Operations Research for Health Care 2 (2013) 52–64

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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

article info abstract

Article history: A high level of service for medical supplies and effective inventory policies are essential objectives for
Received 28 January 2013 all health care industries. Medicine shortages and improper use of pharmaceuticals can not only lead
Accepted 14 August 2013 to financial losses but also have a significant impact on patients. Many health systems and hospitals
Available online 28 August 2013
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
Keywords:
in health care industries and to offer decision support tools that improve health policy, public health,
Pharmaceutical supply chain
Inventory management
patient safety, and strategic decision-making in the pharmaceutical supply chain. We present an inventory
Service level constraint 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 minimum total 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 $600 billion globally in 2009 [1]. Phar-
maceutical products can be expensive to purchase and distribute,
but shortages of essential medicines, improper use of medicines,
and spending on unnecessary or low-quality medicines also have a
high costs in terms of wasted resources and preventable illness and
death. Almarsdóttir and Traulsen identified a number of reasons
why pharmaceutical deserve special consideration in the control of
inventory [2]. In the current economic crisis, increasing attention
is being focused on the rising costs of health care and specifically
pharmaceuticals.
Careful management of pharmaceutical is directly related to a
country’s ability to address public health concerns. Aptel and Pour-
jalali stated that management of pharmaceutical supplies is one of
the most important managerial issues in health care industries [3].
However, many health care industries experience difficulty in
managing their pharmaceutical products. A pharmaceutical supply
∗ Corresponding author. Tel.: +91 451 2452371; fax: +91 451 2453071.
E-mail addresses: uthayagri@gmail.com (R. Uthayakumar),
jaisilpriyan@gmail.com (S. Priyan).
2211-6923/$ – see front matter © 2013 Elsevier Ltd. All rights reserved.
http://dx.doi.org/10.1016/j.orhc.2013.08.001
chain (PSC) can be defined as ‘‘the integration of all activities asso-
ciated with the flow and transformation of drugs from raw materi-
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, integrated delivery networks (IDNs), and alterna-
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 chain to ensure a fill rate close to 100%. 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
 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 52–64
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 given changing 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 to effectively serve their customers. They also have to manage
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 [8–11]. 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 Van de Poel
53
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-echelon models 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 and distributors to combine services have generated ben-
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,
and set-up time [25]. In many practical situations, lead times can be
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
in integrated production–inventory models for lead time reduction
in a single-vendor, single-buyer supply chain [28–30].
54 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 52–64
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
minimum expected total inventory cost. We present a continuous-
review integrated production–distribution 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, lead time and the 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
Qi : 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
Di : Average demand for the ith product per year
di : Expiry rate for the ith product
hbi : Holding cost per unit per year excluding interest charges for
the ith product
Ai : Ordering cost per order for the ith product
tc : Common trade credit period for all products offered by the
pharmaceutical company in years
Id : Common deposit interest rate for all products per year
Ic : Interest charge paid per $ in stock to the bank for all products
per year
pi : Purchase price per unit for the ith product
si : Selling price per unit for the ith product
ri : Reorder point for the ith product
Xi : Lead time demand for the ith product, which follows a nor-
mal √ distribution with finite mean Di L and standard deviation
σi L, where σi is the standard deviation for the demand per
unit time for the ith product
E (Xi − ri )+ : Expected demand shortage for the ith product at
the end of a cycle
θi : Fraction of demand for the ith product that is not met from
stock, so 1 − θi is the service level
F : Fixed transportation cost for all products per delivery
fi : Storage space for the ith product
W : Total space available for the M products
Other parameters for the pharmaceutical company
hv i : Holding cost per unit time for the ith finished product
Si : Set-up cost for the ith finished product
Pi : Production rate for the ith finished product
Iv : Interest rate for calculating the opportunity interest loss for
the pharmaceutical company due to delayed payment per year
dci : Expiration rate for the ith finished product
Cdci : Cost of expiry for the ith finished product
Qwi : Replenishment quantity for the ith raw material for pro-
duction in each production cycle
Awi : Ordering cost for the ith raw material
hwi : Holding cost per unit time for the ith raw material
Fw : Fixed transportation cost for all raw materials
vwi : Labor cost for order handling and receipt for the ith raw
material
αi : Defect rate for the ith raw material in an order lot, αi ∈
[0, 1), a random variable
sci : Screening cost per unit time for the ith raw material
rsi : 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 Qi (i = 1, 2, 3, . . . , M) and the pharmaceutical company
produces nQi units at a finite production rate of Pi (Pi > Di ) per
unit time in one production cycle, but ships in quantity Qi to the
hospital n times. All products for the hospital are in shortage and
completely backordered.
2. For the ith raw material, 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) 52–64
4. The hospital uses a continuous-review inventory policy for all
products and the order quantity Qi for the ith product is placed
when its inventory level falls to the reorder point ri .
5. The reorder point for the ith product is ri = expected demand
for product i during the lead time (Di L)+ safety stock of i (ssi ),
where ssi = ki x (standard deviation for the lead time demand
for i), that is,
√ hospital can sell the goods and accumulate revenue and earn
ri = Di L + ki σi L,
where ki is the safety factor for product i and satisfies Pr (Xi >
ri ) = qi , and qi 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 tc 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 Id 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 Iv , where Iv = Id .
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
L = L0 ,

