first will first be released
for consumption before that of RW. After the end of TF3 (see Fig. 3), when production stops, inventory
items in RW will remain in storage but with a deterioration rate b. Any demands are withdrawn from
OW until the inventory items in OW are completely consumed, thereafter withdrawing from RW. Other
inventory fluctuations and the decision objectives are all to be the same as those in a LIFO system.
The differential equations describing inventory behavior for IFi, for i = 1, 2 and 8, are the same as LIFO
model and can be obtained from (1), (2) and (8). Inventory level IFi, for i = 3, . . . , 7, are described as
follows:
dI F3 ðtÞ=dt þ aI F3 ðtÞ ¼ 0; 0 6 t 6 T F3 ;
dI F4 ðtÞ=dt þ bI F4 ðtÞ ¼ P  D; 0 6 t 6 T F3 ;
dI F5 ðtÞ=dt þ bI F5 ðtÞ ¼ 0; 0 6 t 6 T F4 ;
dI F6 ðtÞ=dt þ aI F6 ðtÞ ¼ D; 0 6 t 6 T F4 ;
dI F7 ðtÞ=dt þ bI F7 ðtÞ ¼ D; 0 6 t 6 T F5 .
Using the boundary conditions that IF3(0) = W, IF4(0) = 0, IF5(0) = IF4(TF3), IF6(TF4) = 0, IF7(TF5) =
0, one can obtain following inventory level functions:
I F3 ðtÞ ¼ W eat ; 0 6 t 6 T F3 ; ð21Þ
bT
I F4 ðtÞ ¼ ðP  DÞð1  e Þ=b; 0 6 t 6 T F3 ; ð22Þ
bT F3 bt
I F5 ðtÞ ¼ ðP  DÞ½1  e e =b; 0 6 t 6 T F4 ; ð23Þ
aðT F4 tÞ
I F6 ðtÞ ¼ D½e  1=a; 0 6 t 6 T F4 ; ð24Þ
bðT F5 tÞ
I F7 ðtÞ ¼ D½e  1=b; 0 6 t 6 T F5 . ð25Þ
The inventory holding in RW and OW are
S 1 ¼ ½P T F3  DðT F3 þ T F5 Þ=b and S 2 ¼ ½P T F2  DðT F2 þ T F4 Þ=a. ð26Þ
The total inventory deteriorated and shortages are
S 3 ¼ bS 1 þ aS 2 ¼ P ðT F2 þ T F3 Þ  DðT F2 þ T F3 þ T F4 þ T F5 Þ and S 4 ¼ DðP  DÞT 2FB =ð2P Þ; ð27Þ
where TFB = TF1 + TF6.

Inventory level

IF5(t)
RF
IF4(t) IF7(t)

W
IF3(t)
IF2(t) IF6(t)

Time
TF1 TF2 TF3 TF4 TF5 TF6

IF1(t) IF8(t)
BF

Fig. 3. Inventory level of two-warehouse FIFO model.

868 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873

Finally, total system cost per unit of time under FIFO dispatching policy is

TC F ¼ ð1=T F ÞðF S 1 þ HS 2 þ C1 S 3 þ C 2 S 4 þ C 3 Þ
¼ ð1=T F ÞfF ½P T F3  DðT F3 þ T F5 Þ=b þ H ½P T F2  DðT F2 þ T F4 Þ=a
þ C 1 ½P ðT F2 þ T F3 Þ  DðT F2 þ T F3 þ T F4 þ T F5 Þ þ C 2 DðP  DÞðT FB Þ2 =ð2P Þ þ C 3 g. ð28Þ

In (28), TF2 is a constant that should have no difference with TL2, we have
 
1 P D
T F2 ¼ T L2 ¼ ln . ð29Þ
a P  D  aW

By using IF3(TF3) = IF6(0) and IF7(0) = IF5(TF4), from (21), (23), (24) and (25), the value of TF4 and TF5
can be derived respectively as
  
1 aW eaT F3 1 ðP  DÞð1  ebT F3 ÞebT F4
T F4 ¼ ln 1 þ and T F5 ¼ ln 1 þ . ð30Þ
a D b D
Let TF3 and TFB be the two decision variables of (28). The optimal value of TF3 and TFB must satisfy the
two necessary conditions: oTC/oTF3 = 0 and oTC/oTFB = 0. After rearrangement, we have
       
