Operations Research for Health Care 2 (2013) 5264

Contents lists available at ScienceDirect

Operations Research for Health Care
journal homepage: www.elsevier.com/locate/orhc
Pharmaceutical supply chain and inventory management strategies:
Optimization for a pharmaceutical company and a hospital
R. Uthayakumar, S. Priyan

Department of Mathematics, The Gandhigram Rural Institute, Deemed University, Gandhigram 624 302, Dindigul, Tamil Nadu, India
a r t i c l e i n f o
Article history:
Received 28 January 2013
Accepted 14 August 2013
Available online 28 August 2013
Keywords:
Pharmaceutical supply chain
Inventory management
Service level constraint
a b s t r a c t
A high level of service for medical supplies and effective inventory policies are essential objectives for
all health care industries. Medicine shortages and improper use of pharmaceuticals can not only lead
to financial losses but also have a significant impact on patients. Many health systems and hospitals
experience difficulties in achieving these goals as they have not addressed how medicines are managed,
supplied, and used to save lives and improve health. Studies are essential to understand operations
in health care industries and to offer decision support tools that improve health policy, public health,
patient safety, andstrategic decision-making inthe pharmaceutical supply chain. We present aninventory
model that integrates continuous review with production and distribution for a supply chain involving
a pharmaceutical company and a hospital supply chain. The model considers multiple pharmaceutical
products, variable lead time, permissible payment delays, constraints on space availability, and the
customer service level (CSL). We develop a procedure for determining optimal solutions for inventory
lot size, lead time, and the number of deliveries to achieve hospital CSL targets with a minimumtotal cost
for the supply chain. A numerical example illustrates the model application and behavior.
2013 Elsevier Ltd. All rights reserved.
1. Introduction
Research into supply chain and inventory management has
been extensive in the field of health care. The main goal of this re-
search is to reduce health care costs without sacrificing customer
service. Pharmaceuticals represent a significant part of health care
costs, account for approximately 10% of annual health care expen-
diture in the USA and about $600 billion globally in 2009 [1]. Phar-
maceutical products can be expensive to purchase and distribute,
but shortages of essential medicines, improper use of medicines,
and spending on unnecessary or low-quality medicines also have a
high costs in terms of wasted resources and preventable illness and
death. Almarsdttir and Traulsen identified a number of reasons
why pharmaceutical deserve special consideration in the control of
inventory [2]. In the current economic crisis, increasing attention
is being focused on the rising costs of health care and specifically
pharmaceuticals.
Careful management of pharmaceutical is directly related to a
countrys ability to address public health concerns. Aptel and Pour-
jalali stated that management of pharmaceutical supplies is one of
the most important managerial issues in health care industries [3].
However, many health care industries experience difficulty in
managing their pharmaceutical products. Apharmaceutical supply

Corresponding author. Tel.: +91 451 2452371; fax: +91 451 2453071.
E-mail addresses: uthayagri@gmail.com (R. Uthayakumar),
jaisilpriyan@gmail.com (S. Priyan).
chain (PSC) can be defined as the integration of all activities asso-
ciated with the flowand transformation of drugs fromrawmateri-
als through to the end user, as well as associated information flows,
through improved supply chain relationships to achieve a sus-
tainable competitive advantage [4]. The PSC comprises three ma-
jor players: producers, purchasers, and pharmaceutical providers.
Producers consist of pharmaceutical companies, medical surgical
product companies, device manufacturers, and manufacturers of
capital equipment and information systems. Purchasers include
grouped purchasing organizations (GPOs), pharmaceutical whole-
salers, medical surgical distributors, independent contracted dis-
tributors, and product representatives. Providers include hospitals,
hospital systems, integrateddelivery networks (IDNs), andalterna-
tive site facilities [5].
The PSC is very complex and carries high responsibility in en-
suring that the right drug reaches the right people at the right time
and in the right condition to fight against disease and suffering. It is
a highly sensitive supply chain in which anything less than a cus-
tomer service level (CSL) of 100% is unacceptable because of the
direct impact on health and safety. The solution adopted by many
pharmaceutical industries is to carry a huge inventory in the sup-
ply chaintoensure a fill rate close to100%. However, ensuring 100%
product availability at an optimal cost represents a huge challenge
unless the supply chain processes are streamlined towards cus-
tomer needs and demands. Product perishability is another critical
PSC issue. Outdated or expired items may be overlooked and dis-
pensed to patients, which could have potentially disastrous effects
2211-6923/$ see front matter 2013 Elsevier Ltd. All rights reserved.
http://dx.doi.org/10.1016/j.orhc.2013.08.001
R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264 53
on both patient care and public relations. In a 2003 survey, the es-
timated cost for expiration of branded products in supermarkets
and drug stores was over 500 million dollars [6]. Apart from this
perishability issue, health care managers are challenged with de-
veloping inventory policies givenchanging demands, limited space
capacity, CSL, patient safety, and regulations affecting supply.
In considering a PSC, health care managers have to decide or-
der quantities and purchasing dates and the inventory level they
carry toeffectively serve their customers. They alsohave tomanage
their interactions with pharmaceutical companies to minimize the
integrated total cost for PSC and inventory management without
sacrificing CSL. Therefore, PSCs require effective inventory man-
agement policies and coordination among producers, purchasers,
and providers. PSC decisions are significant because a shortage of
medicines and improper use of pharmaceutical products lead to fi-
nancial losses and have a significant impact on patients. Therefore,
PSC decision-makers require expert knowledge to make the best
use of their organizational resources and improve customer satis-
faction without negatively affecting public health, patient safety,
or relations with PSC members.
Unlike many industries, hospital administrators and pharmacy
managers have to manage very complicated distribution networks
and inventory management problems without proper guidance on
efficient practices. This is because most hospital administrators
and pharmacy managers are doctors with expert knowledge in
medicine, and are not supply chain professionals [7]. Hence, given
the high costs, coordination, constraints, and perishability of phar-
maceuticals, more study is necessary to help health care managers
in setting optimal PSC and inventory management policies. Oper-
ations research (OR) provides a wide range of methodologies that
can help hospitals and other health care systems to significantly
improve their operations. A number of studies have considered
problems related to health care using OR techniques [811]. Here
we develop an OR model for PSC and inventory management for a
pharmaceutical company and a hospital. The next section reviews
the literature on supply chain management issues from the per-
spective of health care industries.
2. Literature review
Management of the procurement, storage, and distribution of
pharmaceutical supplies is crucial for hospitals and pharmaceuti-
cal companies from economic and organizational points of view.
PSC issues have been addressed by several authors from differ-
ent point of views. Norris investigated cost reductions for hospi-
tals by considering the total delivered cost of a product rather than
just the unit cost [12]. This involves quantifying every cost asso-
ciated with a product, including the unit cost and costs related to
ordering, inventory, distribution, preparation and use, and paper-
work. Lapierre and Ruiz presented a strategy for improving hospi-
tal logistics by focusing on scheduling decisions and a supply chain
approach rather than the more common multi-echelon inventory
management [13]. They placed an emphasis on scheduling deci-
sions, such as when to buy a product, when to deliver to each care
unit, when each employee should work, and what task should be
done. Scott and Graham proposed that implementation of an off-
site warehouse to pool resources would result in a great savings for
hospital supply chains [14]. The savings would be achieved as a re-
sult of dramatic reductions in inventory holding costs and on-hand
inventory.
Bevilacqua et al. compared two different management ap-
proaches for procurement of medical items by hospitals in a region
of central Italy [15]. They focused on a selected range of medical
supplies according to their prevalence in three separate hospital
budgets. Comparisons were made for parameters such as buffer
stock, the reorder point, and relative costs. Dellaert and Vande Poel
developed a simple inventory rule for joint ordering in a univer-
sity hospital, but they ignored capacity constraints [16]. Kelle et al.
provided decision support tools that improve operational, tactical,
and strategic decision-making in PSC and inventory management
under an inventory policy that involves periodic review [17]. The
inventory models mentioned above are single-echelonmodels that
consider a constant lead time, which is not a controllable factor un-
der a periodic review environment.
Outsourcing is allocation of specific business processes to an
external specialist service provider and can yield organizational
flexibility. Although outsourcing has a variety of organizational
benefits, it can also pose difficulties if a suitable service provider
is not identified. As in other industries, outsourcing has become
an important strategy for pharmaceutical companies owing to in-
creasing competitive pressures to reduce costs and the time to
market. Regardless of the specific product, partnerships among
suppliers anddistributors to combine services have generatedben-
efits for health care providers [18][20]. However, outsourcing
leads to longer and more complex PSCs and reduces their trans-
parency. Nicholson et al. developed analytical models to study and
analyze the impact of outsourcing of inventory management de-
cisions in health care to a third-party provider [19]. They com-
pared inventory costs and service levels for non-critical inventory
items of an in-house three-echelon distribution network to an out-
sourced two-echelon distribution network. According to Veral and
Rosen, a long-term benefit of outsourcing is the ability to reduce
the number of suppliers in the system, which will eventually lower
procurement costs for downstream members of the supply chain
[20]. Chasin et al. investigated medical errors arising from out-
sourcing of laboratory and radiology services [21]. As for any com-
plicated area of study, the limitations of an investigation must be
considered. The lack of outsourcing is a limitation of this study.
All steps from the supply of raw materials to the finished prod-
ucts can be included in a supply chain connecting raw mate-
rial suppliers, manufacturers, retailers, and the customer/hospital.
Multi-echelon inventory management is the management of in-
ventory and coordination of the distribution process at more than
one level of a supply chain network. Multi-echelon inventory mod-
els have attracted much attention and the integrated approach has
been extensively studied. This approach was first implemented in
retail and manufacturing industries, but has since spread to health
care industries. Kim presented an explanation of an integrated
supply chain management system developed to specifically ad-
dress issues related to pharmaceuticals in the health care sector
[22]. Meijboom and Obel addressed supply chain coordination for
a pharmaceutical company with a multi-location and multi-stage
operations structure [23]. Amir et al. developed a generalized net-
work oligopoly model for PSC competition that takes into account
product perishability, brand differentiation, and discard costs [24].
Their generalized network-based framework captures competition
among firms in the various supply chain activities of manufactur-
ing, storage, and distribution.
Lead time is an essential factor in any supply chain and inven-
tory management system. Pharmaceutical manufacturers typically
set a specific time for delivery products to customers that consid-
ers factors such as labor strikes and natural disasters. This time is
called the inventory lead time and comprises components such as
order preparation, order transit, supplier lead time, delivery time,
andset-uptime [25]. Inmany practical situations, leadtimes canbe
reduced by paying an additional crash cost. According to Hsu and
Lee, crash costs could be expenditure on equipment improvement,
information technology, order expedition, or special shipping and
handling [26]. Using this viewpoint, Liao and Shyu devised a prob-
abilistic inventory model in which lead time was considered as a
decision variable [27]. Several researchers extended this approach
inintegrated productioninventory models for lead time reduction
in a single-vendor, single-buyer supply chain [2830].
54 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264
In practice, a periodic-review inventory policy is not applicable
for health care inventory management because customer demands
and patient arrivals are uncertain. Thus, efficient management of
health care inventory systems requires a different approach than a
periodic-review reorder point model. According to Woosley, there
are at least three limitations for use of the continuous replenish-
ment model in the context of health care supply systems [7]. The
model does not account for limited human resources or physical
storage capacity, CSL which is critical in most hospitals, and deci-
sions are based only on costs and do not consider inventory control
activities and restricted capacity. Because of the above-mentioned
limitations in health care industries, a continuous-review inven-
tory policy is more suitable than a periodic review approach in
health care inventory management.
Multi-echelon inventory problems for perishable products have
been widely studied for general applications. However, existing
inventory models are not applicable to pharmaceutical products
for several reasons. Pharmaceutical products can be more expen-
sive than other products to purchase and distribute, and short-
ages and improper use of essential medicines can have a high cost
in terms of wasted resources and preventable illness and death.
Therefore, special care should be taken in pharmaceutical inven-
tory decisions to ensure 100% product availability at the right time,
at the right cost, and in good condition to the right customers. The
quality of health care industries strongly depends on the availabil-
ity of pharmaceuticals on time. If a shortage occurs at a hospital,
an emergency delivery is necessary, which is very costly and can
be implications for patient health. Inventory management strate-
gies that are unsuitable for health care industries may lead to large
financial losses and a significant impact on patients. Hence, inven-
tory strategies for pharmaceutical products are more critical than
those for other products. Thus, a specific inventory model is nec-
essary for control of pharmaceutical products to save patient lives
and reduce unnecessary inventory costs.
Here we investigate a two-echelon supply chain inventory
model for multiple pharmaceutical products under realistic prob-
lems in health care industries. These include effective inventory
policies and decisions, constraints and limitations, customer sat-
isfaction, permissible payment delays, inventory lead time, and a
minimumexpected total inventory cost. We present a continuous-
review integrated productiondistribution inventory model for
supply chain involving a pharmaceutical company and a hospi-
tal. We consider multiple pharmaceutical products, a variable lead
time that can be controlled via crash cost, permissible payments
delays, and realistic constraints such as space availability and CSL.
We develop a procedure for determining the optimal solutions for
inventory lot size, leadtime andthe total number of deliveries from
the pharmaceutical company to the hospital to achieve the target
hospital CSL at a minimum supply chain cost.
The remainder of the paper is organized as follows. Section 3
provides the notations and assumptions used. Derivation of the OR
model is described in Section 4 and the solution procedure is pre-
sented in Section 5. A numerical example is provided in Section 6.
Section 7 concludes.
3. Notations and assumptions
We develop an OR model using the notations and assumptions
listed below. Additional notations and assumptions are provided
when required.
3.1. Notations
M: Number of products controlled in the supply chain
Decision variables
Q
i
: Order quantity for the ith product (i = 1, 2, 3, . . . , M)
L: Lead time (days) for all products
n: Total number of lots of M products delivered by the phar-
maceutical company to the hospital in one production cycle, a
positive integer
Other parameters for the hospital
D
i
: Average demand for the ith product per year
d
i
: Expiry rate for the ith product
h
bi
: Holding cost per unit per year excluding interest charges for
the ith product
A
i
: Ordering cost per order for the ith product
t
c
: Common trade credit period for all products offered by the
pharmaceutical company in years
I
d
: Common deposit interest rate for all products per year
I
c
: Interest charge paid per $ in stock to the bank for all products
per year
p
i
: Purchase price per unit for the ith product
s
i
: Selling price per unit for the ith product
r
i
: Reorder point for the ith product
X
i
: Lead time demand for the ith product, which follows a nor-
mal distribution with finite mean D
i
L and standard deviation

