Determining the Reorder Point and Order-Up-To-Level in a Periodic Review System So As to Achieve a Desired Fill Rate and a Desired

Average Time Between Replenishments

Edward A. Silver Haskayne School of Business University of Calgary 2500 University Drive NW Calgary, AB T2N 1N4 Canada Hussein Naseraldin Joseph L. Rotman School of Management 105 St. George Street Toronto, ON M5S 3E6 Canada Diane P. Bischak Haskayne School of Business University of Calgary 2500 University Drive NW Calgary, AB T2N 1N4 Canada

October 2007

Abstract In this paper we consider a periodic review, reorder point, order-up-to-level system, a type commonly used in practice. Motivated by a specific practical context, we present a novel approach to determining the reorder point and order-up-to-level (for a given review interval) so as to target desired values of i) customer fill rate and ii) average time between consecutive replenishments. Specifically, by using a diffusion model (producing normally distributed demand) we convert a periodic review, constant lead time setting into one having continuous review and a random lead time. The method is simple to implement and produces quite reasonable results.

Keywords: Inventory control, Heuristics, Stochastic, Diffusion process, Supply chain management

Suggested running head: Determining s and S in a periodic system

1. Introduction This paper is concerned with an inventory control system commonly used in practice. Specifically, the status of an item is examined at equi-spaced (review) intervals and, if the inventory position (on-hand plus on-order minus backorders) is at or below the reorder point (denoted by s), then a replenishment, that raises it to the order-up-to-level (denoted by S), is initiated. The review interval (denoted by R) is often preset at a convenient value (e.g., day, week), which is what will be assumed here. The research leading to this paper was motivated by the practical context of a major international producer and distributor of food products. In particular, it was deemed crucial to determine s and S so as to approximately satisfy two practical constraints: i) a specified fill rate (fraction of demand satisfied without backordering), i.e., a marketing requirement, and ii) a specified average time between consecutive replenishments (e.g., two weeks), desirable from the perspective of the supplier (production department). It is inherently difficult to find proper values of the two control parameters, the reorder point and order-up-to-level, primarily due to periodic review causing undershoots of the reorder point before replenishments are triggered. This is illustrated in Figure 1, where replenishments are placed at times 0 and 3R and a shortage occurs because the undershoot at time 3R plus the demand during the lead time L exceeds the reorder point s. The probability distribution of the undershoot is a complicated function of the distance S s and the distribution of demand during the review interval R. The complexity is not present in the simpler periodic review, order-up-tolevel system where a replenishment is initiated at each review instant (see, for example, Robb and Silver, 1998, or Silver et al., 1998).

The aforementioned practical context necessitated a relatively simple procedure for determining appropriate values of s and S. An early software package, IBMs IMPACT system (IBM, 1971), provided a simple, but overly conservative, choice of s by assuming that the inventory position is just above s at the review prior to the one at which a replenishment is initiated, hence s must provide protection over an interval of length R + L . This approach had been advocated even earlier (Brown, 1967). In contrast, most of the literature presents rather complicated procedures. Moreover, none of these explicitly deals with both of the above-mentioned constraints. Schneider (1978, 1981) and Tijms and Groenevelt (1984) used asymptotic results from renewal theory (Roberts, 1962) to approximate the undershoot distribution. For a different type of service measure (fraction of demand being on backorder), Schneider and Ringuest (1990) developed power approximations for s and S in the spirit of the original power approximation work of Erhardt (1979). Bashyam and Fu (1998) advocated a simulation-based approach to minimize setup and holding costs subject to meeting a prescribed fill rate. Other authors (e.g., Erhardt and Mosier, 1984, and Zheng and Federgruen, 1991) considered shortage costs rather than a service constraint. More recently, Moors and Strijbosch (2002) developed an efficient descriptive method for determining the fill rate for given values of s and S under the assumption of gamma distributed demand. Unlike in the approach we propose, their method would have to be combined with a search on s and S to achieve a desired value of the fill rate. In the next section we provide an overview of the general approach we advocate for determining appropriate values of s and S. Section 3 is then concerned with the details of the model development and analysis. Simulation testing (in terms of how closely the two constraints are met) is presented in Section 4. This is followed, in Section 5, by an adjustment procedure

whose use may be appropriate under certain conditions. Summary comments are provided in Section 6 and some technical details are provided in the appendix.

