Optimal ordering based on shortage scenarios under presence of a low-quality substitute and supply uncertainty

Abstract

Global trade has shifted from short-distance supply chains within countries to long-distance supply chains between countries. As a result, delivery lead time has become a key operational factor, and uncertainty causes stock-outs, resulting in massive losses. An important solution for shortages is product substitutes, but they can affect the quality of the end products. Moreover, even when demand is expected and planned for, unexpected last-minute demand makes operational conditions challenging. This paper considers a single-period problem of replenishing a high-quality product under both lead time and demand-related uncertainty. Stock-outs during and at the end of the replenishment period can be handled only by providing a low-quality substitute product that requires repeated replacements, therefore affecting pending demand. We provide detailed modeling of possible stock-out scenarios and show that, in presence of these two types of uncertainty, the optimal order quantity of a high-quality product can be determined using an upper and lower threshold and a base stock level equal to anticipated (planned) demand over the replenishment period. In particular, we derive a closed-form solution for the optimal order quantity under general probability distributions of lead time and demand and explicit solutions for uniform distributions. We also show the conditions under which optimal order quantities can be insensitive to the cost of the high-quality product.