L, where
i
is the standard deviation for the demand per
unit time for the ith product
E(X
i
r
i
)
+
: Expected demand shortage for the ith product at
the end of a cycle

i
: Fraction of demand for the ith product that is not met from
stock, so 1
i
is the service level
F: Fixed transportation cost for all products per delivery
f
i
: Storage space for the ith product
W: Total space available for the M products
Other parameters for the pharmaceutical company
h
vi
: Holding cost per unit time for the ith finished product
S
i
: Set-up cost for the ith finished product
P
i
: Production rate for the ith finished product
I
v
: Interest rate for calculating the opportunity interest loss for
the pharmaceutical company due to delayed payment per year
d
ci
: Expiration rate for the ith finished product
C
dci
: Cost of expiry for the ith finished product
Q
wi
: Replenishment quantity for the ith raw material for pro-
duction in each production cycle
A
wi
: Ordering cost for the ith raw material
h
wi
: Holding cost per unit time for the ith raw material
F
w
: Fixed transportation cost for all raw materials
v
wi
: Labor cost for order handling and receipt for the ith raw
material

i
: Defect rate for the ith raw material in an order lot,
i

[0, 1), a random variable
s
ci
: Screening cost per unit time for the ith raw material
r
si
: Screening rate per unit time for the ith raw material
IETC(.): PSC integrated expected total cost for all products
3.2. Assumptions
1. The supply chain consist of a single pharmaceutical company
and a single hospital and they deal with multiple (M) pharma-
ceutical products. For the ith product, the hospital orders a lot
of size Q
i
(i = 1, 2, 3, . . . , M) and the pharmaceutical company
produces nQ
i
units at a finite production rate of P
i
(P
i
> D
i
) per
unit time in one production cycle, but ships in quantity Q
i
to the
hospital ntimes. All products for the hospital are inshortage and
completely backordered.
2. For the ith rawmaterial, all orders are delivered to the pharma-
ceutical company in one shipment by an external supplier. In
other words, the quantity of the ith raw material required for
production in each production cycle is instantaneous.
3. All expired pharmaceutical products held in inventory by
the pharmaceutical company are a constant fraction of the
accumulated inventory.
R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264 55
4. The hospital uses a continuous-review inventory policy for all
products and the order quantity Q
i
for the ith product is placed
when its inventory level falls to the reorder point r
i
.
5. The reorder point for the ith product is r
i
= expected demand
for product i during the lead time (D
i
L)+ safety stock of i (s
si
),
where s
si
= k
i
x (standard deviation for the lead time demand
for i), that is,
r
i
= D
i
L +k
i