2. Overview of the suggested approach The key idea in the approach is to recognize that the reorder point is reached at a random time between reviews. As shown in Figure 1, at the instant that the inventory position drops to the reorder point there is a time, denoted by , remaining until the next review instant. (Under periodic review, the actual value of would not be observed in practice.) Thus, we can think in terms of a continuous review model with effective lead time + L , where is a random variable. Under the assumption of stationary, independent, normally distributed demands in nonoverlapping time intervals, the behaviour of the inventory position can be modeled by a diffusion process which, in turn, permits us to develop estimates of the first two moments of as a function of the distance S s and a measure of variability (coefficient of variation) of the demand process. These moments are used as building blocks in choosing S and s so as to meet the two constraints in the following manner. First, we recognize that the expected time between consecutive replenishments in the (R,

s, S) system is the average size of a replenishment divided by the demand rate. But the average
size of a replenishment is S s plus the average size of the undershoot (see Figure 1). The latter, in turn, is easily developed from the expected value of . Thus we can select S s so as to target the desired expected time between replenishments. Second, the moments of also lead to expressions for the mean and variance of total demand over the effective lead time + L . Assuming the total demand is approximately

normally distributed, we can then determine a value of s appropriate to meet the fill rate constraint.

3. Model development and analysis In this section we first lay out the assumptions and a summary of the notation to be used. Then we move into the details of the development and analysis of the model.

3.1

Assumptions and notation

The assumptions, most of which have already been mentioned, include the following:

i)

The inventory position is reviewed every R units of time, where R is prespecified, not controllable. (For convenience in the development we will set R=1, which means that the review interval is redefined as unit time.)

ii)

There is a constant replenishment lead time (L) from when a replenishment is triggered (at a review instant) until it is available in stock.

iii)

Demands in disjoint intervals of time are independent, stationary, normally distributed variables.

iv) v)

There is complete backordering of any demand during a stockout situation. The service measure used is the fill rate, the fraction of demand to be routinely met from stock.

vi)

A target average time between consecutive replenishments is specified rather than explicitly incorporating setup and carrying costs. For reference purposes the following is a summary of most of the notation to be used (all

time variables are defined in units of R):

P2 desired (fractional) value of the fill rate n desired (integer) average number of review intervals between consecutive
replenishments

s reorder point S order-up-to-level Q size of a replenishment L replenishment lead time

average demand in a unit time interval

standard deviation of demand in a unit time interval

CV = / coefficient of variation of demand in a unit time interval

a random variable representing the time from when the inventory position hits s until
the next review instant

f ( 0 ) probability density function of

E( ) the mean value of

Var( ) the variance of

X the total demand in + L

X the standard deviation of X

k safety factor
m = ( S s) / u the first passage time for the inventory position to drop from S to s fu (u0 ) probability density function of u

3.2

E ( ) and Var ( ) for a given value of S s As indicated in Figure 2 (which reflects setting R = 1 ), is the time from the instant that

the inventory position first reaches s until the moment of the next review. The behaviour of cumulative normally distributed demand (hence the change in the inventory position away from the order-up-to-level, S) can be modeled as a continuous time diffusion process (Miltenburg and Silver, 1984). Moreover, the probability density function of the first passage time, u, for the inventory position to drop from S to s is given by (Cox and Miller, 1965)
fu (u0 ) = Setting m= and CV = we obtain S s ( S s u0 ) 2 exp 2 2u0 2 u03 S s 0 < u0

(1)

(2)

fu (u0 ) =

( m u0 ) 2 exp 2 CV 2 u03 2(CV ) u0 m

0 < u0

(3)

As an aside, Burgin (1969) developed an analytic expression for the expected value of u. Now, multiple values of u can produce the same value of . Specifically = 0 will result from any of u = 1 0 , 2 0 , etc. Hence, the density function of is given by

f ( 0 ) = fu (i 0 )
i =1

Using (3) we have

f ( 0 ) =

m CV 2

i =1

(m + 0 i) 2 exp 2 (i 0 )3 2(CV ) (i 0 ) 1

0 <0 <1

(4)

Unfortunately, it is not possible to analytically develop expressions for the moments of . However, note that the density function, hence the moments, depend on only two parameters, namely m and CV. For given values of these parameters 0 can be discretized on a fine grid and accurate estimates of E( ) and Var( ) can be found by numerical integration. An illustrative case of the density function is shown in Figure 3. Initially we had hoped that would have a uniform distribution, hence E( ) and Var( ) could be analytically determined. As illustrated in Figure 3, this was not the case, particularly for combinations of low values of n and CV where the first passage time distribution is not very spread out.

3.3

Determining S s to target the desired average time between replenishments

For a given value of the expected size of the undershoot E(undershoot | 0 ) = 0 Hence E(undershoot) = E( ) . The average order size

E(Q) = S s + E(undershoot) = S s + E( )
The average time between replenishments E(t ) = Using (1), E(t ) = m + E( ) But we want to target an integer n for E(t). Thus we require m + E( ) = n (5) E(Q)