0 0
R(L) =
eC / L Lb ≤ L < Lb −1 ,
where C is a positive constant and L0 and Lb 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 Qi
units. Therefore, for an average cycle time of Qi /Di , the expected
AD D R(L)
order cost is Qi i and the lead time crash cost per unit time is iQ .
i i
The order cost involves the cost of preparing the order or invoice,
stationery and postage, wages, telephone charges, and travel ex-
penses.
The expected net inventory level just before arrival of a procure- √
ment quantity Qi is only the safety stock ssi = ri − Di L = ki σi L
according to Eq. (1). The expected net inventory level√immediately
after arrival of procurement quantity Qi is Qi + ki σi L. Hence, the
expected on-hand inventory over the cycle is Max. on hand 2+ Min. on hand
√ √ √ Di
= (Qi +ki σi L)+ki σi L
= Qi
+ ki σi L.
2 2
55
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
(1) 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 tc be the common credit period for all products and let hbi 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 2i + ki σi L, where 2i is the expected cycle stock. Therefore,
Q Q
hbi Qi
the holding cost per unit time for the cycle stock of i is . A safety
√ 2
stock of ki σi L is held throughout the cycle. Therefore, according
to the trade credit policy, the pharmaceutical company charges
interest at rate Ic 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 sum of the holding cost and interest
charged: (hbi + pi Ic )ki σi L.
The credit period tc 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
Id up to the end of the credit period. Hence, the interest earned by
si Id Di
 tc D2i tc2 si Id
the hospital per unit time for product i is Di tdt = .
Qi 2Qi
The expected shortage for i, E (Xi − ri ) , is completely backlogged
+
in the previous cycle and is cleared at the beginning of the current
cycle. Therefore, the hospital earns interest of i cQd i E (Xi − ri )+ per
st I D
i
unit time during the credit period.
Conversely, the hospital still has (Qi − Di tc ) 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 Ic .
Therefore, the opportunity interest cost per unit time for unsold
Qi
(Q −D t )2 p I
units of product i is i Qc i tc i (Qi − Di t )dt = i 2Q
pI D
 D i c i c
.
i 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 di is
the proportional probability for expiry of product i at the hospital.
Consequently, the total amount of expired product for i is di Qi . We
assume that the expiry cost applies immediately when the hospital
orders the product from the pharmaceutical company. Hence, the
expiry cost Cdi (L) is a function of the lead time. Therefore, the
expected expiry cost is di Di Cdi (L), where Cdi (L) is a linear function
of lead time L, that is, Cdi (L) = Γi + Γ0i L, where 0 ≤ Γ0i ≤ 1 and
Γi is a positive constant.
In practice, the hospital pays a fixed transportation cost and
labor costs for order handling and receipt from the pharmaceutical
company. We assume that the hospital pays a fixed transportation
cost of F for all products and a labor cost of vi for product i. Hence,
the expected transportation and labor costs per unit time are Q i
FD
and vi Di , respectively.
i
Accordingly, the expected total cost per unit time for product i
is
(Qi − Di tc )2 pi Ic
ETChi (Qi , L) = (Ai + F + R(L)) +
Qi 2Qi
56 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 52–64

hbi Qi √
+ + (hbi + pi Ic )ki σi L + Di (di Cdi (L) + vi ) According to Assumption 3, the total number of expired prod-
2 ucts held by the pharmaceutical company is
D2i tc2 si Id si tc Id Di  
Qi Qi

n2 Qi2

− − E (Xi − ri )+ . = dci nQi + (n − 1) − .
2Qi Qi Pi Di 2Pi
The expected total cost per unit time for all (M ) products is then Therefore, the expiration cost per unit time
M M    
  Di Di nDi
ETCh (Q , L) = [ETChi (Qi , L)] = (Ai + F + R(L)) = dci Qi Cdci + (n − 1) − .
i=1 i=1
Qi Pi 2Pi
(Qi − Di tc ) pi Ic 2
hbi Qi √ Consequently, the total production cost is Pi T1i Pci (Qi ), where
+ + + (hbi + pi Ic )ki σi L nQ
T1i = P i is the production cycle for product i. The unit production
2Qi 2 i
cost Pci (Qi ) is a linear function of the order quantity Qi , that is,
D2i tc2 si Id

si tc Id Di Pci (Qi ) = δi + δoi Qi , where δi is the fixed cost per unit finished
+ Di (di Cdi (L) + vi ) − − E (Xi − ri )+ (2)
2Qi Qi product and δoi Qi is the tool/die cost per unit finished product,
where Q = (Q1 , Q2 , Q3 , . . . , QM ). which is proportional to the lot size Qi . Hence, the total production
cost per unit time for product i is Di Pci (Qi ). Since Si is the set-up
cost and the production quantity for a lot is nQi units, the expected
4.2. Inventory model for the pharmaceutical company
set-up cost per unit time is given by nQ
Si Di
i
.
Most production–distribution inventory models assume that The hospital has a loan from a bank for unsold products. There-
the total cost for the manufacturer comprises holding, set-up, and fore, during the trade credit period, the pharmaceutical company
production costs for finished goods. However, this total cost is has an opportunity interest loss at an annual rate of Iv , where
not suitable for real-life production situations because a manufac- Iv = Id . Hence, the expected opportunity interest loss per unit time
turing company generally procures raw materials from external for product i is Iv pi tc Di .
suppliers and holds them in inventory before starting production. Let ETCfi (n, Qi ) denote the expected total cost per unit time for
Therefore, the inventory for a manufacturing company should in- finished product i for the pharmaceutical company, which equals
clude raw materials and associated costs such ordering, purchas- the sum of set-up, holding, production, and product expiry costs
ing, and holding costs. Here we assume that the pharmaceutical and opportunity interest losses for product i. That is,
   
company procures multiple raw materials from supplier and pro- Si Di hv i Qi Di 2Di
duces multiple finished products. Therefore, we derive expected ETCfi (Qi , n) = + n 1− −1+
nQi 2 Pi Pi
total costs for both finished products and raw materials.
+ Di Pci (Qi ) + Iv pi tc Di
  