F H dT F4 F dT F5 dT F4 dT F5
ðP  DÞ C 1 þ  D C1 þ  D C1 þ  TC 1 þ þ ¼ 0; ð31Þ
b a dT F3 b dT F3 dT F3 dT F3
and
C 2 DðP  DÞ
T FB  TC ¼ 0; ð32Þ
P
where
dT F4 aW dT F5 ðP  DÞðaW þ DeðabÞT F3 Þ
¼ ; ¼ .
dT F3 DeaT F3 þ aW dT F3 ðaW þ DeaT F3 Þ½DebT F4 þ ðP  DÞð1  ebT F3 Þ
DðP DÞ
Furthermore, BF can be derived as BF ¼ P
T FB , and by using IF4(TF3) = RF, from (22)
bT F3
ðP  D  aW Þð1  e Þ
RF ¼ .
b
Therefore, the optimal production policy under FIFO dispatching, i.e., BF and RF , can also be derived after
the optimal solutions T F3 and T FB are obtained.
From (14) and (28), one interesting observation is shown between the two policies.
Theorem 2. If the two warehouses have the same deterioration rate, i.e., a = b, then TCF > TCL for H < F,
otherwise TCF > TCL if H < F, or TCF < TCL if H > F.

Proof. Let T3 and TB be the decision objectives of the two models. We want to prove that if F < H and
a = b, then TCF < TCL for any combinations of TC (T3, TB). First, let TL3 = TF3, TLB = TFB. The follow-
ing Lemmas will hold:

Lemma 1. TL4 + TL5 = TF4 + TF5.

aW
Lemma 2. D
T L3 þ T F4 > T L5 .
 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873 869

Proof of Lemma 1

(i) Add TL4 to both sides of (17), we have

   
1 aW aT L4 1 1 aW
T L5 þ T L4 ¼ ln 1 þ e þ lnðeaT L4 Þ ¼ ln þ eaT L4 .
a D a a D
Substitute the value of TL4 in (16) to above equation and after simplification

1 P  ðP  D  aW ÞebT L3
T L4 þ T L5 ¼ ln .
a D
(ii) Add TF4 to both sides of (30), we have
   bT F4 
1 ðP  DÞð1  ebT F3 ÞebT F4 1 1 De þ ðP  DÞð1  ebT F3 Þ
T F5 þ T F4 ¼ ln 1 þ þ ln ebT F4 ¼ ln .
b D b b D

Substitute the value of TF4 in (30) to above equation and after simplification

1 P  ðP  D  aW ÞebT F3
T F4 þ T F5 ¼ ln ¼ T L4 þ T L5 .
b D
(iii) Note also that, from (29) TL2 = TF2, we hence have
T LB þ T L2 þ T L3 þ T L4 þ T L5 ¼ T FB þ T F2 þ T F3 þ T F4 þ T F5 ; i.e., T L ¼ T F . 

Proof of Lemma 2. Denote r = aW/D > 0, and let T 0F4 ¼ 1a lnð1 þ rÞ.
Define f ðT F3 Þ ¼ T F4 þ rT F3  T 0F4 , from (30)
aT 
f ðT F3 Þ ¼ 1a lnð1 þ reaT F3 Þ  1a lnð1 þ rÞ þ rT F3 ¼ 1a ln 1þre1þr F3 þ rT F3 ,
h aT F3
i
þreaT F3 Þ
where f (0) = 0, f 0 ðT F3 Þ ¼ rð1e1þreaT F3
> 0 ðby eaT F3 < 1Þ.
Which implies that f (TF3) > 0 for TF3 > 0. We hence have T F4 þ rT F3 > T 0F4 .
Furthermore, from (17) T L5 ¼ 1a lnð1 þ reaT L4 Þ, which implies
T L5 < T 0F4 < T F4 þ rT F3 . h

Proof of Theorem 2. From (14), (28), and the two lemmas

 
1 F H
TC F  TC L ¼ ðDT L4  DT F5 þ aW T L3 Þ þ ½DT L5  DT F4  aW T L3 
TF b a
 
1 F
¼ ðDT L4  DT F5 þ aW T L3 þ DT L5  DT F4  aW T L3 Þ
TF b

ðH  F Þ
þ ½DT L5  DT F4  aW T L3 
a
   
D ðF  H Þ aW T L3
¼ þ T F4  T L5 > 0; provided that F > H .
TF a D
The above theorem implies that, in facing policy choice, if the two warehouses have similar preservation
conditions that the inventory deterioration are nearly the same, then the policy choice solely depends on the
difference in inventory holding cost, namely H and F. FIFO policy will be less expensive when HF, other-
wise, LIFO is suggested. Undoubtedly, when the two warehouses have all the same parameters i.e., b = a,
and F = H, these two policies should have no difference, i.e., TCF > TCL. h
870 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873