Now E( ) is a function of both m and CV. Thus, for a given value of CV we have to find the m that satisfies (5). This was done using Mathematica where for each value of m, as mentioned earlier, numerical integration is needed to estimate E( ) . In all of our experimentation the resulting m is reasonably close to n- 0.5. The top part of Figure 4 shows E( ) as functions of CV for n = 3 and 6. For very small values of CV the first passage time distribution approaches a spike at m and for a specific n value equation (5) is satisfied by m = n 0.5 and E( ) = 0.5 (with Var( ) being very small). As CV increases, the u distribution, which is skewed to the right, spreads out more, leading to E( ) increasing above 0.5. Eventually, as CV tends towards 0.5 (the largest value considered because larger values would be inappropriate for the assumption of normally distributed demand), the u distribution flattens out so much that f ( 0 ) tends towards a uniform distribution, hence E( ) tends back to 0.5. Rather than providing detailed tables of E( ) vs. CV, for several practical values of n we have instead used Stata (StataCorp. 2003) to fit fractional polynomial functions of degree 3 (with very high R2 values). The results of fitting functions to 51 values of E( ) , resulting from equi-spaced values of CV between 0.1 and 0.5, are shown in Table 1. Note that the powers of CV have been adjusted to the average CV value (0.3) in the approximation expressions; see the Stata Base Reference Manual (vol. 1, pp. 402-3) for further information. In the above, once the m is found that satisfies (5) for given values of n and CV, we then use numerical integration to estimate Var( ) . Illustrative results are shown for two values of n in the lower part of Figure 4. Again, very accurate fractional polynomial functions were fit to Var( ) as a function of CV for selected values of n. The results are shown in Table 2.

3.4

Determining s to give a desired service level As discussed in the previous subsection, for given values of n and CV we are able to

determine E( ) and Var( ) . Let X represent the total demand in the effective lead time + L . As evident in Figure 1, a shortage will occur if X exceeds the reorder point s. We can model the situation as a continuous review, reorder point system where the effective lead time + L is a random variable with mean E( ) + L and variance Var( ) . Under such circumstances X has moments (see Silver et al., 1998, p. 283) E( X ) = [E( ) + L] and Var( X ) = [E( ) + L] 2 + 2 Var( ) In the usual fashion, set s = E( X ) + k X It is convenient to divide through by to obtain s = E( X ) +k (8) (7) (6)

Using (6) and (7), this reduces to s

= E( ) + L + k [E( ) + L](CV ) 2 + Var( )

(9)

If we assume that X is normally distributed (which we know is an approximation because is a random variable; however, Tyworth and ONeill, 1997, and Silver et al., 1998, pp. 272-3, argue that as long as X / E( X ) 0.5 , there is little risk in making the normality assumption), then use of (8) leads to the expected units short per replenishment cycle (see Silver et al., 1998) EUSPRC X Gu (k ) (10)

where
Gu (k ) = ( z0 k ) ( z0 )dz0
k

(11)

is the unit normal loss function and ( z0 ) is the unit normal density function. There are tables, spreadsheet functions (e.g., in Excel), and other accurate, rational approximations for the G function. Note that there is a more precise version of (10) which turned out to not be required in our numerical experiments, specifically n EUSPRC = X Gu (k ) Gu k + X The target allowed (average) units short per replenishment cycle AUSPRC = (1 P2 )E(Q) From (10) and (13) and noting that E(Q) = n, we thus require Gu (k ) = Also, using (7), we can express (1 P2 )n (14) (13) (12)

X = [E( ) + L](CV ) 2 + Var( )

(15)

Hence, the choice of k in (14) depends only upon the values of four parameters, namely CV, n, L and P2. Finally, to obtain S we proceed as follows. Use of (1) and (5) gives S s

Hence S

+ E( ) = n

+ n E( )

(16)

10

It is seen from (9), (15) and (16) that the key results are normalized with respect to , the average demand per unit time.

Numerical illustration Consider the following set of parameters values: n = 4 (i.e., on average, a replenishment every 4 periods) CV = 0.3 L = 2 periods P2 = 0.9 (desired fill rate) From the fractional polynomial approximations in Tables 1 and 2, E( ) = 0.5033 and Var( ) = 0.0839. Then from (15)

X = (2.5033(0.3) 2 + 0.0839 = 0.5561

Next, (14) leads to Gu (k ) = (0.1)4 / 0.5561 = 0.7194 Using a table lookup or Excel function (see Appendices B and C of Silver et al., 1998)
k = 0.5309

Subsequently (9) gives s

Finally, (15) results in

= 2.5033 + ( 0.5309)(0.5561) = 2.208

= 5.705

So, for example, if = 100, then s = 220.8 and S = 570.5.

11

Our approach has involved approximations including the assumption of a normal distribution of X. Thus, it is important to simulate the actual performance associated with using the prescribed values of s and S. This is the topic of the next section.

4. Simulation testing of the approach

The simulation replicates what would happen in actual application of (R, s, S) control. Specifically, the inventory position is only updated at each review instant (recall that we have set R = 1 ). For the update

( inventory position at a review instant )

( inventory position after a possible order at previous review ) ( total demand in the review interval ) .

