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Just-in-time purchasing: an
integrated inventory model involving
deterministic variable lead time and
quality improvement investment
a b
Jin-Shan Yang & Jason Chao-Hsien Pan
a
Department of Industrial Management , Southern Taiwan
University of Technology , Tainan, Taiwan, ROC
b
Department of Industrial Management , National Taiwan
University of Science and Technology , Taipei, Taiwan, ROC
Published online: 21 Feb 2007.

To cite this article: Jin-Shan Yang & Jason Chao-Hsien Pan (2004) Just-in-time purchasing:
an integrated inventory model involving deterministic variable lead time and quality
improvement investment, International Journal of Production Research, 42:5, 853-863, DOI:
10.1080/00207540310001632448

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 int. j. prod. res., 2004, vol. 42, no. 5, 853–863

Just-in-time purchasing: an integrated inventory model involving

deterministic variable lead time and quality improvement investment

JIN-SHAN YANGy and JASON CHAO-HSIEN PANz*

Nowadays supply chain management is a popular practice in manufacturing

systems, and just-in-time (JIT) production plays a crucial role in supply chain
environments. Companies are using JIT production to gain and maintain a com-
petitive advantage. The characteristics of JIT systems are consistent high quality,
Downloaded by [University of Sussex Library] at 02:15 09 February 2015

small lot sizes, frequent delivery, short lead time, and close supplier ties. This
paper presents an integrated inventory model to minimize the sum of the order-
ing/setup cost, holding cost, quality improvement investment and crashing cost
by simultaneously optimizing the order quantity, lead time, process quality and
number of deliveries while the probability distribution of the lead time demand is
normal. This integrated inventory model is useful particularly for JIT inventory
systems where the vendor and the purchaser form a strategic alliance for profit
sharing.

1. Introduction
The JIT system plays an important role in present supply chain management.
One of the major tasks of maintaining the competitive advantages of JIT production
is to compress the lead time needed to perform activities associated with delivering
high-quality products to customers. In the dynamic, competitive environment, suc-
cessful companies have devoted considerable attention to reducing inventory cost
and lead time and improving quality simultaneously.
In recent years, companies have found that there are substantial benefits from
establishing a long-term sole-supplier relationship with a supplier (Martinich 1997).
In the JIT environment, a close cooperation exists between supplier and purchaser to
solve problems together, and thus to maintain stable, long-term relationships. Since
both purchaser and supplier may benefit from the negotiation process, the two sides
must then negotiate to determine how to divide the savings (Thomas and Griffin
1996). The advantages of the integrated inventory model include improved quality,
lowered inventory cost, technology sharing and reduction of lead time.
In the production environment, lead time is an important element in any
inventory management system. Traditionally, most of the literature dealing with
inventory problems treated lead time as a prescribed constant (Kim and Park
1985, Ravichandran 1995) or a stochastic variable (Foote et al. 1988), which
therefore is not subject to control. However, in many practical situations, lead

Revision received May 2003.

yDepartment of Industrial Management, Southern Taiwan University of Technology,
Tainan, Taiwan, ROC.
zDepartment of Industrial Management, National Taiwan University of Science and
Technology, Taipei, Taiwan, ROC.
*To whom correspondence should be addressed. e-mail: chpan@im.ntust.edu.tw

International Journal of Production Research ISSN 0020–7543 print/ISSN 1366–588X online # 2004 Taylor & Francis Ltd
http://www.tandf.co.uk/journals
DOI: 10.1080/00207540310001632448
 854 J.-S. Yang and J. C.-H. Pan

time can be reduced by an additional crashing cost, and hence is controllable. By