L, (1)
where k
i
is the safety factor for product i and satisfies Pr(X
i
>
r
i
) = q
i
, and q
i
is the allowable stock-out probability for i during
the lead time.
6. The pharmaceutical company offers a certain trade credit pe-
riod (permissible payment delay) for all products to cooperate
with the hospital in an integrated strategy. Thus, the hospital
does not have to pay immediately on receipt of products.
7. The credit period t
c
is less than the reorder interval for each
product, which means that the credit period cannot be longer
than the time at which another order is placed. This is in
agreement with usual practice in health care industries.
8. The hospital deposits sales income in a bank with an annual
interest rate of I
d
before payment is due. At the time of
payment, the hospital pays the pharmaceutical company for
products purchased. The hospital has a loan from a bank for
unpaid purchase costs for unsold units. During the payment
delay period, the pharmaceutical company has an opportunity
interest loss at an annual rate of I
v
, where I
v
= I
d
.
9. Crash costs increase as an approximate exponential function of
the lead time. Therefore, the lead-time crash cost R(L) per order
for all products is assumed to be an exponential function of L
and is defined as
R(L) =
_
0 L = L
0
,
e
C/L
L
b
L < L
b1
,
where C is a positive constant and L
0
and L
b
represent the
existing and shortest lead times, respectively.
4. OR model development
OR provides methodologies that can support logistical opera-
tions in health care industries and help in process optimization.
We examine an OR model for PSC and inventory management for a
single pharmaceutical company and a single hospital. We consider
a two-echelon supply chain inventory model for multiple pharma-
ceutical products under realistic conditions. In this section, we for-
mulate an OR model to identify the optimal inventory lot size, lead
time, and total number of deliveries in a production cycle by mini-
mizing the integrated expected total cost while satisfying hospital
space availability and CSL constraints.
4.1. Inventory model for the hospital
For product i, the hospital administrator places an order of Q
i
units. Therefore, for an average cycle time of Q
i
/D
i
, the expected
order cost is
A
i
D
i
Q
i
and the lead time crash cost per unit time is
D
i
R(L)
Q
i
.
The order cost involves the cost of preparing the order or invoice,
stationery and postage, wages, telephone charges, and travel ex-
penses.
The expectednet inventory level just before arrival of a procure-
ment quantity Q
i
is only the safety stock s
si
= r
i
D
i
L = k
i

L
according to Eq. (1). The expected net inventory level immediately
after arrival of procurement quantity Q
i
is Q
i
+k
i

L. Hence, the
expected on-hand inventory over the cycle is
Max. on hand + Min. on hand
2
=
(Q
i
+k
i

L)+k
i

L
2
=
Q
i
2
+k
i

L.
To accommodate a more realistic inventory situation, we add
the effects of trade credit finance. In real life, business via share
marketing, trade credit finance, or permissible payment delays
can improve sales in health care industries. Many pharmaceutical
companies offer hospitals an interest-free credit period to promote
market competition and improve health policy, patient safety,
and public health. Before the end of the trade credit period, the
hospital can sell the goods and accumulate revenue and earn
interest. However, higher interest is charged if the payment is not
settled by the end of the trade credit period. Therefore, it makes
economic sense for the hospital to delay payment to the end of the
permissible delay period allowed by the pharmaceutical company.
We assume that the pharmaceutical company offers a common
trade credit period for all products to attract hospital cooperation
in our integrated strategy.
Let t
c
be the common credit period for all products and let h
bi
be
the unit stock-holding cost per unit time excluding interest charges
for stock financing. The expected inventory for product i over the
cycle is
Q
i
2
+k
i

L, where
Q
i
2
is the expected cycle stock. Therefore,
the holding cost per unit time for the cycle stock of i is
h
bi
Q
i
2
. Asafety
stock of k
i

L is held throughout the cycle. Therefore, according

to the trade credit policy, the pharmaceutical company charges
interest at rate I
c
for this portion of the stock and the hospital must
pay the corresponding holding cost. Hence, the total cost of the
safety stock per unit time is the sumof the holding cost andinterest
charged: (h
bi
+p
i
I
c
)k
i

L.
The credit period t
c
is less than the reorder interval for each
product. This is a reasonable assumption because previous orders
should be paid for before another order is placed. Therefore, the
hospital can sell products and earn interest at the common rate of
I
d
up to the end of the credit period. Hence, the interest earned by
the hospital per unit time for product i is
s
i
I
d
D
i
Q
i
_
t
c
0
D
i
tdt =
D
2
i
t
2
c
s
i
I
d
2Q
i
.
The expected shortage for i, E(X
i
r
i
)
+
, is completely backlogged
in the previous cycle and is cleared at the beginning of the current
cycle. Therefore, the hospital earns interest of
s
i
t
c
I
d
D
i
Q
i
E(X
i
r
i
)
+
per
unit time during the credit period.
Conversely, the hospital still has (Q
i
D
i
t
c
) unsold units at the
end of the permissible delay period. The pharmaceutical company
charges interest for this portion of the stock. However, the hospital
has a loan from a bank for unpaid purchase costs for unsold units,
at the common interest rate of I
c
.
Therefore, the opportunity interest cost per unit time for unsold
units of product i is
p
i
I
c
D
i
Q
i
_
Q
i
D
i
t
c
(Q
i
D
i
t)dt =
(Q
i
D
i
t
c
)
2
p
i
I
c
2Q
i
.
In general, pharmaceutical products have a deterministic shelf
life: if a product is not used within its lifetime, it is considered to be
expired and must be destroyed. Accordingly, we assume that d
i
is
the proportional probability for expiry of product i at the hospital.
Consequently, the total amount of expired product for i is d
i
Q
i
. We
assume that the expiry cost applies immediately when the hospital
orders the product from the pharmaceutical company. Hence, the
expiry cost C
di
(L) is a function of the lead time. Therefore, the
expected expiry cost is d
i
D
i
C
di
(L), where C
di
(L) is a linear function
of lead time L, that is, C
di
(L) =
i
+
0i
L, where 0
0i
1 and

i
is a positive constant.
In practice, the hospital pays a fixed transportation cost and
labor costs for order handling and receipt fromthe pharmaceutical
company. We assume that the hospital pays a fixed transportation
cost of F for all products and a labor cost of v
i
for product i. Hence,
the expected transportation and labor costs per unit time are
FD
i
Q
i
and v
i
D
i
, respectively.
Accordingly, the expected total cost per unit time for product i
is
ETC
hi
(Q
i
, L) =
D
i
Q
i
(A
i
+F +R(L)) +
(Q
i
D
i
t
c
)
2
p
i
I
c
2Q
i
56 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264
+
h
bi
Q
i
2
+(h
bi
+p
i
I
c
)k
i

L +D
i
(d
i
C
di
(L) +v
i
)

D
2
i
t
2
c
s
i
I
d
2Q
i

s
i
t
c
I
d
D
i
Q
i
E(X
i
r
i
)
+
.
The expected total cost per unit time for all (M) products is then
ETC
h
(Q, L) =
M

i=1
[ETC
hi
(Q
i
, L)] =
M

i=1
_
D
i
Q
i
(A
i
+F +R(L))
+
(Q
i
D
i
t
c
)
2
p
i
I
c
2Q
i
+
h
bi
Q
i
2
+(h
bi
+p
i
I
c
)k
i

L
+ D
i
(d
i
C
di
(L) +v
i
)
D
2
i
t
2
c
s
i
I
d
2Q
i

s
i
t
c
I
d
D
i
Q
i
E(X
i
r
i
)
+
_
(2)
where Q = (Q
1
, Q
2
, Q
3
, . . . , Q
M
).
4.2. Inventory model for the pharmaceutical company
Most productiondistribution inventory models assume that
the total cost for the manufacturer comprises holding, set-up, and
production costs for finished goods. However, this total cost is
not suitable for real-life production situations because a manufac-
turing company generally procures raw materials from external
suppliers and holds them in inventory before starting production.
Therefore, the inventory for a manufacturing company should in-
clude raw materials and associated costs such ordering, purchas-
ing, and holding costs. Here we assume that the pharmaceutical
company procures multiple raw materials from supplier and pro-
duces multiple finished products. Therefore, we derive expected
total costs for both finished products and raw materials.
4.2.1. Finished products
In our integrated inventory system, the pharmaceutical com-
pany begins production once the hospital orders l products of lot
size Q
l
, where the production rate is P
i
(i = 1, 2, 3, . . . , M) and
a constant number of units are added to the inventory until the
production run has been completed. The pharmaceutical company
produces product i in lot size nQ
i
in each production cycle of length
nQ
i
D
i
, and the hospital receives the product in n lots each of size
Q
i
(i = 1, 2, 3, . . . , M). The first lot of size Q
i
is ready for ship-
ment after time Q
i
/P
i
and then the pharmaceutical company con-
tinues to the deliver the product on average every Q
i
/D
i
units of
time until the inventory level falls to zero. Hence, the expected
on-hand inventory of product i for the pharmaceutical company
is evaluated as the difference in accumulated inventory between
the pharmaceutical company and the hospital. According to Fig. 1,
the inventory of product i for the pharmaceutical company is
nQ
i
_
Q
i
P
i
+(n 1)
Q
i
D
i
_

n
2
Q
2
i
2P
i
units and the accumulated inventory
for the hospital is
Q
2
i
D
i
(1+2+3+ +(n1)) units. Hence, the ex-
pected inventory per unit time for the pharmaceutical company is
__
nQ
i
_
Q
i
P
i
+(n 1)
Q
i
D
i
_

n
2
Q
2
i
2P
i
_

_
Q
2
i
D
i
(1 +2 +3 + +(n 1))
__
D
i
nQ
i
=
_
nQ
2
i
D
i
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_