(17)

The total demand is randomly generated from a normal distribution with parameters and . Note that in the simulation the times at which the inventory position hits s (hence the s) are not observed. If the updated inventory position (denoted by I) is less than or equal to s, then an order (of size Q = S I) is placed. Otherwise nothing is done until at least the next review. Any order placed arrives a constant time L later. Rather than keeping track of any backorders just before replenishments arrive, we have used a far more efficient method of estimating the actual fill rate achieved. It uses the virtual measures approach of variance reduction first suggested by Ignall and Carter (1975). Specifically, let I i ( s ) be the inventory position when the ith order (of size
Qi) is placed. Then (for reference purposes see (12)) the expected units short at the end of the

lead time conditional on I i can be computed analytically as

12

 I L I i + Qi L EUS( I i ) = L Gu i Gu L L

Over a large number (N) of replenishments the estimated average number of units short per replenishment is EUS = Also, I i + Qi = S . Thus EUS 1 = L N 1 N

EUS( I )
i =1 i

G
i =1

I i L S L Gu L L

where the last term on the right side is a constant. Consequently, we only have to compute
I L Gu i for each replenishment i. L

Now an estimate of the average order size is given by

E(Q) = and the expected fill rate is FR = 1 EUS E(Q) 1 N

Q
i =1

The other performance measure we need is the average time between replenishments AT =

E(Q)

Besides point estimates of each of FR and AT, confidence intervals were developed based upon the replication-deletion method for estimating a steady-state mean (see, e.g., Law and Kelton, 2000).

13

4.1

Selection of parameter values As discussed earlier, after normalizing with respect to , there are four remaining,

independent, parameters, namely CV, n, L and P2. As shown in Table 3, each of these was set at three reasonable values to produce a total of 81 experiments. A few associated comments are in order. As mentioned earlier, in the practical context that motivated this work, integer values of n were desired. The lowest value of interest is 2 (in that n = 1 would imply ( R, S ) control, which is much easier to analyze as the protection period is always exactly R + L). Because demand is normally distributed we used an upper value of 0.5 for the CV. For higher values of CV a different distribution (e.g., gamma) would likely be more appropriate. The L values were selected so that the smallest was less than the review interval and the largest appreciably larger than the interval. Finally, the three fill rates span the range typically targeted in practice.

4.2

Results The results are displayed in Table 4. Although the details are not shown, all half-widths

of 95% confidence intervals were less than 0.007 (0.12%) for the estimates of the average time between orders and less than 0.0004 (0.05%) for the estimates of the fill rates. The major finding, indicated by the low percent deviations from the two targets (n and P2), is that the approach works very well overall. Deviations from n as high as 5+% occur in the average time (AT) between replenishments. However, such deviations are relatively unimportant in practice because, even if the average time between replenishments was right at the targeted value, such as 2 periods, there would still be occasions where the observed times would differ,

14

e.g., be 1 or 3 periods, simply due to the random nature of the demand, i.e., one could never assure that the time between consecutive replenishments was a constant. All of the entries in the last column of the table are negative, indicating that the fill rate achieved is always somewhat below the target. The largest deviation of 3.0334% occurs in Case 3 in which n = 2 and CV = 0.5. (Case 3 also produces one of the highest deviations of AT from n.) The combination of n = 2 and CV = 0.5 tends to produce a significant number of instances of small values (in that the distribution of first passage time from S to s has a significant mass below, but close to, 2). This occurs for all cases where CV = 0.5, but to a lesser degree as n, L and P2 increase. There are two possible causes of the inaccuracy. The more obvious reason is the inaccuracy in assuming that X (the total demand in + L ) has a normal distribution. By randomly generating values of (through values of the first passage time u see equation (3)) and then for each such randomly generating a value of X from a normal distribution with mean

( + L) and variance 2 ( + L) we developed empirical distributions of X for different

combinations of parameters, comparing each with a normal distribution having the same moments. As expected, the empirical distribution became closer to the normal as the fixed component L increased. This helps explain why the fill rate deviation decreases as L increases. The second cause of the inaccuracy of our method is more subtle. If the reorder point (s) is first reached at a distance from the next review instant, we have used an associated effective lead time of length + L . However, recalling the diffusion representation of the demand process, it is conceivable that by the time of the next review the inventory position could have come back up above s due to negative overall demand in the interval . As will be shown in the next section, this is far more likely to happen for low values of . In such a case the position will very

15

quickly drop back to the reorder point, resulting in a relatively large value of (occurring in the next R interval). Thus, low values of will tend to be replaced by large values. Consequently, our approach underestimates both E( ) and Var( ) , resulting in a fill rate somewhat lower than the target as well as an average order size (which has a component proportional to E( ) ) larger than targeted, hence leading to an average time between replenishments higher than n. As mentioned earlier, it is precisely when CV takes on its highest value of 0.5 that there is a significant probability of small values occurring. In the next section we propose a modified approach for adjusting the estimates of E( ) and Var( ) under such circumstances.