shortening the lead time, a company can lower the safety stock, reduce the loss
caused by stockout, improve customer service level and thus increase the competitive
edge in business (Ouyang and Wu 1997). The reduction of lead time mainly consists
of the following components: order preparation, order transit, supplier lead time and
delivery time (Tersine 1982).
Liao and Shyu (1991) initiated a study on lead time reduction by presenting a
continuous review model in which the order quantity was predetermined and lead
time was the only decision variable. Ben-Daya and Raouf (1994) extended the model
of Liao and Shyu (1991) by allowing both lead time and the order quantity to be
decision variables. They derived the optimal lead time and optimal order quantity
that minimized the sum of the ordering cost, holding cost and lead-time crashing
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cost. Ouyang et al. (1996) generalized the Ben-Daya and Raouf (1994) model by
allowing shortages with a mixture of backorders and lost sales.
The integrated model between supplier and purchaser for improving the perfor-
mance of inventory control has attracted a great deal of attention from researchers.
Goyal (1977) suggested a joint economic lot-size model where the objective was to
minimize the total relevant costs for both the vendor and the buyer. Banerjee (1986)
presented a joint economic-lot-size model where a vendor produced to order for a
purchaser on a lot-for-lot basis under deterministic conditions. Goyal (1988) general-
ized the Banerjee model (1986) by relaxing the assumption of the lot-for-lot policy of
the vendor. Lu (1995) presented a model for one-vendor one-buyer problems, and
developed a heuristic approach for the one-vendor multi-buyer case. The model is an
improvement over the models of Banerjee (1986) and Goyal (1988). Ha and Kim
(1997) addressed an integrated lot-splitting model of facilitating multiple shipments
in small lots and compared it with the existing approaches in a simple JIT environ-
ment. Gurnani (2001) presented quantity discount pricing models with different
ordering structures in a system consisting of a single supplier and heterogeneous
buyers. Woo et al. (2001) addressed an integrated inventory model where a single
vendor purchases and processes raw materials in order to deliver finished items to
multiple buyers. Khan and Sarker (2002) proposed a two-stage integrated inventory
system to incorporate the JIT concept in the conventional joint batch-sizing prob-
lem. Kelle et al. (2003) studied quantitative models of establishing and negotiating
buyer–supplier partnerships, and presented the two typical cases of supplier dom-
inance with large production lot sizes and shipment sizes, and purchaser dominance
with small, frequent shipments. David and Eben-Chaime (2003) analysed aspects of
the relationships between a purchaser and a vendor in an attempt to answer how far
they should go in terms of lot sizes and delivery frequency.
The integrated model can contribute significantly to improve the vendor–pur-
chaser relationship. The success and resulting performance of the integrated model is
based upon the cooperation between the purchaser and supplier; for example, the
integrated model practices characterized by a sole-supplier base whose firms are
located close to the buyer’s plant, make frequent deliveries, and are considered
long-term partners with the buying company (Gunasekaran 1999). When establish-
ing a long-term relationship, it is important that the purchaser selects the vendors
that have consistently exhibited high levels of quality and delivery reliability
(Schonberger and Ansari 1984). Several researchers have shown that in integrated
models, one partner’s gain exceeds the other partner’s loss. Thus, the net benefit can
be shared by both parties in some equitable fashion (Goyal and Gupta 1989).
 Just-in-time purchasing 855

Pan and Yang (2002) presented an integrated supplier–purchaser model focused

on the benefit from lead-time reduction while excluding quality-related issues.
However, defective items are often and inevitably produced in real production sys-
tems. These defective items must be rejected, repaired, reworked, or, if they have
reached the customer, refunded. In all cases, substantial costs are incurred (Ouyang
et al. 2002). Porteus (1986) and Rosenblatt and Lee (1986) first presented the sig-
nificant relationship between quality imperfection and lot size. Following Porteus
(1986), there is abundant quality improvement related literature; for example, see
Keller and Noori (1988), Hong and Hayya (1995), Ouyang and Chang (2000) and
Ouyang et al. (2002).
Since it is more appropriate to take the quality-related cost into account in
determining the optimal ordering policy, this paper presents an integrated inventory
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model for minimizing the sum of the ordering/setup cost, holding cost, quality
improvement and crashing costs by simultaneously optimizing the order quantity,
the lead time, the process quality and the number of deliveries when the probability
distribution of the lead time demand is normal. The advantage of such an integrated
model over the traditional model is illustrated by a numerical example.

