Computing a Stationary Base-Stock Policy for a Finite Horizon Stochastic Inventory Problem with Non-linear Shortage Costs

Abstract

We consider a periodic-review stochastic inventory problem in which demands for a single product in each of a finite number of periods are independent and identically distributed random variables. We analyze the case where shortages (stockouts) are penalized via fixed and proportional costs simultaneously. For this problem, due to the finiteness of the planning horizon and non-linearity of the shortage costs, computing the optimal inventory policy requires a substantial effort as noted in the previous literature. Hence, our paper is aimed at reducing this computational burden. As a resolution, we propose to compute “the best stationary policy.” To this end, we restrict our attention to the class of stationary base-stock policies, and show that the multi-period, stochastic, dynamic problem at hand can be reduced to a deterministic, static equivalent. Using this important result, we introduce a model for computing an optimal stationary base-stock policy for the finite horizon problem under consideration. Fundamental analytic conclusions, some numerical examples, and related research findings are also discussed.