_
Q
2
i
n(n 1)
2D
i
__
D
i
nQ
i
=
Q
i
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_
.
Therefore, the holding cost per unit time for the pharmaceutical
company is
h
vi
Q
i
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_
.
According to Assumption 3, the total number of expired prod-
ucts held by the pharmaceutical company is
= d
ci
_
nQ
i
_
Q
i
P
i
+(n 1)
Q
i
D
i
_

n
2
Q
2
i
2P
i
_
.
Therefore, the expiration cost per unit time
= d
ci
Q
i
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_
.
Consequently, the total production cost is P
i
T
1i
P
ci
(Q
i
), where
T
1i
=
nQ
i
P
i
is the production cycle for product i. The unit production
cost P
ci
(Q
i
) is a linear function of the order quantity Q
i
, that is,
P
ci
(Q
i
) =
i
+
oi
Q
i
, where
i
is the fixed cost per unit finished
product and
oi
Q
i
is the tool/die cost per unit finished product,
which is proportional to the lot size Q
i
. Hence, the total production
cost per unit time for product i is D
i
P
ci
(Q
i
). Since S
i
is the set-up
cost and the production quantity for a lot is nQ
i
units, the expected
set-up cost per unit time is given by
S
i
D
i
nQ
i
.
The hospital has a loan from a bank for unsold products. There-
fore, during the trade credit period, the pharmaceutical company
has an opportunity interest loss at an annual rate of I
v
, where
I
v
= I
d
. Hence, the expected opportunity interest loss per unit time
for product i is I
v
p
i
t
c
D
i
.
Let ETC
fi
(n, Q
i
) denote the expected total cost per unit time for
finished product i for the pharmaceutical company, which equals
the sum of set-up, holding, production, and product expiry costs
and opportunity interest losses for product i. That is,
ETC
fi
(Q
i
, n) =
S
i
D
i
nQ
i
+
h
vi
Q
i
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_
+D
i
P
ci
(Q
i
) +I
v
p
i
t
c
D
i
+Q
i
d
ci
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_
.
The expected total cost per unit time for all finished products is
then
ETC
f
(Q, n) =
M

i=1
_
ETC
fi
(n, Q
i
)
_
=
M

i=1
_
S
i
D
i
nQ
i
+
h
vi
Q
i
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_
+D
i
P
ci
(Q
i
) +I
v
p
i
t
c
D
i
+ Q
i
d
ci
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
__
. (3)
4.2.2. Raw materials
Under Assumption 2, replenishment quantity Q
wi
for raw
material i is receivedinstantaneously at the beginning of eachcycle
time
nQ
i
D
i
. Hence, the expected order cost per unit time is given by
A
wi
D
i
nQ
i
. For a practical perspective, we assume that each quantity Q
wi
contains defective raw materials at a rate of
i
, which is a random
variable. Therefore, raw materials lots are screened at a rate of r
si
to separate perfect and imperfect raw material. At the end of the
screening process, imperfect rawmaterials are soldas a single lot at
the lowest sales price per unit item to the external supplier. Thus,
the screening cost is
s
ci
Q
wi
D
i
nQ
i
and the revenue from imperfect raw
materials per unit time is
s
di

i
Q
wi
D
i
nQ
i
.
Without loss of generality, we assume that (1
i
)Q
wi
= P
i
T
1i
,
where T
1i
=
nQ
i
P
i
. In other words, the replenishment quantity is
Q
wi
=
nQ
i
(1
i
)
i = 1, 2, 3, . . . , M. (4)
R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264 57
Fig. 1. Inventory pattern for a supply chain between a pharmaceutical company and a hospital.
Hence, the holding cost per unit time is given by
h
wi
(1
i
)Q
wi
D
i
nQ
i
for perfect raw materials and
h
wi

i
Q
wi
D
i
nQ
i
_
Q
wi
r
si
_
=
h
wi

i
Q
2
wi
D
i
r
si
nQ
i
for
imperfect raw materials.
The pharmaceutical company pays fixed a transportation cost
and labor costs for order handling and receipt, given by
F
w
D
i
nQ
i
and
D
i
Q
wi
v
wi
nQ
i
, respectively.
Let ETC
wi
(Q
i
, Q
wi
, n) denote the expected total cost for raw
material i per unit time for the pharmaceutical company, which
equals the sum of expected ordering, holding, defect, screening,
transportation, and labor costs minus revenue. That is,
ETC
wi
(Q
i
, Q
wi
, n) =
A
wi
D
i
nQ
i
+
D
i
(1 E(
i
))Q
wi
h
wi
nQ
i
+
s
ci
Q
wi
D
i
nQ
i
+
h
wi
E(
i
)Q
2
wi
D
i
r
si
nQ
i
+
F
w
D
i
nQ
i
+
D
i
Q
wi
v
wi
nQ
i

s
di
E(
i
)Q
wi
D
i
nQ
i
. (5)
Using Eq. (4), we can transform Eq. (5) to
ETC
wi
(Q
i
, n) =
D
i
(A
wi
+F
w
)
nQ
i
+h
wi
D
i
+
h
wi
E(
i
)nQ
i
D
i
r
si
(1 E(
i
))
2
+
s
ci
D
i
(1 E(
i
))
+
v
wiD
i
(1 E(
i
))

s
di
D
i
E(
i
)
(1 E(
i
))
. (6)
The expected total cost for all raw materials per unit time is
ETC
w
(Q, n) =
M

i=1
[ETC
wi
(Q
i
, n)] =
M

i=1
_
D
i
(A
wi
+F
w
)
nQ
i
+h
wi
D
i
+
h
wi
E(
i
)nQ
i
D
i
r
si
(1 E(
i
))
2
+
s
ci
D
i
(1 E(
i
))
+
v
wiD
i
(1 E(
i
))

s
di
D
i
E(
i
)
(1 E(
i
))
_
. (7)
Let ETC
p
(Q, n) denote the expected total cost per unit time
for all inventory products held by the pharmaceutical company,
which equals the sum of expected total costs for all finished
products, givenby Eq. (3), and for all rawmaterials, givenby Eq. (7).
That is,
ETC
p
(Q, n) = ETC
f
(Q, n) +ETC
w
(Q, n)
ETC
p
(Q, n) =
M

i=1
_
D
i
(A
wi
+F
w
+S
i
)
nQ
i
+
h
vi
Q
i
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_
+D
i
(P
ci
(Q
i
) +h
wi
) +I
v
p
i
t
c
D
i
+Q
i
d
ci
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_
+
h
wi
E(
i
)nQ
i
D
i
r
si
(1 E(
i
))
2
+
D
i
(s
ci
+v
wi
s
di
E(
i
))
(1 E(
i
))
_
. (8)
Therefore, the integrated expected total cost for the supply
chain, per unit time for all products, IETC(Q, L, n), canbe expressed
as the sum of expected total costs for the hospital, given by
Eq. (2), and for the pharmaceutical company, given by Eq. (8).
58 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264
That is,
IETC(Q, L, n) = ETC
h
(Q, L) +ETC
p
(Q, n)
IETC(Q, L, n) =
M

i=1
_
D
i
(A
i
+F +R(L))
Q
i
+
D
i
(A
wi
+F
w
+S
i
)
nQ
i
+
(Q
i
D
i
t
c
)
2
p
i
I
c
2Q
i
+(h
bi
+p
i
I
c
)k
i

L +
h
bi
Q
i
2
+D
i
[d
i
C
di
(L) +v
i
+P
ci
(Q
i
) +h
wi
]
+
h
vi
Q
i
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_

