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Supply Chain Inventory Model Considering Transportation Risk and Cost
Min-Der Ko
Department of Transportation Science
National Taiwan Ocean University
Keelung, Taiwan
e-mail: mdko@mail.ntou.edu.tw
Tzu-Chen Ho
Department of Transportation Science
National Taiwan Ocean University
Keelung, Taiwan
e-mail: g00168051@gmail.com
AbstractUnder the pressures of global competition, response
to changes in evolving international transport from processing
and marketing system. Enterprises are forced to pace their
supply according to the requirements of customers. Many
enterprises attempt to manage their supply chain e ectively.
The international transportation of the products, which
involved in valuable goods, may cause the happening of
transportation risk. Therefore, this study explores the
feasibility of applying an integrated inventory model with the
consideration of incorporating production programs and
maintenance to an imperfect process. We also consider the
transportation risk between manufacturers, suppliers and
retailers, building a two- echelon inventory and transportation
risk model.
Keywords-imperfect product; transportation risk; inventory;
supply chain
I. INTRODUCTION
In globalized economy, product life cycle is reducing
continuously, customer demands are changing fast, and lead
time for response is decreasing. Also globally distributed
sourcing, production and transport operations are vulnerable
to many types of risks due to an increasing dynamic and
structural complexity of today's supply chain networks.
In this paper, we focus on transportation risk and
imperfect product. Because of the uncertain transportation
delays, it faces the risk that the product might decay or
deteriorate during the transportation process. In Yong-bo
XIAO, Jian CHEN, Xiao-lin XU [11], the optimal initial
quantity, the optimal wholesale price, and the optimal
retailing price are studied under the assumption that both the
decision makers are risk-neutral. Lian Qi, Kangbok Lee [2]
show how to use transportation to make supply chain risk
mitigations, to satisfy the cost-saving. In Rajesh Kumar
Singh [7], the manufacturer is risk-neutral and so his sole
objective is to maximize his expected profit. Yasemin
Merzifonluoglu [10] builds the special case of normal
distribution and risk-neutral objective, and developed
optimality properties. It also examines the sensitivity of the
978-1-5090-6775-6/17/$31.00 2017 IEEE 
Mengru Tu
Department of Transportation Science
National Taiwan Ocean University
Keelung, Taiwan
e-mail: tuarthur@email.ntou.edu.tw
sourcing strategies of firms to risk, shortage cost, demand
uncertainty, salvage value, and capacity reserve options.
To meet the challenges of maintaining good quality and
perfect screening process, rework process becomes a rescue
to compensate for the imperfections present in the
production system. The imperfect rework is an unavoidable
problem to the supplier chain.
Based on Pan AC and Liao CJ [6] applied JIT concept to
the traditional EOQ model. They provide the effect of
frequent shipments for a total cost and small lot size.
Ramasesh [8] separated the total order cost of the EOQ
model into the cost of placing a contact order with multiple
small lots shipments. T. C. E. Cheng [9] recommended an
EOQ model with demand-dependent unit production cost
and imperfect production processes, formulated the problem
as a geometric programing. L.-Y. Ouyang, C.-H. Ho, and
C.-H. Su [1] proposed a model with adjustable production
rate and imperfect product under the condition of
permissible delay in payments. Ming-Cheng Lo and
Ming-Feng Yang [3] develop an improved inventory model
to help the enterprises to advance their profit increasing and
cost reduction in a single vendor single-buyer environment,
adjustable production rate, and imperfect reworking process
under permissible delay in payments. In M.F. Yang and Y.
Lin [4] the main target of this research is consideration of
incorporating production programs and maintenance to an
imperfect process, to build an integrated inventory model
with the issues of repair. Ming-Feng Yang, Yi Lin, Li Hsing
Ho, and Wei Feng Kao [5] point out that uncertain lead time
and defective products have much to do with inventory and
service level.
In our research, based on Ming et al [3] and Ouyang et al
[1] models and data, we construct a two-echelon imperfect
product inventory model considering transportation risks.
II. NOTATIONS AND ASSUMPTION
The decision variables are set as follows:
x n = The total number of shipments per production run
from the vendor to the buyer, a positive integer.
 x L= Buyers replenishment time interval between inventory model established by Ming et al [3]. Imperfect
successive deliveries. quality items may be produced in the vendors production
x P = The unit selling price for the buyer. process, and these items can be reworked immediately in the
There are some assumptions as follow: same batch cycle. These imperfect quality items being
1. There is one vendor and one buyer for a single reworked are of perfect quality.
product. So the vendor delivers an order quantity of Q with
2. The production rate A is adjustable. The ratio perfect quality to the buyer and the buyer accepts it over n
between the production rate A and the demand rate times. Fig. 1 depicts the behavior of inventory levels for
both the vendor and the buyer, which follows the notations
D was set to be A/D=, where > 1 is a constant
and the assumptions shown above. The joint total annual
and A=D.
profit for the vendor and the buyer consists of the vendors
3. The demand function is selected as a price function and the buyers total annual profit.
form throughout this model, and we set D=  ,
with the scaling factor , and  as an
index of price sensitivity (P as unit selling price).
4. The buyer orders a quantity of Q for each ordering
cost  ; the vendor manufactures at rate A, in
batches of size nQ with a lot setup cost  ; each
batch is delivered to the buyer in n equally sized
shipments. For each shipment, the buyer carries a
transportation cost F.
5. The unit holding cost rate for the vendor excluding
interest charges ; the unit holding cost rate for
the buyer . Figure 1. An integrated inventory system for the vendor and the buyer
6. The vendor brings the unit inspecting cost w.
7. Successive shipments are scheduled so that the A. The Vendors Total Annual Profit
next one arrives at the buyer when his stock from (a) sales revenue per year = 
previous shipment has just been consumed.
8. Given that Z is a random variable with a known (b) setup cost per year =