5. Adjusting the estimates of E( ) and Var( )

As discussed in the previous section, our method, based on the diffusion model representation of the normal distribution (which permits negative demands, hence the inventory position rising), ignores the fact that when the reorder point is reached between review instants there is a non-zero probability that the inventory position will be back above the reorder point at the next review instant. The chance of this happening for a given value of is simply the probability that total demand in is negative, i.e., ( / ) or ( / CV ) , which

quickly becomes negligible as increases away from 0 ( () is the cumulative distribution function of a unit normal variable). Thus, in order for the effect to be important we need significant probability mass associated with low values of in its unmodified (original) distribution. Knowing that E( ) distribution. To obtain tractable adjustments in E( ) and Var( ) for the above effect we make two simplifying assumptions, namely
16

0.5 , this implies that we require considerable spread in that

i) ii)

the unmodified (original) distribution of is uniform, and when the inventory position manages to go back above the reorder point by the next review instant, it quickly falls back to the reorder point, resulting in a value assumed to be 1.

In actual fact the inventory position at the next review will be at some distance above s, which wont necessarily lead to a value of 1; in fact, an exact modeling approach, which would become intractable, would recognize that for a given distance above s, were back to a diffusion process starting at a specific distance above the reorder point, and so on. Regarding the first assumption, the original distribution of tends to uniformity as both n and CV increase (through the first passage time distribution becoming very spread out). Using the two assumptions, in the appendix we develop the following expression for AE( ) and AVar( ) , the adjusted values of E( ) and Var( ) :
AE( ) = 1 C2 3 4 1 3 1 C 3C 3 1 + C + C2 + C4 2 2 4 2 C 2 2 C 2

(18)

AVar( ) = AE( 2 ) [ AE( )] where

(19)

3 1 1 C 2 5C 6 2 1 2C 5C AE( 2 ) = + + C 2 + 5C 6 + + + 5C 5 (20) 3 2 2 3 3 C 3 C

and, as earlier, and are the cumulative and density functions of a unit normal variable and, for simplicity, we have used C instead of CV to represent the coefficient of variation.

17

Numerical illustration

We illustrate the above approach for the case where the unadjusted approach had the largest percent deviation from the targeted fill rate, specifically case 3 in Table 4 with n = 2, CV = 0.5, P2 = 0.8 and L = 0.5. Using (18), (20) and (19) we find AE( ) = 0.582571 and AVar( ) = 0.092826 (The unadjusted E( ) and Var( ) values were 0.502672 and 0.086764.) The approach of Section 3.4, using AE( ) and AVar( ) rather than E( ) and Var( ) , then leads to
s

= 0.8114

and

= 2.2289

In contrast, the unadjusted approach gave

s

= 0.7209

and

= 2.2183

As expected, the increases in AE( ) and AVar( ) , relative to E( ) and Var( ) , have led to an appreciably higher value of s. This, in turn, results in an actual fill rate (obtained through simulation) of 0.8002, i.e., much closer to (deviation of only 0.250% from) the target value of 0.80 than the actual fill rate of 0.7757 achieved by the unadjusted method (see case 3 in Table 4).

6. Summary

In this paper we have considered an (R, s, S) inventory control system, a type commonly used in practice. Motivated by a practical context, we have presented a novel approach to determining s and S (for a given review interval R) so as to target desired values of i) customer 18

fill rate and ii) average time between consecutive replenishments. Specifically, by using a diffusion model we converted a periodic review, constant lead time situation into one having continuous review and a random lead time. The basic method is simple to implement and produces quite reasonable results. If a practitioner felt that even nominal underachievement of the desired fill rate was a serious concern, then the adjustment of the preceding section, again easy to implement, could be used. There are a number of possible extensions of this work, including: i) Dealing with a variable lead time. Except for the possibility of crossing of orders (which cannot happen in the context of the current paper because is, by definition, less than R), this should be a straightforward extension. ii) Using a demand distribution other than the normal, particularly to encompass situations where the CV exceeds 0.5. One possibility would be to modify the normal so that it cannot take on negative values as suggested by Strijbosch and Moors (2006). Another would be to use the gamma distribution. A third option would be to consider a discrete distribution, such as the Compound Poisson, so as to be able to model large, individual demand transactions. iii) iv) Incorporating shortage costing rather than a service measure. Treating a different control system, specifically an (R, s, mQ) system where orders must be placed in an integer multiple m of a prescribed, basic replenishment quantity. This would be appealing where the supply comes from production, as in the practical situation that motivated this research. In particular, the production department may prefer to produce only in integer multiples of a convenient lot size (Q). An equivalent context

19

would be where supply is only delivered as an integer number of non-unit-sized (Q) packs.

Acknowledgements

The authors thank Daniel Costa, Supply Chain Director, Nestl Italiana, for describing a practical situation that motivated the topic studied. The research leading to this paper was supported by the Natural Sciences and Engineering Research Council of Canada under grants A1485 and 239153-05. It was carried out while the second author held a postdoctoral position at the University of Calgary. Associated financial support from the Haskayne School of Business is gratefully acknowledged.