D
2
i
t
c
2
s
i
I
d
2Q
i
+I
v
p
i
t
c
D
i

s
i
t
c
I
d
D
i
Q
i
E(X
i
r
i
)
+
+Q
i
d
ci
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_
+
h
wi
E(
i
)nQ
i
D
i
r
si
(1 E(
i
))
2
+
D
i
(s
ci
+v
wi
s
di
E(
i
))
(1 E(
i
))
_
, L [L
j
, L
j1
]. (9)
4.3. Constraints
In practice, when a hospital carries inventory it may face
limitations such as the availability of floor space, total investment
in inventory, the total number of orders to be placed per year, the
number of deliveries that can be accepted, the delivery size that
can be handled, and CSL maintenance. Specifically, most hospitals
have an undersized central area for pharmacy storage that can
hold very limited quantities of the numerous products required. In
addition, the healthcare industry is service-oriented, andcustomer
service and satisfaction are paramount. Therefore, segmentation
by market or customer is a very important step in developing
an appropriate supply chain strategy for the target customer.
Therefore, we consider hospital issues in relation to floor space and
CSL constraints.
Consider first a case in which the hospital floor space is limited
to W square feet and one unit of inventory product i occupies f
i
square feet. If Q
i
is the lot size, then the floor space constraint
means that
M

i=1
f
i
Q
i
W. (10)
For the CSL constraint, certain goals are defined and CSL is the
percentage that should be achieved for each goal. This is used in
supply chain and inventory management to measure the perfor-
mance of inventory replenishment policies. Service levels
i
are
associated with products according to the number of occasions of
shortage that managers are willing to accept during a period of
time. If a hospital pharmacy is out of a product, it can place an
emergency order with the pharmaceutical company to replenish
this product. However, hospitals would like to avoid these emer-
gency orders if possible because they are very costly [7]. We con-
sider the service level
i
for each item separately. We assume that
the hospital has set a target service level in terms of the fill rate cor-
responding to the proportion of all product demands to be satisfied
directly fromavailable stock. Therefore, the CSL constraint imposes
a limit on the proportion of demands that are not met from stock.
For product i this can be expressed as
Expected demand shortages of product i at the end of the cycle for a given safety factor
Quantity of product i available to satisfy the demand per cycle

i
.
That is,
E(X
i
r
i
)
+
Q
i

i
. (11)
We assume that the leadtime demandX
i
follows a normal prob-
ability distribution function (p.d.f.) f (x
i
) with mean D
i
L, standard
deviation
i

L, and reorder point r

i
= D
i
L + k
i

L, where k
i
is
the safety factor for product i.
For product i, shortages occur when X
i
> r
i
. Therefore, the
expected shortage at the end of the cycle time for the hospital is
given by
E(X
i
r
i
)
+
=
_

r
i
(x
i
r
i
)f (x
i
)dx
i
=
i

L(k
i
), (12)
where (k
i
) = (k
i
) k
i
[1 (k
i
)] > 0 and , are the
standard normal p.d.f. and cumulative distribution function (c.d.f),
respectively, for product i.
Hence, using Eqs. (11) and (12), the CSL constraint for product i
can be written as

L(k
i
)
Q
i

i
, L [L
j
, L
j1
].
The CSL constraint for all products is then given by
M

i=1

i
Q
i

M

i=1

L(k
i
), L [L
j
, L
j1
]. (13)
Our problem involves finding the optimal Q
i
, lead time L, and
total number of deliveries n for all products in a production cycle
that minimize the integrated expected total cost expressed by
Eq. (9) and satisfy both the floor space constraint expressed by
Eq. (10) and the CSL constraint expressed by Eq. (13):
Min IETC(Q, L, n) =
M

i=1
_
D
i
(A
i
+F +R(L))
Q
i
+
D
i
(A
wi
+F
w
+S
i
)
nQ
i
+
(Q
i
D
i
t
c
)
2
p
i
I
c
2Q
i
+(h
bi
+p
i
I
c
)k
i

L
+
h
bi
Q
i
2
+D
i
[d
i
C
di
(L) +v
i
+P
ci
(Q
i
) +h
wi
]
+
h
vi
Q
i
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_

D
2
i
t
c
2
s
i
I
d
2Q
i
+I
v
p
i
t
c
D
i

s
i
t
c
I
d
D
i
Q
i

L(k
i
) +Q
i
d
ci
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_
+
h
wi
E(
i
)nQ
i
D
i
r
si
(1 E(
i
))
2
+
D
i
(s
ci
+v
wi
s
di
E(
i
))
(1 E(
i
))
_
subject to
M

i=1
f
i
Q
i
W,
M

i=1

i
Q
i

M

i=1

L(k
i
),
(14)
where Q = (Q
1
, Q
2
, Q
3
, . . . , Q
M
), L [L
j
, L
j1
] and (k
i
) =
(k
i
) k
i
[1 (k
i
)] > 0.
5. Solution
The solution to Eq. (14) is complex because of the number of
variables and constraints in this nonlinear problem. Therefore, we
apply a Lagrangian multiplier algorithmic approach. The solution
is discussed in detail for the following cases.
Case 1.
In this case, we temporarily ignore the constraints

M
i=1
f
i
Q
i
W and

M
i=1

i
Q
i


M
i=1

i

L(k
i
) and then determine the
Q
i
, L, and n that minimize the integrated expected total cost
IETC(Q, L, n).
R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264 59
Initially, for fixed Q
i
and L [L
j
, L
j1
], we can prove that
IETC(Q, L, n) is a convex function of n. Hence, the search for an
optimal number of lots, n

, is reduced to finding a local minimum.

Property 1. For fixed Q
i
and L, IETC(Q, L, n) is convex in n
Proof. Taking the first and second partial derivatives of IETC(Q, L,
n) with respect to n, we have
IETC(Q, L, n)
n
=
M

i=1
_

D
i
(A
wi
+F
w
+S
i
)
n
2
Q
i
+
h
vi
Q
i
2
_
1
D
i
P
i
_
+d
ci
Q
i
C
cdi
_
1
D
i
2P
i
_
+
h
wi
E(
i
)Q
i
D
i
r
si
(1 E(
i
))
2
_
(15)
and

2
IETC(Q, L, n)
n
2
=
M

i=1
_
2D
i
(A
wi
+F
w
+S
i
)
n
3
Q
i
_
> 0.
Therefore, for fixed Q
i
and L, IETC(Q, L, n) is convex in n.
This completes the proof of Property 1.
For fixed n, we take the first partial derivative of IETC(Q, L, n)
with respect to Q
i
and L [L
j
, L
j1
], respectively, to obtain
IETC(Q, L, n)
Q
i
=
D
i
(A
i
+F +R(L))
Q
2
i

D
i
(A
wi
+F
w
+S
i
)
nQ
2
i
+
p
i
I
c
2

D
2
i
t
2
c
(p
i
I
c
s
i
I
d
)
2Q
2
i
+
h
bi
2
+D
i

0i
+
h
vi
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_
+
s
i
t
c
I
d
D
i

L(k
i
)
Q
2
i
+d
ci
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_
+
h
wi
E(
i
)nD
i
r
si
(1 E(
i
))
2
(16)
and
IETC(Q, L, n)
L
=
M

i=1
_

D
i
Ce
C/L
Q
i
L
2
+
k
i

i
(h
bi
+p
i
I
c
)
2

s
i
t
c
I
d
D
i

i
(k
i
)
2Q
i

L
+D
i
d
i

0i
_
.
By examining the second-order sufficient conditions (SOSC) for
fixed n, it can be verified that IETC(Q, L, n) is a convex function
of Q
i
and L [L
j
, L
j1
] because the second partial derivatives of
IETC(Q, L, n) with respect to Q
i
and L [L
j
, L
j1
] are

2
IETC(Q, L, n)
Q
2
i
=
2D
i
(A
i
+F +R(L))
Q
3
i
+
2D
i
(A
wi
+F
w
+S
i
)
nQ
3
i
+
D
i
t
c
_
D
i
t
c
p
i
I
c
s
i
I
d
_
D
i
t
c
+2

L(k
i
)
__
Q
3
i
> 0
and

2
IETC(Q, L, n)
L
2
=
M

i=1
_
2D
i
Ce
C/L
Q
i
L
3
+
D
i
C
2
e
C/L
Q
i
L
4
+

i
(s
i
t
c
I
d
D
i
(k
i
) k
i
(h
bi
+p
i
I
c
))
4L
3/2
_
> 0,
respectively, when s
i
t
c
I
d
D
i
(k
i
) > k
i
(h
bi
+p
i
I
c
).
For fixed n and L [L
j
, L
j1
], we obtain optimal Q
i
(see Eq. (17)
given in Box I) by setting Eq. (16) to zero.
Thus, for fixed n and L [L
j
, L
j1
], when all the constraints
are ignored, Eq. (17) gives an optimal value of Q
i
such that the
integrated expected total cost is minimum. Using the convexity
behavior of the objective function with respect to the decision
variables, we propose the following algorithm to find optimal
values of Q
i
, L, and n.
Algorithm 1. Step 1. Set n = 1.
Step 2. For each L
j
, j = 0, 1, . . . , b, perform (2.1) and (2.2).
Step 2.1. Compute Q
i
(i = 1, 2, . . . , M) from Eq. (17).
Step 2.2. Compute the corresponding IETC(Q, L
j
, n), where
Q = Q
1
, Q
2
, . . . , Q
M
, by putting Q
i
in Eq. (9).
Step 3. Find Min
j=0,1,...,b
IETC(Q, L
j
, n).
Step 4. Set IETC(Q

, L

, n) = Min
j=0,1,...,b
IETC(Q, L
j
, n). Then the
set (Q

, L

) is the optimal solution for fixed n.