4.2.1. Finished products Di nDi
+ Qi dci Cdci + (n − 1) − .
In our integrated inventory system, the pharmaceutical com- Pi 2Pi
pany begins production once the hospital orders l products of lot The expected total cost per unit time for all finished products is
size Ql , where the production rate is Pi (i = 1, 2, 3, . . . , M ) and then
a constant number of units are added to the inventory until the M
production run has been completed. The pharmaceutical company

ETCf (Q , n) = ETCfi (n, Qi )
 
produces product i in lot size nQi in each production cycle of length i =1
nQi
Di
, and the hospital receives the product in n lots each of size M     
Si Di hv i Qi Di 2Di
Qi (i = 1, 2, 3, . . . , M). The first lot of size Qi is ready for ship-

= + n 1− −1+
ment after time Qi /Pi and then the pharmaceutical company con- i =1
nQi 2 Pi Pi
tinues to the deliver the product on average every Qi /Di units of + Di Pci (Qi ) + Iv pi tc Di
time until the inventory level falls to zero. Hence, the expected   
on-hand inventory of product i for the pharmaceutical company Di nDi
+ Qi dci Cdci + (n − 1) − . (3)
is evaluated as the difference in accumulated inventory between Pi 2Pi
the pharmaceutical company and the hospital. According to Fig. 1,
the inventory of product i for the pharmaceutical company is
 
n2 Q 2 4.2.2. Raw materials
nQi
Qi
Pi
+ (n − 1) DQii − 2Pii units and the accumulated inventory Under Assumption 2, replenishment quantity Qwi for raw
Q2 material i is received instantaneously at the beginning of each cycle
for the hospital is Di (1 + 2 + 3 +· · ·+(n − 1)) units. Hence, the ex- nQ
i time D i . Hence, the expected order cost per unit time is given by
pected inventory per unit time for the pharmaceutical company is i
Aw i D i
2 nQi
. For a practical perspective, we assume that each quantity Qwi
n2 Qi
   
Qi Qi
nQi + (n − 1) − contains defective raw materials at a rate of αi , which is a random
Pi Di 2Pi variable. Therefore, raw materials lots are screened at a rate of rsi
Qi2 to separate perfect and imperfect raw material. At the end of the
 
Di
− (1 + 2 + 3 + · · · + (n − 1)) screening process, imperfect raw materials are sold as a single lot at
Di nQi
the lowest sales price per unit item to the external supplier. Thus,
nQi2 Qi n(n − 1)
     2 
Di nDi Di s Q D
the screening cost is ci nQwi i and the revenue from imperfect raw
= + (n − 1) − − i
Di Pi 2Pi 2Di nQi i wi i s αQ D
materials per unit time is di nQ .
    i
Qi Di 2Di Without loss of generality, we assume that (1 − αi )Qwi = Pi T1i ,
= n 1− −1+ . nQ
2 Pi Pi where T1i = P i . In other words, the replenishment quantity is
i
Therefore, theholding cost
 per unit time
 for the pharmaceutical nQi
∀i = 1, 2, 3, . . . , M .

hv i Qi Di 2Di Qwi = (4)
company is n 1− −1+ .
2 Pi Pi (1 − αi )
 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 52–64 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

hwi (1−αi )Qwi Di hwi E (αi )nQi Di sci Di
nQi + hw i D i + +
hwi αi Qwi Di

Qwi

hwi αi Qw
2 D rsi (1 − E (αi ))2
(1 − E (αi ))
i i
for perfect raw materials and = for
nQi rsi rsi nQi
vwiDi sdi Di E (αi )

imperfect raw materials. + − . (7)
The pharmaceutical company pays fixed a transportation cost (1 − E (αi )) (1 − E (αi ))
Fw D i
and labor costs for order handling and receipt, given by nQ and Let ETCp (Q , n) denote the expected total cost per unit time
i
Di Qwi vwi
nQi
,
respectively. for all inventory products held by the pharmaceutical company,
Let ETCwi (Qi , Qwi , n) denote the expected total cost for raw which equals the sum of expected total costs for all finished
material i per unit time for the pharmaceutical company, which products, given by Eq. (3), and for all raw materials, given by Eq. (7).
equals the sum of expected ordering, holding, defect, screening, That is,
transportation, and labor costs minus revenue. That is,
Awi Di Di (1 − E (αi ))Qwi hwi ETCp (Q , n) = ETCf (Q , n) + ETCw (Q , n)
ETCwi (Qi , Qwi , n) = +
Di (Awi + Fw + Si )
M 
nQi nQi 
ETCp (Q , n) =
sci Qwi Di hwi E (αi )Qw2 i Di Fw Di i =1
nQi
+ + +
nQi rsi nQi nQi
   
hv i Qi Di 2Di
+ n 1− −1+
Di Qwi vwi sdi E (αi )Qwi Di 2 Pi Pi
+ − . (5)
nQi nQi + Di (Pci (Qi ) + hwi ) + Iv pi tc Di
Using Eq. (4), we can transform Eq. (5) to
  