2. Notation and assumptions

To establish the proposed model, the following notation is used:
D ¼ average demand per year;
P ¼ production rate;
Q ¼ contract quantity;
A ¼ purchaser’s ordering cost per order;
S ¼ vendor’s setup cost per setup;
L ¼ length of lead time;
CV ¼ unit production cost paid by the vendor;
CP ¼ unit purchase cost paid by the purchaser;
r ¼ annual inventory holding cost per dollar invested in stocks;
i ¼ the fractional per unit time opportunity cost of capital.
The assumptions made in the paper are as follow:
1. The product is manufactured with a finite production rate P, and P > D.
2. The demand X during the lead time L follows a normal distribution with
mean DL and standard deviation .
3. The reorder point (ROP) equals the sum of the expected demand during lead pffiffiffiffi
time and the safety stock, that is, the reorder point equals ROP ¼ L þ k L,
where k is known as the safety factor.
4. Inventory is continuously reviewed and replenished.
5. The out-of-control probability  is a continuous decision variable, and is
described by a logarithmic investment function. The quality improvement
and capital investment is represented by q() ¼ qln(0/) for 0<
0,
where 0 is the current probability that the production process can go out
of control, and q ¼ 1/, with  denoting the percentage decrease in  per
dollar increase in q(). The application of the logarithmic function on quality
improvement and capital investment has been proposed by many authors, for
example, Porteus (1986), Hong and Hayya (1995), Ouyang and Chang (2000)
and Ouyang et al. (2002).
 856 J.-S. Yang and J. C.-H. Pan

6. The lead time L has n mutually independent components and these compo-
nents are crashed one at a time starting with the one of least crashing cost per
unit time, and so on.

3. A basic model
The expected annual total cost of an integrated inventory model with normally
distributed lead-time demand for minimizing the sum of the ordering cost, holding
cost and crashing cost can be expressed as (Pan and Yang 2002):

JTECðQ, L, mÞ


    
pffiffiffiffi
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D S Q D 2D
¼ A þ þ RðLÞ þ r m 1

1þ CV þ CP þ rCP k
L
Q m 2 P P
" ( )#
D S X
i
1  
¼ A þ þ ci ðLi
1
LÞ þ c j bj
aj
Q m j¼1

    
Q D 2D pffiffiffiffi
þ r m 1

1þ CV þ CP þ rCP k
L ð1Þ
2 P P

where m is an integer representing the number of shipments of the item delivered

to the purchaser, and ai, bi, ci are the minimum duration, normal duration and
crashing
Pn cost Pper unit time, respectively, of the ith component of lead time. Let
n
i¼1 ai  L  i¼1 bi , and let Li be the length of the ith component of the lead
time
Pn crashed
Pi to its minimum duration. Then Li can be expressed as Li ¼
b
i¼1 i
ðb
j¼1 j
aj Þ, i ¼ 1, 2, . . . , n. Also let R(L) denote the lead-time
P crashing
cost per cycle for a given L 2 [Li, Li
1], and R(L) ¼ ci[Li
1
L] þ i
1 j¼1 j j
aj Þ.
c ðb
In order to include the essence of an imperfect production process, consider the
assumption made in the model proposed by Porteus (1986). The integrated inventory
model is designed for vendor production situations in which, once an order is placed,
production begins and a constant number of units is added to the inventory each day
until the production run has been completed. The vendor produces the item in the
quantity mQ with a given probability of  that the process can go out of control.
Porteus (1986) suggested the expected number of defective items in a run of size mQ
can be evaluated as m2Q2/2. Suppose g is the cost of replacing a defective unit, and
the production quantity for the supplier in a lot of mQ. Then its expected defective
cost per year is given by gmQD/2.
Hence, the total expected annual cost incorporating the defective cost per year
can be represented by
gmQD
TCðQ, m, LÞ ¼ JTECðQ, m, LÞ þ ð2Þ
2

4. Investment in quality improvement

Based on equation (2), we wish to study the effect of investment on quality
improvement. Consequently, the objective of the integrated model is to minimize
the sum of the ordering/setup cost, holding cost, quality improvement and crashing
cost by simultaneously determining the optimal values of Q, m,  and L, subject to
 Just-in-time purchasing 857

the constraint that 0<  0. Thus, the total relevant cost per year is

TRCðQ, m, , LÞ ¼ TCðQ, m, LÞ þ iq ln 0

 
    