probability density function f(z). Then we set the (c) inventory holding cost per year
expected value of Z, =E(Z). Repair cost per
=
imperfect quality item .
9. Shortages are not allowed. (d) inspecting cost per year = 

  

10. The relationship between the buyers selling price
, buyers purchasing cost and vendors (e)    =sales revenuesetup costinspecting
production cost is P . costholding cost
11. The risk is separated as low risk,medium risk and =  

  


high risk, 0R1

12. During the vendors production process, the (1)

produced items are continuously reviewed.
13. We assume that the reworking of defective items B. The Buyers Total Annual Profit
starts instantly they are found in the same batch (a) sales revenue per year = 
cycle and these reworked items are of perfect
(b) cost of pacing orders per year =
quality.
14. In a batch at the end of the vendors 100% (c) transportation cost per year=



inspecting process, if imperfect quality items are

found and the repair cost must be paid. (d) inventory holding cost per year=

15. The time horizon is infinite.
(e)    sales revenue ordering cost
III. MODEL FORMULATION transportation risk costholding cost
In this section, we formulate the model for the reality  





(2)
assuming that imperfect quality items may be produced

during a production run and each shipment may carry C. The Expected Joint Total Profit
transportation risk.
We make use of the imperfect quality items and Hence, the joint total annual profit function,
transportation risk consideration to extend the integrated JTP(n,P,Q),as follow:




     
 (3)
We replace Q=DL and D=D(p)= into the joint
total annual profit function
  

Firstly, taking the first-order and second-order partial
derivatives of EJTP(n,P,L) with respect to n, we obtain
Therefore, for fixed P and L, EJTP(n,P,L) is strongly
concave on n > 0.
Thus, in each production run, determining the optimal
number of shipment n*, is simplified to obtain a global
optimum.
Determination of the optimal replenishment time
interval L for any given n and P
By taking the first-order and second-order partial
derivatives of EJTP(n,P,L), with respect to L, we have
 
 
Consequently, EJTP (n,P,L) is strongly concave on L for
fixed n and p. So there exists a unique replenishment time
interval value of L, which maximizes EJTP (n,P,L). The
value of L can be found by equating (7) to be zero, and we
obtain

Determination of the optimal price P for any given n
and L
Solving for the optimal selling price P*, by taking the
first-order partial derivative of (4), we obtain

    
  

 
(10)
  
    (11)
Determining the optimal selling price by taking (10)
equal to zero, we obtain
  (12)
D. Optimal Solution Procedure
Thus, we can use the following solution procedure to
find optimal values n, P, and L for this model. The
solution procedure is commonly known as dichotomy as in
(5) Algorithm 1. To illustrate the effectiveness of the models
presented above, we examine the models with a simplified
numerical study. In the example, we are trying to find out
(6)
an optimal value of joint profit which is shown by the
following steps.
Algorithm 1
Step1: n=1
Step2: Determine the L by taking first-order partial
derivative of with respect to L
Step3: Take L into EJTP and take first-order partial
derivative of with respect to P
Step4: Take P into EJTP.
Step5: Set n=n+1, repeat steps 2-5 to obtain
EJTP (n, P[n],L[n]).
Step6: f EJTP (n,P[n],L[n]) EJTP (n-1,p[n-1],L[n-1]),
go to step 6. if not, go to step 8 and stop.