Di nDi
Di (Awi + Fw ) hwi E (αi )nQi Di + Qi dci Cdci + (n − 1) −
ETCwi (Qi , n) = + hw i D i + Pi 2Pi
nQi rsi (1 − E (αi ))2
hwi E (αi )nQi Di Di (sci + vwi − sdi E (αi ))

sci Di vwiDi sdi Di E (αi ) + + . (8)
+ + − . (6) rsi (1 − E (αi ))2 (1 − E (αi ))
(1 − E (αi )) (1 − E (αi )) (1 − E (αi ))
The expected total cost for all raw materials per unit time is Therefore, the integrated expected total cost for the supply
chain, per unit time for all products, IETC (Q , L, n), can be expressed
Di (Awi + Fw )
M M
as the sum of expected total costs for the hospital, given by

ETCw (Q , n) = [ETCwi (Qi , n)] =
i =1 i =1
nQi Eq. (2), and for the pharmaceutical company, given by Eq. (8).
58 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 52–64

That is, We assume that the lead time demand Xi follows a normal prob-
IETC (Q , L, n) = ETCh (Q , L) + ETCp (Q , n) ability distribution
√ function (p.d.f.) f (xi ) with mean
√Di L, standard
deviation σi L, and reorder point ri = Di L + ki σi L, where ki is
Di (Ai + F + R(L)) Di (Awi + Fw + Si )
M 
 the safety factor for product i.
IETC (Q , L, n) = +
Qi nQi For product i, shortages occur when Xi > ri . Therefore, the
i=1
expected shortage at the end of the cycle time for the hospital is
(Qi − Di tc ) pi Ic2 √ hbi Qi given by
+ + (hbi + pi Ic )ki σi L+
2Qi 2 ∝
 √
+ Di [di Cdi (L) + vi + Pci (Qi ) + hwi ] E (Xi − ri )+ = (xi − ri )f (xi )dxi = σi LΨ (ki ), (12)
D2i tc 2 si Id ri
   
hv i Qi Di 2Di
+ n 1− −1+ − + Iv pi tc Di
2 Pi Pi 2Qi where Ψ (ki ) = ϕ(ki ) − ki [1 − Φ (ki )] > 0 and ϕ, Φ are the
   standard normal p.d.f. and cumulative distribution function (c.d.f),
si tc Id Di Di nDi
− E (Xi − ri )+ + Qi dci Cdci + (n − 1) − respectively, for product i.
Qi Pi 2Pi Hence, using Eqs. (11) and (12), the CSL constraint for product i
hwi E (αi )nQi Di can be written as
+ √
rsi (1 − E (αi ))2 σi LΨ (ki )
≤ θi , L ∈ [Lj , Lj−1 ].
Di (sci + vwi − sdi E (αi ))

Qi
+ , L ∈ [Lj , Lj−1 ]. (9)
(1 − E (αi )) The CSL constraint for all products is then given by
M M √
4.3. Constraints
 
θi Qi ≥ σi LΨ (ki ), L ∈ [Lj , Lj−1 ]. (13)
i =1 i=1
In practice, when a hospital carries inventory it may face
limitations such as the availability of floor space, total investment Our problem involves finding the optimal Qi , lead time L, and
in inventory, the total number of orders to be placed per year, the total number of deliveries n for all products in a production cycle
number of deliveries that can be accepted, the delivery size that that minimize the integrated expected total cost expressed by
can be handled, and CSL maintenance. Specifically, most hospitals Eq. (9) and satisfy both the floor space constraint expressed by
have an undersized central area for pharmacy storage that can Eq. (10) and the CSL constraint expressed by Eq. (13):
hold very limited quantities of the numerous products required. In
Di (Ai + F + R(L))
M 
addition, the health care industry is service-oriented, and customer

Min IETC (Q , L, n) =
service and satisfaction are paramount. Therefore, segmentation i=1
Qi
by market or customer is a very important step in developing
an appropriate supply chain strategy for the target customer. Di (Awi + Fw + Si ) (Qi − Di tc )2 pi Ic √
+ + + (hbi + pi Ic )ki σi L
Therefore, we consider hospital issues in relation to floor space and nQi 2Qi
CSL constraints. hbi Qi
Consider first a case in which the hospital floor space is limited + + Di [di Cdi (L) + vi + Pci (Qi ) + hwi ]
2
to W square feet and one unit of inventory product i occupies fi
D2 tc 2 si Id
   
square feet. If Qi is the lot size, then the floor space constraint hv i Qi Di 2Di
+ n 1− −1+ − i
means that 2 Pi Pi 2Qi
si tc Id Di √
 