D S Q D 2D
¼ A þ þ RðLÞ þ m 1

1þ rCV þ rCP þ gmD
Q m 2 P P
pffiffiffiffi 
þ rCP k
L þ iq ln 0 ð3Þ

for 0<  0, where i is the fractional opportunity cost of capital per unit time.
Therefore, the problem under study can be formulated as the following non-
linear programming model:
Minimize TRCðQ, m, , LÞ
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D S Q D 2D
¼ A þ þ RðLÞ þ m 1

1þ rCV þ rCP þ gmD
Q m 2 P P
pffiffiffiffi 0
þ rCP k
L þ iq ln ð4Þ

Subject to 0<  0
In order to find the minimum cost for this non-linear programming problem,
ignore the constraint 0<  0 for the moment and minimize the total relevant cost
function over Q,  and L with classical optimization techniques by taking the first
partial derivatives of TRC(Q, m, , L) with respect to Q,  and L as follows:
@TRCðQ, m, , LÞ
@Q
 
    
D S 1 D 2D
¼
2 A þ þ RðLÞ þ m 1

1þ rCV þ rCP þ gmD ð5Þ
Q m 2 P P
@TRCðQ, m, , LÞ gmDQ iq
¼
ð6Þ
@ 2 
@TRCðQ, m, , LÞ D 1 1
¼
ci þ rCP k
L
2 ð7Þ
@L Q 2
However, for fixed values of Q and , TRC(Q, m, , L) is concave in L 2 (Li,
Li
1), because
@2 TRCðQ, m, , LÞ r 3
2
¼
CP k
L
2 < 0
@L 4
Therefore, for fixed Q and , the minimum joint total expected annual cost will
occur at the end-points of the interval. On the other hand, for a given value of
L 2 [Li, Li
1], setting equations (5) and (6) equal to zero and solving for Q and ,
it follows that

1
2DðA þ S=m þ RðLÞÞ 2
Q¼ L 2 ðLi , Li
1 Þ ð8Þ
rðCV ðmð1
D=PÞ
1 þ 2D=PÞ þ CP Þ þ gmD
and
2iq
¼ ð9Þ
gmDQ
 858 J.-S. Yang and J. C.-H. Pan

Theoretically, for fixed L 2 [Li, Li
1], one can find the optimal values of Q* and
* from (8) and (9). In addition, for fixed L 2 [Li, Li
1], the Hessian matrix of
TRC(Q, m, , L) is positive definite at Q* and *. The proof is shown in the
appendix.
For a particular value of m, the total relevant annual cost is described by
"    ! !#12
S D 2D
TRCðmÞ ¼ 2D A þ þ RðLÞ rCV m 1

1þ þ rCP þ gmD
m P P
pffiffiffiffi 
þ rCP k
L þ iq ln 0 ð10Þ

Ignore the terms that are independent of m, and take the square of (10); then,
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minimizing TRC(m) is equivalent to minimizing

ðTRCðmÞÞ2
      
S D 2D
¼ 2D A þ þ RðLÞ rCV m 1

1þ þ rCP þ gmD
m P P
"        
2D D
¼ 2D ðA þ RðLÞÞ rCP
1
rCV þ S rCV 1
þ gD
P P
       #
D S 2D
þ mðA þ RðLÞÞ rCV 1
þ gD þ rCP
1
rCV
P m P

Once again, ignoring the terms that are independent of m, the minimization of the
problem can be reduced to that of minimizing
       
D S 2D
ZðmÞ ¼ mðA þ RðLÞÞ rCV 1
þ gD þ rCP
1
rCV ð11Þ
P m P

The optimal value of m ¼ m is obtained when

Zðm Þ  Zðm
1Þ and Zðm Þ  Zðm þ 1Þ: ð12Þ

Substituting relevant values in (12), the following condition holds:

SðrCP
ð1
2D=PÞrCV Þ
m ðm
1Þ   m ðm þ 1Þ ð13Þ
ðA þ RðLÞÞðrCV ð1
D=PÞ þ gDÞ

Hence, for fixed L 2 [Li, Li
1], when the constraint 0<  0 is ignored, one can
find the optimal values of Q , m and  such that the annual total relevant cost
reaches a minimum.
The following procedure is constructed to find optimal values of Q, m,  and L
for the problem under investigation.
Step 1. For each Li, i ¼ 1, 2, . . . , n, set i ¼ 0 and perform (i)–(iii):
(i) Substitute i into equation (13) to find mi, and use i and mi to compute Qi
using equation (8).
(ii) Use Qi and mi to determine i from equation (9).
(iii) Repeat (i)–(ii) until no change occurs in the values of Qi, mi and i. Denote
these solutions by Qi , mi and i , respectively.
 Just-in-time purchasing 859

Step 2. If i  0, then the solution found in step 1 is optimal for the given Li; so
use equation (4) to compute TRC(Qi ,mi ,i , Li), for i ¼ 0, 1, . . . , n, and go to
step 4.
Step 3. If i > 0, set i ¼ 0 for the given Li, then substitute i into equation (13)
to compute mi , and use i and mi to determine Qi from equation (8); so use
equation (4) to calculate TRC(Qi , mi , i, Li), for i ¼ 0, 1, . . . , n.
Step 4. Set TRC(Qs, ms, s, Ls) ¼ mini ¼ 0,1, . . ., n{TRC(Qi , mi , i, Li)}. Then
TRC(Qs, ms, s, Ls) is a set of optimal solutions.

5. An illustrative example
Consider an inventory system with the following characteristics (Pan and Yang
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2002): D ¼ 1000 unit/year, P ¼ 3200 unit/year, A ¼ $25/order, S ¼ $200/setup,

CP ¼ $25/unit, CV ¼ $20/unit, r ¼ 0.2, k ¼ 2.33,
¼ 7 unit/week, i ¼ 0.1/$/year,
g ¼ $15 per defective unit, q() ¼ 400 ln(0.0002/), and the lead time has three
components with data shown in table 1.
Applying the proposed solution procedure yields optimal lead time Ls ¼ 42 days,
optimal number of deliveries ms ¼ 4, optimal probability s ¼ 0.000 010 336, and
optimal order quantity Q* ¼ 129 units. The total relevant annual cost is $2273.359.
The resulting solution procedure is summarized in table 2.
Without crashing, frequent delivery and quality investment, the traditional
integrated inventory model is given by:
 
D Q D pffiffiffiffi
TRCðQÞ ¼ ðA þ SÞ þ rCV þ rCP þ gD þ rCP k
L ð14Þ
Q 2 P
To obtain the minimum cost lot size, take the first derivative of TRC(Q), and set
it to zero; thus,
 
@TRCðQÞ D 1 D
¼
2 ðA þ SÞ þ rCV þ rCP þ gD ¼ 0 ð15Þ
@Q Q 2 P

Lead time Normal duration Minimum duration Unit crashing cost

component i bi (days) ai (days) ci ($/day)

1 20 6 0.1
2 20 6 1.2
3 16 9 5.0

Table 1. Lead time data for the illustrative example.

i Li mi Qi i TRC(Qi , mi , i, Li)

0 56 4 129 0.000010336 2293.408

1 42 4 129 0.000010336 2273.359a
2 28 3 170 0.000010458 2358.321
3 21 3 186 0.000009558 2532.913
a
The minimum total relevant annual cost.
Table 2. Summary of the solution procedure for the illustrative example.
 860 J.-S. Yang and J. C.-H. Pan

Traditional Proposed
model model

Purchaser order lot size 303 129

Vender produce lot size 303 516
Lead time 56 42
Number of deliveries 1 4
Probability of process being out of control 0.0002 0.000010336
Joint total annual cost 3034.673 2273.359

Table 3. Summary of comparison for the illustrative example.