References

Bashyam S and Fu MC (1998). Optimization of (s, S) inventory systems with random lead times and a service level constraint. Mngt Sci 44: 243-256. Brown, RG (1967). Decision Rules for Inventory Management. Holt, Rinehart and Winston: New York, p. 238. Burgin TA (1969). Time to sell a fixed quantity of stock depleted by distributed demand. Operational Research Quarterly 20: 421-428. Carter G and Ignall E (1975). Virtual measures: a variance reduction technique. Mngt Sci 21: 607-616. Cox DR and Miller HD (1965). The Theory of Stochastic Processes. John Wiley & Sons: New York. Ehrhardt R (1979). The power approximation for computing (s, S) policies. Mngt Sci 25: 777786. Ehrhardt R and Mosier C (1984). Revision of the power approximation for computing (s, S) policies. Mngt Sci 30: 618-622. IBM (1971) System/360 Inventory Control (360 A-MF-04X). Program description manual GH20-0555-1. New York. 20

Law AM and Kelton WD (2000). Simulation Modeling and Analysis. Third Edn. McGraw-Hill: Boston. Miltenburg GJ and Silver EA (1984). The diffusion process and residual stock in periodic review, coordinated control of families of items. Int J Prod Res 22: 629-646. Moors JJA and Strijbosch LWG (2002). Exact fill rates for (R, s, S) inventory control with gamma distributed demand. J Opl Res Soc 53: 1268-1274. Patel JK and Read CB (1982). Handbook of the Normal Distribution. Marcel Dekker: New York, p. 23. Robb DJ and Silver EA (1998). Inventory management with periodic ordering and minimum order quantities. J Opl Res Soc 49: 1085-1094. Roberts DM (1962). Approximations to Optimal Policies in a Dynamic Inventory Model. In: Arrow K, Karlin S and Suppes P (eds.), Studies in Applied Probability and Management Science. Stanford University Press: Stanford, pp. 207-229. Schneider H (1978). Methods for determining the reorder point of an (s, S) ordering policy when a service level is specified. J Opl Res Soc 29: 1181-1193. Schneider H (1981). Effect of service-levels on order-points or order-levels in inventory models. Int J Prod Res 19: 615-531. Schneider H and Ringuest JL (1990). Power approximation for computing (s, S) policies using service level. Mngt Sci 36: 822-834. Silver EA, Pyke D and Peterson R (1998). Inventory Management and Production Planning and Scheduling. Third Edn. John Wiley & Sons: New York. Stata Corp. (2003). Stata Statistical Software: Release 8.0. Stata Corporation: College Station, TX. Strijbosch LWG and Moors JJA (2006). Modified normal distributions in (R, S)-inventory control. Eur J Opl Res 172: 201-212. Tijms HC and Groenevelt H (1984). Simple approximations for the reorder point in periodic and continuous review (s, S) inventory systems with service level constraints. Eur J Oper Res 17: 175-190. Tyworth JE and ONeill L (1997). Robustness of the normal approximation of lead-time demand in a distribution setting. Nav Res Logist 44: 165-186. Zheng YS and Federgruen A (1991). Finding optimal (s, S) policies is about as simple as evaluating a single policy. Oper Res 39: 654-665.

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Appendix Derivation of Adjusted Mean and Variance of

To simplify the presentation we use C, rather than CV, to represent the coefficient of variation of demand in a unit time interval. As indicated in the main text the adjustment is based on two assumptions: i) ii) the original distribution of is uniform when the inventory position manages to go back above the reorder point by the next review, it quickly falls back to the reorder point and we assume that the associated value of is effectively 1. For a given value of the original , denoted by 0 , two things can happen. With probability 0 / C the inventory position gets back above the reorder point by the next review resulting (by assumption ii) in an adjusted value of 1. With probability 1 0 / C the original 0 value remains in effect. Thus, using the uniform distribution of

0 (assumption i) the adjusted first two moments, AE( ) and AE( 2 ) , are
AE( ) = 0 / C d 0 + 0 1 0 / C d 0
0 0 1

and
AE( 2 ) = 0 / C d 0 + 0 2 1 0 / C d 0
0 0 1

These can be simplified to

1 AE( ) = + (1 0 ) 0 / C d 0 2 0
1

and

22

1 AE( 2 ) = + 1 0 2 0 / C d 0 3 0

) (

Substituting z0 = 0 / C results in
1 AE ( ) = 2C 2 z0 C 2 z03 ( z0 )dz0 2 1/ C
0

(21)

and
AE

( )
2

1 = 2C 2 z0 C 4 z05 ( z0 )dz0 3 1/ C

(22)

In these two equations there are three integrations involving the function, namely
J1 =

1/C 0

z0 ( z0 ) dz0

(23)

J2 =

1/C

z03 ( z0 ) dz0

(24)

and
J3 =

1/C

z05 ( z0 ) dz0

(25)

Each of these can be integrated by parts to produce

J1 = z2 1 1 0 ( z0 ) dz0 2C 2 C 1/ C 2 z4 1 1 0 ( z0 ) dz0 4C 4 C 1/ C 4
0 0

(26)