M Di
+ Iv pi tc Di − σi LΨ (ki ) + Qi dci Cdci + (n − 1)

fi Qi ≤ W . (10) Qi Pi
i =1
hwi E (αi )nQi Di Di (sci + vwi − sdi E (αi ))
 
nDi
For the CSL constraint, certain goals are defined and CSL is the − + +
percentage that should be achieved for each goal. This is used in 2Pi rsi (1 − E (αi ))2 (1 − E (αi ))
supply chain and inventory management to measure the perfor- M
mance of inventory replenishment policies. Service levels θi are

subject to fi Qi ≤ W ,
associated with products according to the number of occasions of i =1
M M
(14)
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 θi Qi ≥ σi LΨ (ki ),
emergency order with the pharmaceutical company to replenish i =1 i =1

this product. However, hospitals would like to avoid these emer- where Q = (Q1 , Q2 , Q3 , . . . , QM ), L ∈ [Lj , Lj−1 ] and Ψ (ki ) =
gency orders if possible because they are very costly [7]. We con- ϕ(ki ) − ki [1 − Φ (ki )] > 0.
sider the service level θi 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 5. Solution
directly from available stock. Therefore, the CSL constraint imposes
a limit on the proportion of demands that are not met from stock. The solution to Eq. (14) is complex because of the number of
For product i this can be expressed as variables and constraints in this nonlinear problem. Therefore, we
apply a Lagrangian multiplier algorithmic approach. The solution
Expected demand shortages of product i at the end of the cycle for a given safety factor
is discussed in detail for the following cases.
Quantity of product i available to satisfy the demand per cycle
≤ θi .
Case 1. M
In this case, we temporarily ignore the constraints i=1 fi Qi
That is, √
θi Qi ≥ σi LΨ (ki ) and then determine the
M M
≤ W and i =1 i=1
E (Xi − ri ) + Qi , L, and n that minimize the integrated expected total cost
≤ θi . (11) IETC (Q , L, n).
Qi
 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 52–64 59

Initially, for fixed Qi and L ∈ [Lj , Lj−1 ], we can prove that and
IETC (Q , L, n) is a convex function of n. Hence, the search for an
∂ 2 IETC (Q , L, n)  2Di CeC /L D i C 2 eC / L
M 
optimal number of lots, n∗ , is reduced to finding a local minimum. = +
∂ L2 i=1
Qi L3 Qi L4
Property 1. For fixed Qi and L, IETC (Q , L, n) is conv ex in n σi (si tc Id Di Ψ (ki ) − ki (hbi + pi Ic ))

+ 3/2
> 0,
Proof. Taking the first and second partial derivatives of IETC (Q , L, 4L
n) with respect to n, we have respectively, when si tc Id Di Ψ (ki ) > ki (hbi + pi Ic ).
For fixed n and L ∈ [Lj , Lj−1 ], we obtain optimal Qi (see Eq. (17)
∂ IETC (Q , L, n)  M 
Di (Awi + Fw + Si )
= − given in Box I) by setting Eq. (16) to zero.
∂n i=1
n2 Qi Thus, for fixed n and L ∈ [Lj , Lj−1 ], when all the constraints
hv i Qi

Di
 
Di
 are ignored, Eq. (17) gives an optimal value of Qi such that the
+ 1− + dci Qi Ccdi 1 − integrated expected total cost is minimum. Using the convexity
2 Pi 2Pi behavior of the objective function with respect to the decision
hwi E (αi )Qi Di variables, we propose the following algorithm to find optimal

+ (15) values of Qi , L, and n.
rsi (1 − E (αi ))2
and Algorithm 1. Step 1. Set n = 1.
Step 2. For each Lj , j = 0, 1, . . . , b, perform (2.1) and (2.2).
∂ IETC (Q , L, n)
2 M
 2Di (Awi + Fw + Si )

= > 0. Step 2.1. Compute Qi (i = 1, 2, . . . , M ) from Eq. (17).
∂ n2 i =1
n3 Qi Step 2.2. Compute the corresponding IETC (Q , Lj , n), where
Q = Q1 , Q2 , . . . , QM , by putting Qi in Eq. (9).
Therefore, for fixed Qi and L, IETC (Q , L, n) is convex in n. Step 3. Find Minj=0,1,...,b IETC (Q , Lj , n).
This completes the proof of Property 1.  Step 4. Set IETC (Q • , L• , n) = Minj=0,1,...,b IETC (Q , Lj , n). Then the
For fixed n, we take the first partial derivative of IETC (Q , L, n) set (Q • , L• ) is the optimal solution for fixed n.
with respect to Qi and L ∈ [Lj , Lj−1 ], respectively, to obtain Step 5. Set n = n+1 and repeat steps 2–4 to obtain IETC (Q • , L• , n).
Step 6. If IETC (Q • , L• , n) ≤ IETC (Q • , L• , n − 1), then go to step 5;
∂ IETC (Q , L, n) Di (Ai + F + R(L)) Di (Awi + Fw + Si ) otherwise go to step 7.
=− − Step 7. Set (Q ∗ , L∗ , n∗ ) = (Q • , L• , n − 1). Then set (Q ∗ , L∗ , n∗ ) is
∂ Qi Qi2 nQi2
the set of optimal solutions.
p i Ic D2i tc2 (pi Ic − si Id ) hbi
+ − + + Di δ0i Case 2. In this case, we consider the floor space constraint and
2 2Qi2 2
√ ignore CSL constraint. To solve this problem, we optimize the
si tc Id Di σi LΨ (ki )
   
hv i Di 2Di following function by adding a Lagrange multiplier β :
+ n 1− −1+ +
2 Pi Pi Qi2
Di (Ai + F + R(L))
M 

hwi E (αi )nDi Min IETC (Q , L, n, β) =
  
Di nDi
+ dci Cdci + (n − 1) − + (16) i=1
Qi
Pi 2Pi rsi (1 − E (αi ))2
Di (Awi + Fw + Si ) (Qi − Di tc )2 pi Ic √
and + + + (hbi + pi Ic )ki σi L
nQi 2Qi
∂ IETC (Q , L, n)  Di CeC /L ki σi (hbi + pi Ic )
M 
hbi Qi
= − + √ + + Di [di Cdi (L) + vi + Pci (Qi ) + hwi ]
∂L i=1
Q i L 2
2 L 2
D2 tc 2 si Id
   
hv i Qi Di 2Di
si tc Id Di σi Ψ (ki )