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The function TRC(Q) is convex in Q, since

@2 TRCðQÞ 2D
¼ 3 ðA þ SÞ > 0
@Q2 Q

Therefore, solving for the optimal order quantity in (15), we obtain

" #12
2DðA þ SÞ
Q¼ D
ð16Þ
rð P CV þ CP Þ þ gD

From (16), the optimal order quantity is Q* ¼ 303 units and the corresponding
minimum total relevant annual cost is $3034.673. The summary of the comparison is
presented in table 3. From table 3, the proposed model is shown to provide a lower
total inventory cost with higher quality, more frequent delivery with smaller lot size
and shorter lead time.
The philosophy of JIT purchasing is to establish a long-term relationship with
vendors to maintain regulated shipments to minimize ordering cost and to buy
enough parts as needed to avoid paying holding cost. However, these two costs
will inevitably exist, though they may not be very significant, in many practical
situations. The proposed integrated model can be shown to cope with these partic-
ular circumstances. For example, suppose that the fixed cost per order is as low as
$0.1 in the illustrative example. Applying the solution procedure it can be shown that
the optimal lead time is Ls ¼ 56 days, the optimal number of deliveries is ms ¼ 70,
the optimal probability is s ¼ 0.000002067, and the optimal order quantity Q* is
decreased to 8 units with total relevant annual cost of $1903 and annual ordering
cost of $12.5. Compared to the original result, the holding cost is reduced because of
smaller order quantity.
This result can also be obtained theoretically. From equation (13), the number of
deliveries increases as the ordering cost decreases, which in turn causes the
order quantity to decrease by equation (8). Consequently, the average inventory
level and the associated annual holding cost are reduced. That is, an insignificant
ordering cost in the integrated system will result in frequent delivery of small
quantities with low on-hand inventory that lives up to the expectation of JIT philo-
sophy. The JIT system emphasizes the reduction of inventory cost. There are several
reasons why this is desirable, and the reduction of order quantity is certainly one
of them.
 Just-in-time purchasing 861

6. Conclusions
Many researchers focus on the benefit from quality improvement or lead-time
reduction in inventory models but only from a single party’s viewpoint. However,
consideration of the dyadic relationship between the vendor and purchaser is essen-
tial for implementing a just-in-time purchasing model. This paper investigates a JIT
purchasing model where a single vendor supplies a single purchaser with a product
by presenting an integrated inventory model that accounts for replenishment lead-
time reduction and quality improvement investment considerations. The model is to
minimize the sum of the ordering/setup cost, holding cost, quality improvement and
crashing cost by simultaneously optimizing the order quantity, the lead time, the
process quality and the number of deliveries with normally distributed lead time
demand and is shown to provide a lower total cost, higher quality, smaller lot size
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and shorter lead time. JIT purchasing has an enormous impact on a company’s
profitability, especially in a competitive environment characterized by small profit
margins. Furthermore, the application of JIT technologies such as small lot size, lead
time reduction and quality improvement play a significant role in achieving JIT
purchasing. The proposed model serves as a pioneering work on investigating the
effects of lead time reduction and quality improvement on the integrated inventory
model.

Appendix
For fixed L 2 (Li, Li
1), TRC(Q, m, , L) is convex with respect to Q and , since
 
@2 TRCðQ, m, , LÞ 2D S
¼ A þ þ RðLÞ >0
@Q2 Q3 m
@2 TRCðQ, m, , LÞ iq
¼ 2>0
@2 
The determinant of the Hessian matrix can be calculated as
" #2
@2 TRCðQ, m, , LÞ @2 TRCðQ, m, , LÞ @2 TRCðQ, m, , LÞ


@Q2 @2 @Q@
    2
2D S iq gm D
¼  3 A þ  þ RðLÞ

ðQ Þ m ð Þ2 2
  2
S 
gm D 2DðA þ m þ RðLÞÞ
¼
1
2 iqQ
  2
 
gm D Q ðrCV ðm ð1
D=PÞ
1 þ 2D=PÞ þ rCP þ gm D Þ
¼
1
2 iq
  2
 
gm D Q ðrCV ðm ð1
D=PÞ
1 þ 2D=PÞ þ rCP Þ
¼ þ1 >0
2 iq
Hence, for a fixed L, the Hessian matrix is positive and TRC(Q, m, , L) is convex
with respect to Q and .

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