Step 5. Set n = n+1andrepeat steps 24toobtainIETC(Q

, L

, n).
Step 6. If IETC(Q

, L

, n) IETC(Q

, L

, n 1), then go to step 5;

otherwise go to step 7.
Step 7. Set (Q

, L

, n

) = (Q

, L

, n 1). Then set (Q

, L

, n

) is
the set of optimal solutions.
Case 2. In this case, we consider the floor space constraint and
ignore CSL constraint. To solve this problem, we optimize the
following function by adding a Lagrange multiplier :
Min IETC(Q, L, n, ) =
M

i=1
_
D
i
(A
i
+F +R(L))
Q
i
+
D
i
(A
wi
+F
w
+S
i
)
nQ
i
+
(Q
i
D
i
t
c
)
2
p
i
I
c
2Q
i
+(h
bi
+p
i
I
c
)k
i

L
+
h
bi
Q
i
2
+D
i
[d
i
C
di
(L) +v
i
+P
ci
(Q
i
) +h
wi
]
+
h
vi
Q
i
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_

D
2
i
t
c
2
s
i
I
d
2Q
i
+I
v
p
i
t
c
D
i

s
i
t
c
I
d
D
i
Q
i

L(k
i
)
+Q
i
d
ci
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_
+
h
wi
E(
i
)nQ
i
D
i
r
si
(1 E(
i
))
2
+
D
i
(s
ci
+v
wi
s
di
E(
i
))
(1 E(
i
))
+ [f
i
Q
i
W]
_
. (18)
In this case, for fixed n and L [L
j
, L
j1
], the optimal Q
i
can be
determined by solving m+1 equations in m+1 unknown variables
given by
IETC(Q,L,n,)
Q
i
= 0 and
IETC(Q,L,n,)

= 0.
Q
i
=

_
2D
i
_
A
i
+F +R(L) +(A
wi
+F
w
+S
i
)/n +D
i
t
2
c
(p
i
I
c
s
i
I
d
)/2 s
i
t
c
I
d

L(k
i
)
_
p
i
I
c
+h
vi
G
0
(n) +h
bi
+2D
i
_

0i
+
h
wi
E(
i
)n
r
si
(1E(
i
))
2
_
+2G
1
(n)
, L [L
j
, L
j1
], (17)
where G
0
(n) =
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_
and G
1
(n) = d
ci
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_
Box I.
60 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264
Q
i
=

_
2D
i
_
A
i
+F +R(L) +(A
wi
+F
w
+S
i
)/n +D
i
t
2
c
(p
i
I
c
s
i
I
d
)/2 s
i
t
c
I
d

L(k
i
)
_
p
i
I
c
+h
vi
G
0
(n) +h
bi
+2D
i
_

0i
+
h
wi
E(
i
)n
r
si
(1E(
i
))
2
_
+2(G
1
(n) +f
i
)
, L [L
j
, L
j1
], (19)
where the value can be determined by solving the following equation:
M

i=1
f
i
_
_
_

_
2D
i
_
A
i
+F +R(L) +(A
wi
+F
w
+S
i
)/n +D
i
t
2
c
(p
i
I
c
s
i
I
d
)/2 s
i
t
c
I
d

L(k
i
)
_
p
i
I
c
+h
vi
G
0
(n) +h
bi
+2D
i
_

0i
+
h
wi
E(
i
)n
r
si
(1E(
i
))
2
_
+2(G
1
(n) +f
i
)
_

_ W = 0 (20)
Box II.
Without loss of generality, we only present the final results as
Eqs. (19) and (20) given in Box II.
Furthermore, as in the first case, we can prove that IETC(Q, L, n,
) is a convex function of n and L [L
j
, L
j1
]. Using the convexity
behavior of the objective function with respect to the decision
variables, we propose the following algorithm to find optimal
values of Q
i
, L, n, and .
Algorithm 2. Step 1. Set n = 1.
Step 2. For each L
j
, j = 0, 1, . . . , b, perform (2.1) to (2.3).
Step 2.1. Calculate the value solving Eq. (20).
Step 2.2. Compute Q
i
(i = 1, 2, . . . , M) fromEq. (19) using
the value of .
Step 2.3. Compute the corresponding IETC(Q, L
j
, n, ) (Q
= Q
1
, Q
2
, . . . , Q
M
) by putting Q
i
and inEq. (18).
Step 3. Find Min
j=0,1,...,b
IETC(Q, L
j
, n, ).
Step 4. Set IETC(Q

, L

, n,

) = Min
j=0,1,...,b
IETC(Q, L, n, ).
Then the set (Q

, L

) is the optimal solution for fixed n.

Step 5. Set n = n + 1 and repeat steps 24 to obtain IETC(Q

, L

,
n,

).
Step 6. If IETC(Q

, L

, n,

) IETC(Q

, L

, n 1,

), then go to
step 5; otherwise go to step 7.
Step 7. Set (Q

, L

, n

) = (Q

, L

, n 1,

). Then the set

(Q

, L

, n

) is the set of optimal solutions.

Case 3.
In this case, we consider the CSL constraint and ignore the floor
space constraint. To solve this problem, we optimize the following
function by adding a Lagrange multiplier :
Min IETC(Q, L, n, ) =
M

i=1
_
D
i
(A
i
+F +R(L))
Q
i
+
D
i
(A
wi
+F
w
+S
i
)
nQ
i
+
(Q
i
D
i
t
c
)
2
p
i
I
c
2Q
i
+(h
bi
+p
i
I
c
)k
i

L
+
h
bi
Q
i
2
+D
i
[d
i
C
di
(L) +v
i
+P
ci
(Q
i
) +h
wi
]
+
h
vi
Q
i
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_

D
2
i
t
c
2
s
i
I
d
2Q
i
+I
v
p
i
t
c
D
i

s
i
t
c
I
d
D
i
Q
i

L(k
i
)
+Q
i
d
ci
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_
+
h
wi
E(
i
)nQ
i
D
i
r
si
(1 E(
i
))
2
+
D
i
(s
ci
+v
wi
s
di
E(
i
))
(1 E(
i
))
+
_
Q
i

i
+
i

L(k
i
)
_
_
. (21)
In this case, for fixed n and L [L
j
, L
j1
], the optimal Q
i
can be
determined by solving m+1 equations in m+1 unknown variables
given by
IETC(Q,L,n, )
Q
i
= 0 and
IETC(Q,L,n, )

= 0.
Without loss of generality, we only present the final results as
Eqs. (22) and (23) given in Box III.
Furthermore, as in the first case, we can prove that IETC(Q, L, n,
) is a convex function of n and L [L
j
, L
j1
]. Using the convexity
behavior of the objective function with respect to the decision
variables, we propose the following algorithm to find optimal
values for Q
i
, L, n, and .
Algorithm 3. Step 1. Set n = 1.
Step 2. For each L
j
, j = 0, 1, . . . , b, perform (2.1) to (2.3).
Step 2.1. Calculate value by solving Eq. (23).
Step 2.2. Compute Q
i
(i = 1, 2, . . . , M) fromEq. (22) using
the value of .
Step 2.3. Compute the corresponding IETC(Q, L
j
, n, ) (Q
= Q
1
, Q
2
, . . . , Q
M
) by putting Q
i
and inEq. (21).
Step 3. Find Min
j=0,1,...,b
IETC(Q, L
j
, n, ).
Step 4. Set IETC(Q

, L

, n,

) = Min
j=0,1,...,b
IETC(Q, L
j
, n, ).
Then the set (Q

, L

) is the optimal solution for fixed

n.
Step 5. Set n = n + 1 and repeat steps 24 to obtain
IETC(Q

, L

, n,

).
Step 6. If IETC(Q

, L

, n,

) IETC(Q

, L

, n 1,

), then go to
step 5; otherwise go to step 7.
Step 7. Set (Q

, L

, n

) = (Q

, L

, n 1,

). Then the set

(Q

, L

, n

) is the set of optimal solutions.