+ n 1− −1+ − i
− √ + Di di Γ0i . 2 Pi Pi 2Qi
2Qi L
si tc Id Di √
By examining the second-order sufficient conditions (SOSC) for + Iv pi tc Di − σi LΨ (ki )
Q
fixed n, it can be verified that IETC (Q , L, n) is a convex function  i
hwi E (αi )nQi Di
 
Di nDi
of Qi and L ∈ [Lj , Lj−1 ] because the second partial derivatives of + Qi dci Cdci + (n − 1) − +
IETC (Q , L, n) with respect to Qi and L ∈ [Lj , Lj−1 ] are Pi 2Pi rsi (1 − E (αi ))2
Di (sci + vwi − sdi E (αi ))

∂ 2 IETC (Q , L, n) 2Di (Ai + F + R(L)) 2Di (Awi + Fw + Si ) + + β [fi Qi − W ] . (18)
= + (1 − E (αi ))
∂ Qi2
Q 3
nQ 3
  i √  i In this case, for fixed n and L ∈ [Lj , Lj−1 ], the optimal Qi can be
Di tc Di tc pi Ic − si Id Di tc + 2σ LΨ (ki ) determined by solving m + 1 equations in m + 1 unknown variables
+ >0 ∂ IETC (Q ,L,n,β)
3
Qi given by ∂Q i
= 0 and ∂ IETC (∂β
Q ,L,n,β)
= 0.

√
  
 2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )

, L ∈ [Lj , Lj−1 ],

Qi =    (17)
h i E (αi )n
pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (w1− E (αi )) 2 + 2G1 (n )
si
      
where G0 (n) = n 1 − P i − 1 + P i and G1 (n) = dci Cdci ( n − 1) − 2P i
D 2D Di nD
i i Pi
+ i

Box I.
60 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 52–64

√
  
 2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )

, L ∈ [Lj , Lj−1 ],

Qi =    (19)
h i E (αi )n
pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (w1− E (α ))2
+ 2(G1 (n) + β fi )
si i

where the β value can be determined by solving the following equation:

  √ 
 2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )

M

fi  −W =0 (20)

 
hwi E (αi )n
i=1 pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (1−E (α ))2 + 2(G1 (n) + β fi )
si i

Box II.

Without loss of generality, we only present the final results as si tc Id Di √

+ Iv pi tc Di − σi LΨ (ki )
Eqs. (19) and (20) given in Box II. Q
 i
Furthermore, as in the first case, we can prove that IETC (Q , L, n, hwi E (αi )nQi Di
 
Di nDi
β) is a convex function of n and L ∈ [Lj , Lj−1 ]. Using the convexity + Qi dci Cdci + (n − 1) − +
Pi 2Pi rsi (1 − E (αi ))2
behavior of the objective function with respect to the decision
variables, we propose the following algorithm to find optimal Di (sci + vwi − sdi E (αi ))  √ 
values of Qi , L, n, and β .
+ + γ Qi θi + σi LΨ (ki ) . (21)
(1 − E (αi ))
Algorithm 2. Step 1. Set n = 1. In this case, for fixed n and L ∈ [Lj , Lj−1 ], the optimal Qi can be
Step 2. For each Lj , j = 0, 1, . . . , b, perform (2.1) to (2.3). determined by solving m + 1 equations in m + 1 unknown variables
Step 2.1. Calculate the β value solving Eq. (20). given by
∂ IETC (Q ,L,n,γ )
= 0 and ∂ IETC (∂γ
Q ,L,n,γ )
= 0.
∂Q
Step 2.2. Compute Qi (i = 1, 2, . . . , M ) from Eq. (19) using i
Without loss of generality, we only present the final results as
the value of β .
Eqs. (22) and (23) given in Box III.
Step 2.3. Compute the corresponding IETC (Q , Lj , n, β) (Q
= Q1 , Q2 , . . . , QM ) by putting Qi and β in Eq. (18). Furthermore, as in the first case, we can prove that IETC (Q , L, n,
Step 3. Find Minj=0,1,...,b IETC (Q , Lj , n, β). γ ) is a convex function of n and L ∈ [Lj , Lj−1 ]. Using the convexity
Step 4. Set IETC (Q • , L• , n, β • ) = Minj=0,1,...,b IETC (Q , L, n, β). behavior of the objective function with respect to the decision
Then the set (Q • , L• , β • ) is the optimal solution for fixed n. variables, we propose the following algorithm to find optimal
Step 5. Set n = n + 1 and repeat steps 2–4 to obtain IETC (Q • , L• , values for Qi , L, n, and γ .
n, β • ).
Step 6. If IETC (Q • , L• , n, β • ) ≤ IETC (Q • , L• , n − 1, β • ), then go to Algorithm 3. Step 1. Set n = 1.
step 5; otherwise go to step 7. Step 2. For each Lj , j = 0, 1, . . . , b, perform (2.1) to (2.3).
Step 7. Set (Q ∗ , L∗ , n∗ , β ∗ ) = (Q • , L• , n − 1, β • ). Then the set
Step 2.1. Calculate γ value by solving Eq. (23).
(Q ∗ , L∗ , n∗ , β ∗ ) is the set of optimal solutions.
Step 2.2. Compute Qi (i = 1, 2, . . . , M ) from Eq. (22) using
Case 3. the value of γ .
In this case, we consider the CSL constraint and ignore the floor
Step 2.3. Compute the corresponding IETC (Q , Lj , n, γ ) (Q
space constraint. To solve this problem, we optimize the following
= Q1 , Q2 , . . . , QM ) by putting Qi and γ in Eq. (21).
function by adding a Lagrange multiplier γ :
Step 3. Find Minj=0,1,...,b IETC (Q , Lj , n, γ ).
Di (Ai + F + R(L))
M 
Step 4. Set IETC (Q • , L• , n, γ • ) = Minj=0,1,...,b IETC (Q , Lj , n, γ ).