Step7: Set EJTP (n*,P*,L*)= (n-1,P[n-1],L[n-1]), so
(n*,P*,L*) is an optimal solution in this case, go
(7) to next case and repeat step 2-7.
Step8: After obtained each optimal solution in cases,
(8)
choose the best EJTP. The highest value is the
most optimal solution in the end. Consequently,
the buyers optimal order quantity per order is
Q*= D(P*)L*.
IV. NUMERICAL EXAMPLE
Consider an inventory situation with the following
parametric values partially adopted in Ouyang et al. [1], and
(9) Ming-Cheng Lo, Ming-Feng Yang. [3]
(i) Scaling factor =100000.
(ii) Index of price sensitivity =1.5.
(iii) Ratio between the production rate and the demand rate
=1.5.

(iv) The unit purchasing cost for the buyer  =$4.5/unit.
(v) The unit production cost for the vendor =$2.2/unit.
(vi) Setup cost per production run for the vendor
 =$350/order.
(vii) Ordering cost per order for the buyer =$10/order.
(viii) Vendors unit holding cost =0.045.
(ix) Buyers unit holding cost =0.111.
(x) Percentage of defective items =0.04.
(xi) The unit inspecting cost w=$0.5/unit.
(xii) Repair cost per item of imperfect quality for the
vendor  =$2/unit. Figure 2. The relationship between profit and n.
(xiii) The probability of risk, low risk R=0.3, medium risk
R=0.6, high risk R=0.9. In the Table I, II, III, the joint profit increase follow by
The above solution algorithm is applied to each case and increasing the number of n. It can be seen clearly in Fig.2,
we choose the best case which has the best joint profit in the when n is increased to a certain number, the joint profit will
fixed values of risk value R. For example, in the low risk, no longer increase. The result that is when the number of
medium risk, high risk value (R=0.3, 0.6, 0.9), we calculate n increased, the higher risk may happen during shipments.
n=1 to 10 with R=0.3, 0.6, 0.9 in computer, and we get 30 As Table I, II, III show, in low risk of R = 0.3, the best
results with different numerical data. We choose the case profit is on n = 9, profit = 22211.77; in medium risk of R =
with the best joint profit as the optimal solution. 0.6, the best profit is on n = 8, profit = 22158.55; and in the
high risk time R = 0.9, respectively the best profit is on n =
TABLE I. OPTIMAL SOLUTIONS IN LOW RISK R=0.3 7, profit = 22109.37.
n profit P D Q nQ V. CONCLUSIONS
1 21704.32 8.87 3782.39 2384.38 2384.38
2 21990.21 8.75 3858.44 1795.39 3590.78 In this research, we assume that in the vendors
3 22098.50 8.71 3887.31 1536.12 4608.37 production process, the imperfect quality items are
4 22152.37 8.69 3901.69 1381.40 5525.61 reworked immediately and meantime, the vendor must bear
5 22181.95 8.68 3909.58 1274.94 6374.73 the repair cost. Also we assume that there are transportation
6 22198.54 8.67 3914.01 1195.32 7171.94 risk in each transportation and the buyer bear the
7 22207.38 8.67 3916.38 1132.42 7926.94 transportation risk and cost. Here, we can derive the
8 22211.25 8.66 3917.41 1080.78 8646.26 expected joint total annual profit function.
9 22211.77 8.66 3917.55 1037.18 9334.63
By analyzing this function, we can obtain optimal
10 22209.93 8.67 3917.06 999.56 9995.67
solution for the replenishment time interval and develop a
simple solution procedure to determine the buyers optimal
TABLE II. OPTIMAL SOLUTIONS IN MEDIUM RISK R=0.6
selling price, order quantity, and the number of shipments
n profit P D Q nQ per production run from the vendor to the buyer.
1 21680.74 8.88 3776.13 2424.09 2424.09 According to the results of the study, the value will
2 21958.47 8.77 3849.98 1846.44 3692.88 affect the size of the joint profit, resulting in reduced
3 22061.28 8.72 3877.38 1593.06 4779.19 demand for smaller delivery batches. Since the
4 22110.96 8.70 3890.64 1441.70 5766.83 transportation risk is inevitable, we can build the inventory
5 22137.12 8.69 3897.61 1337.21 6686.09 model, targeting for different risks under the vendor's and
6 22150.77 8.69 3901.26 1258.71 7552.28
buyer's profit considerations.
7 22157.02 8.69 3902.93 1196.38 8374.67
8 22158.55 8.69 3903.34 1144.95 9159.61
To be closer to reality, in addition to transportation risk,
9 22156.92 8.69 3902.90 1101.30 9911.76 we can consider other scenarios for the models such as
10 22153.08 8.69 3901.88 1063.47 10634.75 production, delivery process of other risk value, or consider
the multi-product the optimal production quantity and the
TABLE III. OPTIMAL SOLUTIONS IN HIGH RISK R=0.9 maximum joint profit under transportation risk.
n profit P D Q nQ REFERENCES
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