Q
i
=

_
2D
i
_
A
i
+F +R(L) +(A
wi
+F
w
+S
i
)/n +D
i
t
2
c
(p
i
I
c
s
i
I
d
)/2 s
i
t
c
I
d

L(k
i
)
_
p
i
I
c
+h
vi
G
0
(n) +h
bi
+2D
i
_

0i
+
h
wi
E(
i
)n
r
si
(1E(
i
))
2
_
+2(G
1
(n) +
i
)
, L [L
j
, L
j1
], (22)
where the value can be determined by solving the following equation:
M

i=1
_
_
_

_
2D
i
_
A
i
+F +R(L) +(A
wi
+F
w
+S
i
)/n +D
i
t
2
c
(p
i
I
c
s
i
I
d
)/2 s
i
t
c
I
d

L(k
i
)
_
p
i
I
c
+h
vi
G
0
(n) +h
bi
+2D
i
_

0i
+
h
wi
E(
i
)n
r
si
(1E(
i
))
2
_
+2(G
1
(n) +
i
)

i
+
i

L(k
i
)
_

_ = 0 (23)
Box III.
R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264 61
Case 4.
In the final case, we consider both the floor space and CSL
constraints. To solve this problem, we optimize the following
function by adding Lagrange multipliers and :
Min IETC(Q, L, n, , ) =
M

i=1
_
D
i
(A
i
+F +R(L))
Q
i
+
D
i
(A
wi
+F
w
+S
i
)
nQ
i
+
(Q
i
D
i
t
c
)
2
p
i
I
c
2Q
i
+(h
bi
+p
i
I
c
)k
i

L
+
h
bi
Q
i
2
+D
i
[d
i
C
di
(L) +v
i
+P
ci
(Q
i
) +h
wi
]
+
h
vi
Q
i
2
_
n
_
1
D
i
P
i
_
1 +
2D
i
P
i
_

D
2
i
t
c
2
s
i
I
d
2Q
i
+I
v
p
i
t
c
D
i

s
i
t
c
I
d
D
i
Q
i

L(k
i
)
+Q
i
d
ci
C
dci
__
D
i
P
i
+(n 1)
_

nD
i
2P
i
_
+
h
wi
E(
i
)nQ
i
D
i
r
si
(1 E(
i
))
2
+
D
i
(s
ci
+v
wi
s
di
E(
i
))
(1 E(
i
))
+[f
i
Q
i
W]
+
_
Q
i

i
+
i

L(k
i
)
__
. (24)
In this case, for fixed n and L [L
j
, L
j1
], the optimal Q
i
can be determined by solving m + 2 equations in m + 2 un-
known variables given by
IETC(Q,L,n,, )
Q
i
= 0,
IETC(Q,L,n,, )

=
0 and
IETC(Q,L,n,, )

= 0.
Without loss of generality, we only present the final results as
Eqs. (25)(27) given in Box IV.
Furthermore, as in the first case, we can prove that IETC(Q, L, n,
, ) is a convex function of n and L [L
j
, L
j1
]. Using the convex-
ity behavior of the objective function with respect to the decision
variables, we propose the following algorithm to find optimal val-
ues for Q
i
, L, n, , and .
Algorithm 4. Step 1. Set n = 1.
Step 2. For each L
j
, j = 0, 1, . . . , b, perform (2.1) to (2.3).
Step 2.1. Calculate and values by solving Eqs. (26) and
(27), respectively.
Step 2.2. Compute Q
i
(i = 1, 2, . . . , M) fromEq. (25) using
the values of and .
Step 2.3. Compute the corresponding IETC(Q, L
j
, n, , )
by putting Q
i
, , and in Eq. (24).
Step 3. Find Min
j=0,1,...,b
IETC(Q, L
j
, n, , ).
Step 4. Set IETC(Q

, L

, n,

) = Min
j=0,1,...,b
IETC(Q, L
j
, n, ,
). Then the set (Q

, L

, n,

) is the optimal solution

for fixed n.
Step 5. Set n = n + 1 and repeat steps 24 to obtain IETC(Q

, L

,
n,

).
Step 6. If IETC(Q

, L

, n,

) IETC(Q

, L

, n 1,

),
then go to step 5; otherwise go to step 7.
Step 7. Set (Q

, L

, n

) = (Q

, L

, n1,

). Then the
set (Q

, L

, n

) is the set of optimal solutions.

5.1. Main computational procedure
When the two constraints are imposed simultaneously, the
main computational procedure to solve the problem is as follows.
Step 1. Determine the optimal values ignoring both constraints
using Algorithm1. If Q
i
satisfies both constraints, then the values of
Q
i
, L, and n obtained are optimal solutions such that the integrated
expected total cost is minimum; go to step 5.
Step 2. Else solve the optimization problem subject to the floor
space constraint and ignore the CSL constraint. That is, determine
the optimal values using Algorithm 2. If Q
i
satisfies the CSL con-
straint, then the values of Q
i
, L, n, and obtained are optimal solu-
tions such that the integrated expected total cost is minimum; go
to step 5.
Step 3. Else solve the optimization problem subject to the CSL
constraint and ignore the floor space constraint. That is, determine
the optimal values using Algorithm 3. If Q
i
satisfies the floor space
constraint, then the values of Q
i
, L, n, and obtained are optimal
solutions such that the integrated expected total cost is minimum;
go to step 5.
Step 4. If none of the first three steps is applicable, both con-
straints are active. Then solve the optimization problem subject to
both constraints. That is, determine the optimal values using Algo-
rithm 4 and obtain the optimal Q
i
, L, n, , and values such that
the integrated expected total cost is minimum; go to step 5.
Step 5. Stop.
6. Numerical analysis
In this section we conduct a numerical analysis to illustrate the
procedure. Consider a pharmaceutical companyhospital supply
chain for three products (is M = 3) that have identical parameters
of F = $100, F
w
= $400, t
c
= 0.1 year, I
d
= 0.02, I
v
= 0.02,
I
c
= 0.06, C = 10, W = 500 square feet, L
0
= 5, and L
b
= 2. The
other parameters for the hospital and for finished goods and raw
materials for the pharmaceutical company are listed in Tables 13,
respectively. In addition, the defect rates
1
and
2
for the first two
Q
i
=

_
2D
i
_
A
i
+F +R(L) +(A
wi
+F
w
+S
i
)/n +D
i
t
2
c
(p
i
I
c
s
i
I
d
)/2 s
i
t
c
I
d

L(k
i
)
_
p
i
I
c
+h
vi
G
0
(n) +h
bi
+2D
i
_

0i
+
h
wi
E(
i
)n
r
si
(1E(
i
))
2
_
+2(G
1
(n) +f
i
+
i
)
, L [L
j
, L
j1
], (25)
where the and values can be determined by solving the following equations simultaneously:
M

i=1
f
i
_
_
_

_
2D
i
_
A
i
+F +R(L) +(A
wi
+F
w
+S
i
)/n +D
i
t
2
c
(p
i
I
c
s
i
I
d
)/2 s
i
t
c
I
d

L(k
i
)
_
p
i
I
c
+h
vi
G
0
(n) +h
bi
+2D
i
_

0i
+
h
wi
E(
i
)n
r
si
(1E(
i
))
2
_
+2(G
1
(n) +f
i
+
i
)
_

_ W = 0, (26)
M

i=1
_
_
_

_
2D
i
_
A
i
+F +R(L) +(A
wi
+F
w
+S
i
)/n +D
i
t
2
c
(p
i
I
c
s
i
I
d
)/2 s
i
t
c
I
d

L(k
i
)
_
p
i
I
c
+h
vi
G
0
(n) +h
bi
+2D
i
_

0i
+
h
wi
E(
i
)n
r
si
(1E(
i
))
2
_
+2(G
1
(n) +f
i
+
i
)

i
+
i

L(k
i
)
_

_ = 0 (27)
Box IV.
62 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264
Table 1
Numerical parameters for the hospital.
Product (i) D
i
A
i
h
bi
p
i
s
i
d
i
v
i
k
i

i

i

0i
f
i

i
(1
i
)
1 600 20 4 5 10 0.3 1 0.5 2 18 0.3 0.3 0.015 98.5%
2 800 25 6 15 25 0.15 0.5 0.75 5 20 0.1 1 0.01 99%
3 1100 30 3 10 20 0.4 0.8 0.25 4 15 0.2 0.5 0.05 95%
Table 2
Numerical parameters for finished products for the pharmaceutical company.
Product(i) P
i
S
i
h
vi