Min IETC (Q , L, n, γ ) =
Qi Then the set (Q • , L• , γ • ) is the optimal solution for fixed
i=1
n.
Di (Awi + Fw + Si ) (Qi − Di tc )2 pi Ic √
+ + + (hbi + pi Ic )ki σi L Step 5. Set n = n + 1 and repeat steps 2–4 to obtain
nQi 2Qi IETC (Q • , L• , n, γ • ).
hbi Qi Step 6. If IETC (Q • , L• , n, γ • ) ≤ IETC (Q • , L• , n − 1, γ • ), then go to
+ + Di [di Cdi (L) + vi + Pci (Qi ) + hwi ]
2 step 5; otherwise go to step 7.
D2 tc 2 si Id Step 7. Set (Q ∗ , L∗ , n∗ , γ ∗ ) = (Q • , L• , n − 1, γ • ). Then the set
   
hv i Qi Di 2Di
+ n 1− −1+ − i (Q ∗ , L∗ , n∗ , γ • ) is the set of optimal solutions.
2 Pi Pi 2Qi

√
  
 2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )

, L ∈ [Lj , Lj−1 ],

Qi =    (22)
h i E (αi )n
pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (w1− E (α )) 2 + 2( G1 (n ) + θi γ )
si i

where the γ value can be determined by solving the following equation:

  √  
 2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )

M √
θi + σi LΨ (ki ) = 0

(23)

 
hwi E (αi )n

i=1 pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (1−E (α ))2 + 2(G1 (n) + θi γ )
si i

Box III.
 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 52–64 61

Case 4. Step 4. Set IETC (Q • , L• , n, β • , γ • ) = Minj=0,1,...,b IETC (Q , Lj , n, β,

In the final case, we consider both the floor space and CSL γ ). Then the set (Q • , L• , n, β • , γ • ) is the optimal solution
constraints. To solve this problem, we optimize the following for fixed n.
function by adding Lagrange multipliers β and γ : Step 5. Set n = n + 1 and repeat steps 2–4 to obtain IETC (Q • , L• ,
n, β • γ • ).
Di (Ai + F + R(L))
M 
 Step 6. If IETC (Q • , L• , n, β • , γ • ) ≤ IETC (Q • , L• , n − 1, β • , γ • ),
Min IETC (Q , L, n, β, γ ) =
Qi then go to step 5; otherwise go to step 7.
i=1
Step 7. Set (Q ∗ , L∗ , n∗ , β ∗ , γ ∗ ) = (Q • , L• , n − 1, β • , γ • ). Then the
Di (Awi + Fw + Si ) (Qi − Di tc ) pi Ic2 √ set (Q ∗ , L∗ , n∗ , β ∗ , γ ∗ ) is the set of optimal solutions.
+ + + (hbi + pi Ic )ki σi L
nQi 2Qi
hbi Qi 5.1. Main computational procedure
+ + Di [di Cdi (L) + vi + Pci (Qi ) + hwi ]
2
D 2 t c 2 s i Id When the two constraints are imposed simultaneously, the
   
hv i Qi Di 2Di
+ n 1− −1+ − i main computational procedure to solve the problem is as follows.
2 Pi Pi 2Qi
Step 1. Determine the optimal values ignoring both constraints
si tc Id Di √ using Algorithm 1. If Qi satisfies both constraints, then the values of
+ Iv pi tc Di − σi LΨ (ki )
Q Qi , L, and n obtained are optimal solutions such that the integrated
 i
hwi E (αi )nQi Di expected total cost is minimum; go to step 5.
 
Di nDi
+ Qi dci Cdci + (n − 1) − + Step 2. Else solve the optimization problem subject to the floor
Pi 2Pi rsi (1 − E (αi ))2
space constraint and ignore the CSL constraint. That is, determine
Di (sci + vwi − sdi E (αi )) the optimal values using Algorithm 2. If Qi satisfies the CSL con-
+ + β[fi Qi − W ]
(1 − E (αi )) straint, then the values of Qi , L, n, and β obtained are optimal solu-
 √  tions such that the integrated expected total cost is minimum; go
+ γ Qi θi + σi LΨ (ki ) . (24) to step 5.
Step 3. Else solve the optimization problem subject to the CSL
In this case, for fixed n and L ∈ [Lj , Lj−1 ], the optimal Qi constraint and ignore the floor space constraint. That is, determine
can be determined by solving m + 2 equations in m + 2 un- the optimal values using Algorithm 3. If Qi satisfies the floor space
∂ IETC (Q ,L,n,β,γ )
known variables given by ∂Q i
= 0, ∂ IETC (Q∂β
,L,n,β,γ )
= constraint, then the values of Qi , L, n, and γ obtained are optimal
∂ IETC (Q ,L,n,β,γ ) solutions such that the integrated expected total cost is minimum;
0 and ∂γ
= 0.
go to step 5.
Without loss of generality, we only present the final results as
Step 4. If none of the first three steps is applicable, both con-
Eqs. (25)–(27) given in Box IV.
straints are active. Then solve the optimization problem subject to
Furthermore, as in the first case, we can prove that IETC (Q , L, n,
both constraints. That is, determine the optimal values using Algo-
β, γ ) is a convex function of n and L ∈ [Lj , Lj−1 ]. Using the convex-
rithm 4 and obtain the optimal Qi , L, n, β , and γ values such that
ity behavior of the objective function with respect to the decision
the integrated expected total cost is minimum; go to step 5.
variables, we propose the following algorithm to find optimal val-
Step 5. Stop.
ues for Qi , L, n, β , and γ .