3.3. Choice from one-warehouse system (L1) and two-warehouse system (L2)

Let the two warehouses be utterly no difference, i.e., a = b, H = F, total cost of different dispatching
policy in (14) and (28) of L2 can both be reduced to the following expression:
TC F ¼ TC L ¼ ð1=T ÞfðC 1 þ F =bÞ½P ðT 2 þ T 3 Þ  DðT 2 þ T 3 þ T 4 þ T 5 Þ
þ C 2 DðP  DÞðT 1 þ T 6 Þ2 =ð2P Þ þ C 3 g. ð33Þ
After certain variable simplification, expression in (33) is the same as Raafat et al. [13], which is an eco-
nomic production quantity model for deteriorating items with unlimited warehouse space. Denote TCL1
to be the average total cost of L1 system, we have TCF = TCL = TCL1.
Furthermore, let W = 0 and RW be the sole warehouse under consideration. By using the fact that
TL2 = TL5 = 0 [substitute W = 0 into (15) and (17)], same result in (33) can also be obtained from (14)
of our modified LIFO model. Or, similarly, from (28)–(30), one can derive TCL1 from TCF.
Under the assumption that OW is to be utilized first, L2 system will not necessarily be used if it is eco-
nomically less than L1. The following algorithm can be employed to determinate between the systems
choices for the two policies.

Step 1. First solve L1 in (33).

Step 2. Calculate and denote RL1 the optimal maximum inventory level of L1.
Step 3. If RL1 is less than W, L1 will be used. Otherwise, when RL1 > W , compare TC L2 with the boundary
cost on L1 at W, i.e., TCL1(W). L2 will be used if TC L2 < TC L1 ðW Þ, otherwise L1(W) is the optimal
solution.

4. Illustrative example

The following parameters are used to illustrate the application of the two models. The production capac-
ity is 32 000 units per year; the demand rate is 8000 units per year; other related factors are as follows: short-
age cost is $8 per unit per year; deterioration cost is $20 per unit; OW capacity is 1200 units.
In Table 1, in order to make comparison of the deteriorating effect on policy selection, holding cost in
the two warehouses are assumed to be equal, i.e., (H, F) = (2, 2), deterioration rate in RW be fixed at 0.06.
Denoted r = a/b, by increasing the value r (increase a), total cost would increase under both policies.
From Table 1, we can observe that, if r = 1, both policies will utterly bear no difference and have the same
decision as Theorem 2 has shown. In fact, the selection of policy depends on the value of r when there are
no material differences in the holding cost between the two warehouses. If r < 1, when deterioration effect in
OW is smaller than in RW, LIFO is suggested in order to avoid a higher cost in RW due to a higher inven-

Table 1
Comparison of policy by varying deterioration rate
r FIFO LIFO
RF þW BF TC F RL þ W BL TC L
0.1 2305.8 882.6 7061.3 2497.7 837.2 6697.5
0.5 2311.4 902.5 7219.9 2419.3 878.0 7024.1
1 2317.7 927.1 7416.7 2317.7 927.1 7416.7
2 2328.4 975.7 7805.2 2100.7 1018.5 8147.8
4 2342.1 1070.4 8563.3 1588.6 1170.8 9366.3
 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873 871

tory deterioration. On the other hand, if r > 1, FIFO is preferred to LIFO. Defining cost penalty
DTC% = (TCL  TCF)/TCF, in the case of relatively higher deterioration rate in OW, namely r = 2,
and r = 4, the cost penalty of using LIFO policy are 4.39% and 9.37% respectively.
By letting (a, b) = (0.0625, 0.05), i.e., r = 1.25, other parameters remain the same, Table 2 shows the
impact that H and F have on the optimal policy. We have the following observations:

1. Under the L2 system, FIFO policy will always suggest a lower total cost than LIFO when F 5 H. While
for H = 8, the optimal policy suggests the L1 policy, it is unnecessary to make any differentiation.
2. The higher the value of holding cost in H and F, the higher the value of TCF and TCL. While it is indi-
cated that TCL is more sensitive to a change in H than a change in F, and vice versa, TCF is more sen-
sitive to the change of F. When F increases, it is expected that FIFO has a higher increase in total cost
than LIFO, as it implies higher holding cost in RW, since inventory items have to be carried longer than
that of LIFO.
3. Under the assumption that OW is to be stored first, any changes in RW parameters (F or b) will not
change the decision from L2 to L1, or vice versa, from L1 to L2 in both two models. From Table 2,
for example, for H = 2 (where RL1 > W ), L2 is suggested as the optimal solution except when F = 8