i

0i
C
dci
d
ci
1 1000 400 2 3 0.0001 12 0.15
2 1200 300 1.5 3 0.0005 28 0.1
3 1800 500 3 2 0.0002 22 0.2
Table 3
Numerical parameters for raw materials for the pharmaceutical company.
Raw material (i) A
wi
s
di
s
ci
h
wi
v
wi
r
si
1 150 5 0.4 7 0.5 18000
2 200 6 0.6 9 1.5 20000
3 100 3 0.2 10 1 10000
products of the pharmaceutical company have a beta distribution
with parameters x
0
= 1 and y
0
= 4, and x
1
= 1 and y
1
= 3,
respectively.
The p.d.f. for
1
is g(
1
) =
_
4(1
1
)
3
, 0 <
1
< 1
0 otherwise.
Hence, the mean of
1
is E(
1
) =
x
0
x
0
+y
0
= 0.2.
Then the p.d.f. of
2
is g(
2
) =
_
3(1
2
)
2
, 0 <
2
< 1
0 otherwise.
Hence, the mean of
2
is E(
2
) =
x
1
x
1
+y
1
= 0.25. The defect rate for
the third product is a constant:
3
= 0.12.
If the hospital runs out of a product, it can place an emergency
order with the pharmaceutical company to replenish the product.
However, the hospital would like to avoid emergency orders
because they are very costly for the organization. For this objective
we consider the service level
i
for each product separately. We
consider that the service levels required by the hospital are 98.5%,
99%, and 95% for the three different products.
6.1. Computation for the numerical example
Calculation of optimal inventory policies for multiple pharma-
ceutical products with multiple constraints in a multi-echelon in-
ventory system requires efficient solution procedures suitable for
large-scale inventory systems with short computation time and
low model complexity. We proposed computational algorithms
based on a Lagrangian multiplier approach. The computational ef-
fort and time are small for the proposed algorithm and it is simple
to implement. The algorithms were coded in MATLAB.
We performed computational testing to evaluate the algorithm
performance for our numerical example. Twelve different inte-
grated expected total costs were computed using the algorithms
to obtain optimal values. The procedure for the numerical exam-
ple as described in Section 5.1 is as follows.
First, ignore both constraints and do the following:
1. Set n = 1.
Run step 2 of Algorithm 1 to determine the IETC(.) values.
(i) For L = 5, we obtain Q
1
= 433, Q
2
= 383, and Q
3
= 531
using Eq. (17).
(ii) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) =$57157.
(iii) For L = 4, we obtain Q
1
= 436, Q
2
= 391, and Q
3
= 534
using Eq. (17).
(iv) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) =$57062.
(v) For L = 3, we obtain Q
1
= 439, Q
2
= 394, and Q
3
= 537
using Eq. (17).
(vi) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) =$56985.
(vii) For L = 2, we obtain Q
1
= 462, Q
2
= 416, and Q
3
= 564
using Eq. (17).
(viii) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) = $57459. Inspection of the solutions
obtained for all the L values reveals that the optimal
solutions for n = 1 are L = 3, Q
1
= 439, Q
2
= 394,
Q
3
= 537, and IETC(.) = $56 985
2. Set n = 2.
Run step 2 of Algorithm 1 to determine the IETC(.) values.
(i) For L = 5, we obtain Q
1
= 263, Q
2
= 244, and Q
3
= 291
using Eq. (17).
(ii) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) =$56531.
(iii) For L = 4, we obtain Q
1
= 266, Q
2
= 247, and Q
3
= 294
using Eq. (17).
(iv) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) =$56483.
(v) For L = 3, we obtain Q
1
= 269, Q
2
= 250, and Q
3
= 297
using Eq. (17).
(vi) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) =$56465.
(vii) For L = 2, we obtain Q
1
= 294, Q
2
= 274, and Q
3
= 324
using Eq. (17).
(viii) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) = $57351. Inspection of the solutions
obtained for all the L values reveal that the optimal
solutions for n = 2 are L = 3, Q
1
= 269, Q
2
= 250,
Q
3
= 297, and IETC(.) = $56 465.
3. Set n = 3.
Run step 2 of Algorithm 1 to determine the IETC(.) values.
(i) For L = 5, we obtain Q
1
= 195, Q
2
= 185, and Q
3
= 207
using Eq. (17).
(ii) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) =$56601.
(iii) For L = 4, we obtain Q
1
= 198, Q
2
= 187, and Q
3
= 209
using Eq. (17).
(iv) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) =$56593.
(v) For L = 3, we obtain Q
1
= 201, Q
2
= 191, and Q
3
= 213
using Eq. (17).
(vi) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) =$56627.
(vii) For L = 2, we obtain Q
1
= 226, Q
2
= 215 and Q
3
= 237
using Eq. (17).
(viii) Substituting the values of Q
1
, Q
2
, and Q
3
in Eq. (9), we
obtain IETC(.) = $57865. Inspection of the solutions
obtained for all the L values reveals that the optimal
solutions for n = 3 are L = 4, Q
1
= 198, Q
2
= 187,
Q
3
= 209, and IETC(.) = $56 593.
R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 5264 63
Table 4
Illustration of the solution for given parameters (lead time in days).
n L [L
j
, L
j1
] j = 0, 1, 2, 3
j = 0, L
j
= 5 j = 1, L
j
= 4 j = 2, L
j
= 3 j = 3, L
j
= 2
Q
1
Q
2
Q
3
IETC Q
1
Q
2
Q
3
IETC Q
1
Q
2
Q
3
IETC Q
1
Q
2
Q
3
IETC
1 433 383 531 57157 436 391 534 57062 439 394 537 56985 462 416 564 57459
2 263 244 291 56531 266 247 294 56483 269 250 297 56465
a
294 274 324 57351
3 195 185 207 56601 198 187 209 56593 201 191 213 56627 226 215 237 57865
a
Minimum integrated expected total cost.
The integrated expected total cost IETC(Q, L, n) is clearly lower
for n = 2 than for n = 1 and n = 3, and the algorithm reports
this as an approximate minimum. In other words, from the above
solution procedure we can verify that
IETC(Q
1
, Q
2
, Q
3
, L, n = 1) > IETC(Q
1
, Q
2
, Q
3
, L, n = 2)
< IETC(Q
1
, Q
2
, Q
3
, L, n = 3).
Hence, we can choose the optimal lot sizes of Q
1
= 269, Q
2
=
250, and Q
3
= 297, a lead time L = 3 and a delivery number of
n = 2 when both constraints are ignored.
Now we consider both floor space and CSL constraints. Then
f
1
Q
1
+f
2
Q
2
+f
3
Q
3
< 500

1
Q
1
+
2
Q
2
+
3
Q
3
>

L (
1
(k
1
) +
2
(k
2
) +
3
(k
3
)) .
Here, the optimal solutions are not affected by the constraints
as the lot sizes of Q
1
= 269, Q
2
= 250, and Q
3
= 297 satisfy both
constraints. Suppose that the optimal lot sizes do not satisfy the
floor space constraint and satisfy the CSL constraint and we apply
the same procedure to find the optimal solution using Algorithm2.
Similarly, if the optimal lot sizes do not satisfy the CSL constraint
and satisfy floor space constraint, then we apply the same proce-
dure to find the optimal solution using Algorithm 3. If the optimal
lot sizes do not satisfy either of the constraints, we apply the same
procedure to find the optimal solution using Algorithm 4. In this
example, the optimal lot sizes satisfy both constraints, so the con-
straints can be ignored.
Hence, for CSL of 98.5%, 99%, and 95% for three different prod-
ucts, the optimal solutions for an integrated supply chain are lot
sizes of Q

1
= 269, Q

2
= 250, and Q

3
= 297, respectively, a lead
time of L

= 3, and a delivery number of n

= 2. The minimum
integrated expected total cost is then IETC(.) = $56 465. The solu-
tion procedure is illustrated in Table 4.
We can conclude from the numerical results that the hospital
administrator can achieve CSL targets of 98.5%, 99% and 95% for
three products at $56465 under the conditions considered. In
addition, computational experiments showed that the algorithm
is accurate and efficient.
7. Conclusion
Management of pharmaceutical inventory has become a major
challenge for health care industries as they simultaneously try
to reduce costs and improve CSL in an increasingly competitive
business environment. OR has a long history of successful
application for better decision-making in many industrial sectors
(e.g. airline, telecommunication, and manufacturing industries).
Although health care OR is not a new field, the number of OR
applications and their impact lag behind other service industries.
We outlined and discussed an OR model for PSC and inventory
management for health care facilities such as pharmaceutical
companies and hospitals. We developed a two-echelon PSC
inventory model under realistic conditions. We used a Lagrangian
multiplier algorithmic approach to determine the optimal lot size,
lead time, and total number of deliveries from a pharmaceutical
company to a hospital in a production cycle. This yields a PSC that
achieves a target hospital CSL for a minimum integrated expected
total cost.
In practice, pharmaceutical companies carry a huge inventory
to ensure close to 100% CSL. However, ensuring 100% product
availability at an optimal cost is a huge challenge unless supply
chain processes are streamlined towards customer needs and
demands. This paper offers decision support tools that improve
operational, health policy, and strategic decision-making for PSC
and inventory management. The proposed model can achieve
the target CSL at minimum total PSC inventory cost. Our study
improves current inventory management policy in health care and
offers managerial support via the decision support tool developed.
It can be used (i) to maintain medical/pharmaceutical inventory
without overstocking or expiration and (ii) to achieve a target
CSL at a minimum PSC inventory cost. This approach can be used
in health care industries, especially hospitals, to provide good
medical services to customers/patients at a minimum inventory
cost.
Acknowledgments
This research was supported by the University Grants Commis-
sion (UGC-BSR Fellowship and UGC-SAP-DRSII), Government of In-
dia.
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