J2 =

(27)

and
J3 = z6 1 1 0 ( z0 ) dz0 6C 6 C 1/ C 6
0

(28)

23

We next make use of the following result for incomplete moments of the unit normal distribution from Patel and Read (1982). If I r (b) = z0 r ( z0 ) dz0 , then for r a positive, even integer
b

I r (b) = b r 1 + (r 1)b r 3 +

+ (r 1)(r 3)

+(r 1)(r 3) Recognizing that

5 3 [1 (b) ]

5 3 b (b)

(29)

1/C

z0 ( z0 ) dz0 =
j

1/C

z0 ( z0 ) dz0 z0 j ( z0 ) dz0
j
0

we use (29) in (26), (27) and (28) with r = 2, 4 and 6 respectively to obtain, after considerable simplification, 1 1 1 1 1 1 J1 = + 2 + 4 2 2C C 2C C 3 3 1 1 3 1 1 J2 = + 4 + + 3 8 4 4C C 4C 4C C and 5 5 1 1 5 5 1 1 J3 = + 6 + + 3 + 5 4 2 6C C 2C 6C 6C C (32) (30)

(31)

Finally, use of (21) to (25) and (30) to (32) leads directly to the expressions of (18) and (20) of the main text.

24

Figure 1 Undershoots in a Periodic Review System

25

Figure 2 Relation Between First Passage Time (u) and

26

Figure 3 Illustrative Density Function of for m = 1.5, CV = 0.3

27

Figure 4 E( ) that Satisfies Equation (5) and Associated Var( ) for n = 3, 6

E( )

Var( )

28

Table 1 Fractional Polynomial Approximations of E( ) as a Function of CV for Selected Values of n

n 2
3 4 5 6

Adj. R2 0.9863 0.9835 0.9740 0.9726 0.9784

Approximation (note C CV) .53608 + .44271(C 3.333) + 1.7634(C 1.826) + 1.0508(C ln C + 2.198)
1

.51211 + 1.8652(C .3) 1.1430(C2 .09) + 3.1367(C2 ln C + .1084) .50325 + 2.1455(C .5477) .65943(C ln C +.6594) + .50973(C (ln C)2 .794) .50079 .13438(C 1 3.333) .39946(C 1.826) .28188(C ln C + 2.198) .50004 .00237(C 2 11.11) .03307(C 1 3.333) .02296 (C 1 ln C + 4.013)

29

Table 2 Fractional Polynomial Approximations of Var( ) as a Function of CV for Selected Values of n

n 2
3 4 5 6

Adj. R2 0.9993 0.9965 0.9933 0.9931 0.9936

Approximation (note C CV) .07401 + .53380(C .3) .58217(C2 .09) .08283 + .36794(C .5477) .35809(C ln C + .6594) .08387 .12888(C 1.826) .10939(ln C + 1.204) .08371 + .01876(C 1 3.333) + .00887(C 1 ln C + 4.013) .08352 .00078(C 2 11.11) + .00503(C 1 3.333)

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Table 3 Settings of Independent Parameters

Parameter

Definition target average number of review (unit) intervals between replenishments coefficient of variation of (the normally distributed) demand in a unit interval lead time target fill rate

Values Selected 2, 4, 6 0.1, 0.3, 0.5 0.5, 2, 4 0.8, 0.9, 0.99

n CV L P2

31

Table 4 Simulation Results

Average Time (AT) Between Orders % Deviation from Observed Target, n 1.9802 -0.9875% 2.0226 1.1313% 2.1023 5.1132% 3.9648 -0.8802% 4.0047 0.1187% 4.0788 1.9711% 5.9476 -0.8729% 5.9849 -0.2516% 6.0606 1.0094% 1.9803 -0.9859% 2.0227 1.1334% 2.1011 5.0562% 3.9642 -0.8941% 4.0054 0.1348% 4.0812 2.0311% 5.9470 -0.8836% 5.9873 -0.2125% 6.0628 1.0468% 1.9803 -0.9853% 2.0223 1.1128% 2.1012 5.0594% 3.9644 -0.8894% 4.0064 0.1592% 4.0786 1.9638% 5.9472 -0.8806% 5.9857 -0.2390% 6.0596 0.9939% 1.9803 -0.9844% 2.0227 1.1352% 2.1022 5.1110% 3.9641 -0.8965% 4.0074 0.1845% 4.0770 1.9260% 5.9476 -0.8734% 5.9847 -0.2552% 6.0607 1.0117% 1.9803 -0.9846% 2.0224 1.1191% 2.1024 5.1206% 3.9643 -0.8914% Fill Rate (FR) % Deviation from Observed Target, P2 0.7999 -0.0074% 0.7897 -1.2911% 0.7757 -3.0334% 0.7991 -0.1081% 0.7921 -0.9935% 0.7804 -2.4478% 0.7991 -0.1068% 0.7941 -0.7361% 0.7848 -1.9035% 0.7999 -0.0094% 0.7902 -1.2282% 0.7786 -2.6789% 0.7991 -0.1145% 0.7925 -0.9377% 0.7833 -2.0818% 0.7991 -0.1121% 0.7941 -0.7417% 0.7863 -1.7072% 0.7998 -0.0216% 0.7909 -1.1379% 0.7809 -2.3913% 0.7993 -0.0929% 0.7931 -0.8633% 0.7855 -1.8070% 0.7991 -0.1068% 0.7946 -0.6701% 0.7875 -1.5668% 0.8999 -0.0064% 0.8900 -1.1065% 0.8794 -2.2843% 0.8993 -0.0723% 0.8937 -0.7016% 0.8848 -1.6908% 0.8993 -0.0800% 0.8948 -0.5826% 0.8869 -1.4545% 0.8999 -0.0065% 0.8917 -0.9201% 0.8843 -1.7415% 0.8993 -0.0829%