Table 2
Comparison of the difference in policy under varying holding cost combination
H F FIFO LIFO
RF ðþW Þ BF TC F RL ðþW Þ BF TC L
2 2 2417.7 915.8 7326.8 2370.2 926.0 7408.6
4 1715.9 925.6 8044.8 1957.1 961.7 7694.3
8 1200.0(W) 932.2 8365.7 1646.7 992.2 7938.1
4 2 2429.5 996.5 7971.7 1967.8 1073.9 8591.4
4 1721.3 1084.8 8678.2 1684.1 1089.9 8719.4
8 1200.0(W) 1091.2 8973.8 1481.3 1105.5 8820.7
8 2,4,8 1097.2(L1) 1268.9 10151.2 1097.2(L1) 1268.9 10151.2

Table 3
Analysis of change in various parameters has on policy choice
0 0
TC L TC F DTC 0 % Policy suggest
0
W /W 0.5 8075.2 7549.7 6.96% FIFO
2 8729.7 8729.7 0% L1
P 0 /P 0.5 7100.9 6858.4 3.54% FIFO
2 9223.3 8404.7 9.74% FIFO
D 0 /D 0.5 6668.3 6241.2 6.84% FIFO
2 9792.3 9314.6 5.13% FIFO
C 01 =C 1 0.5 8170.0 7462.7 9.48% FIFO
2 9244.5 8792.9 5.14% FIFO
C 02 =C 2 0.5 7360.4 7008.6 5.02% FIFO
2 9456.7 8620.8 9.69% FIFO
C 03 =C 3 0.5 6170.6 5936.9 3.94% FIFO
2 11782.5 10908.3 8.01% FIFO
872 C.C. Lee / European Journal of Operational Research 174 (2006) 861–873

where L1 is to be used but at full capacity (W). Similarly, in LIFO, when F increase (under H = 2 and 4
where L2 is used) it would not reverses back to L1 system. In fact, only as F ! 1, L1(W) would be the
optimal solution of LIFO, a similar result has been shown in (12–56) of Hartley [7].

The sensitivity analysis, with respect to other parameters on the total system cost is examined. The
results are summarized in Table 3. The following inference may be drawn from Table 3.

1. The range of DTC 0 % is from 3.54% to 9.74%. The average value of DTC 0 % is about 6.68%.
2. The value of DTC 0 % is more sensitive to the parameter of subset P, C1, C2, C3, and less sensitive to
parameter D.
3. The higher the value of subset W, D, C1, the smaller the value of DTC 0 %, but the higher the value of
subset P, C 2, C3, the higher the value of DTC 0 %.
4. Changes in the parameter subset W, P, D, C1, C2, C3 do not change the optimal dispatching policy.

5. Summary and conclusions

Previous literature on two-warehouse inventory model has always assumed that inventory holding cost
in RW is higher than OW. This resulted in a LIFO flow of inventory that items in RW must be consumed
prior to OW to avoid higher holding cost. This assumption is not necessarily true in the real world because
RW is a specialized operation faced with severe competition that the opportunity to gain lower holding cost
than OW is higher. Most important for managers that deal with perishable products using FIFO, rather
than LIFO, is a common accepted practice of making sure that the products are dispatched at its maximum
freshness. In this paper, a two-warehouse inventory model with the FIFO dispatching policy for deteriorat-
ing inventory items was proposed. It has been proven that when deterioration rate is the same in the two
warehouses, FIFO is less expensive than LIFO provided that holding cost in RW will be lower than OW. In
addition, Pakkala and Achary’s two-warehouse LIFO model has been sufficiently modified to be more
complete. The modified LIFO model has proven to have a lower cost than Pakkala and Achary’s model
under their assumption that H < F, when a is not significantly less than b.
Numerical analysis have indicated {a, b, H, F} are the key set of factors in choosing LIFO or FIFO.
Particularly, when RW parameters {b, F} are superior to that of OW {a, H}, in this case FIFO would
be employed rather than LIFO. From the analysis, it was pointed out that TCL is more sensitive to a change
in H than a change in F, and to the contrary, TCF is more sensitive to a change in F. Other parameters such
as {P, D, W, C1, C2, C3} would have impacted solely on the magnitude but not in the directions between the
two policies.

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