Case 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40

P2 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9

L 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 2 2 2 2 2 2 2 2 2 4 4 4 4 4 4 4 4 4 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 2 2 2 2

n 2 2 2 4 4 4 6 6 6 2 2 2 4 4 4 6 6 6 2 2 2 4 4 4 6 6 6 2 2 2 4 4 4 6 6 6 2 2 2 4

CV 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1

32

Case 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81

P2 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99 0.99

L 2 2 2 2 2 4 4 4 4 4 4 4 4 4 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 2 2 2 2 2 2 2 2 2 4 4 4 4 4 4 4 4 4

n 4 4 6 6 6 2 2 2 4 4 4 6 6 6 2 2 2 4 4 4 6 6 6 2 2 2 4 4 4 6 6 6 2 2 2 4 4 4 6 6 6

CV 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5 0.1 0.3 0.5

Average Time (AT) Between Orders % Deviation from Observed Target, n 4.0070 0.1746% 4.0820 2.0488% 5.9470 -0.8836% 5.9882 -0.1969% 6.0672 1.1203% 1.9803 -0.9857% 2.0222 1.1097% 2.1017 5.0863% 3.9642 -0.8953% 4.0062 0.1545% 4.0797 1.9923% 5.9467 -0.8883% 5.9873 -0.2120% 6.0654 1.0905% 1.9803 -0.9842% 2.0213 1.0664% 2.1023 5.1134% 3.9646 -0.8838% 4.0058 0.1462% 4.0831 2.0766% 5.9468 -0.8866% 5.9856 -0.2406% 6.0618 1.0294% 1.9803 -0.9836% 2.0222 1.1119% 2.1002 5.0096% 3.9645 -0.8870% 4.0051 0.1271% 4.0828 2.0704% 5.9472 -0.8800% 5.9888 -0.1860% 6.0620 1.0325% 1.9803 -0.9863% 2.0229 1.1462% 2.1018 5.0914% 3.9642 -0.8957% 4.0052 0.1309% 4.0760 1.8988% 5.9474 -0.8759% 5.9862 -0.2295% 6.0636 1.0599%

Fill Rate (FR) % Deviation from Observed Target, P2 0.8937 -0.6998% 0.8867 -1.4744% 0.8992 -0.0853% 0.8949 -0.5629% 0.8886 -1.2690% 0.9000 -0.0029% 0.8934 -0.7369% 0.8872 -1.4212% 0.8993 -0.0737% 0.8943 -0.6329% 0.8892 -1.2038% 0.8993 -0.0761% 0.8952 -0.5331% 0.8901 -1.1045% 0.9900 -0.0042% 0.9865 -0.3555% 0.9825 -0.7566% 0.9896 -0.0393% 0.9865 -0.3505% 0.9841 -0.5969% 0.9893 -0.0682% 0.9870 -0.2994% 0.9851 -0.4934% 0.9900 -0.0033% 0.9877 -0.2352% 0.9859 -0.4176% 0.9896 -0.0405% 0.9876 -0.2405% 0.9865 -0.3585% 0.9895 -0.0531% 0.9880 -0.2031% 0.9868 -0.3242% 0.9900 0.0000% 0.9884 -0.1656% 0.9872 -0.2806% 0.9897 -0.0331% 0.9883 -0.1686% 0.9874 -0.2581% 0.9896 -0.0417% 0.9885 -0.1527% 0.9876 -0.2469%

33

Figure Captions

Figure 1 Undershoots in a Periodic Review System Figure 2 Relation Between First Passage Time (u) and Figure 3 Illustrative Density Function of for m = 1.5, CV = 0.3 Figure 4 E( ) that Satisfies Equation (5) and Associated Var( ) for n = 3, 6

Table Headings
Table 1 Fractional Polynomial Approximations of E( ) as a Function of CV for Selected Values of n Table 2 Fractional Polynomial Approximations of Var( ) as a Function of CV for Selected Values of n Table 3 Settings of Independent Parameters Table 4 Simulation Results

34