Algorithm 4. Step 1. Set n = 1. 6. Numerical analysis

Step 2. For each Lj , j = 0, 1, . . . , b, perform (2.1) to (2.3).
Step 2.1. Calculate β and γ values by solving Eqs. (26) and
(27), respectively.
Step 2.2. Compute Qi (i = 1, 2, . . . , M ) from Eq. (25) using
the values of β and γ .
Step 2.3. Compute the corresponding IETC (Q , Lj , n, β, γ )
by putting Qi , β , and γ in Eq. (24).
Step 3. Find Minj=0,1,...,b IETC (Q , Lj , n, β, γ ).
In this section we conduct a numerical analysis to illustrate the
procedure. Consider a pharmaceutical company–hospital supply
chain for three products (is M = 3) that have identical parameters
of F = $100, Fw = $400, tc = 0.1 year, Id = 0.02, Iv = 0.02,
Ic = 0.06, C = 10, W = 500 square feet, L0 = 5, and Lb = 2. The
other parameters for the hospital and for finished goods and raw
materials for the pharmaceutical company are listed in Tables 1–3,
respectively. In addition, the defect rates α1 and α2 for the first two

√
  
 2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )

, L ∈ [Lj , Lj−1 ],

Qi =    (25)
h i E (αi )n
pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (w1− E (α ))2
+ 2(G1 (n) + β fi + θi γ )
si i

where the β and γ values can be determined by solving the following equations simultaneously:
  √ 
 2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )

 M

 − W = 0,

fi  (26)

 
hwi E (αi )n
i =1 pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (1−E (α ))2 + 2(G1 (n) + β fi + θi γ )
si i
  √  
 2Di Ai + F + R(L) + (Awi + Fw + Si )/n + Di tc2 (pi Ic − si Id )/2 − si tc Id σi LΨ (ki )

 M √
θi + σi LΨ (ki ) = 0

(27)

 
hwi E (αi )n

i =1 pi Ic + hv i G0 (n) + hbi + 2Di δ0i + r (1−E (α ))2 + 2(G1 (n) + β fi + θi γ )
si i

Box IV.
62 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 52–64

Table 1
Numerical parameters for the hospital.
Product (i) Di Ai hbi pi si di vi ki σi Γi Γ0i fi θi (1 − θi )
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 (iv) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we

Numerical parameters for finished products for the pharmaceutical company. obtain IETC (.) = $57 062.
Product(i) Pi Si hv i δi δ0i Cdci dci (v) For L = 3, we obtain Q1 = 439, Q2 = 394, and Q3 = 537
1 1000 400 2 3 0.0001 12 0.15 using Eq. (17).
2 1200 300 1.5 3 0.0005 28 0.1 (vi) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we
3 1800 500 3 2 0.0002 22 0.2
obtain IETC (.) = $56 985.
(vii) For L = 2, we obtain Q1 = 462, Q2 = 416, and Q3 = 564
Table 3
using Eq. (17).
Numerical parameters for raw materials for the pharmaceutical company.
(viii) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we
Raw material (i) Awi sdi sci hw i vwi rsi
obtain IETC (.) = $57 459. Inspection of the solutions
1 150 5 0.4 7 0.5 18 000 obtained for all the L values reveals that the optimal
2 200 6 0.6 9 1.5 20 000
solutions for n = 1 are L = 3, Q1 = 439, Q2 = 394,
3 100 3 0.2 10 1 10 000
Q3 = 537, and IETC (.) = $56 985
2. Set n = 2.
products of the pharmaceutical company have a beta distribution
Run step 2 of Algorithm 1 to determine the IETC (.) values.
with parameters x0 = 1 and y0 = 4, and x1 = 1 and y1 = 3,
respectively. (i) For L = 5, we obtain Q1 = 263, Q2 = 244, and Q3 = 291
using Eq. (17).
4(1 − α1 )3 , 0 < α1 < 1

The p.d.f. for α1 is g (α1 ) = (ii) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we
0 otherwise. obtain IETC (.) = $56 531.
Hence, the mean of α1 is E (α1 ) = = 0.2. (iii) For L = 4, we obtain Q1 = 266, Q2 = 247, and Q3 = 294
x0
x0 +y0
using Eq. (17).
3(1 − α2 )2 , 0 < α2 < 1

Then the p.d.f. of α2 is g̃ (α2 ) = (iv) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we
0 otherwise.
obtain IETC (.) = $56 483.
Hence, the mean of α2 is E (α2 ) = x +1y = 0.25. The defect rate for (v) For L = 3, we obtain Q1 = 269, Q2 = 250, and Q3 = 297
x
1 1
the third product is a constant: α3 = 0.12. using Eq. (17).
If the hospital runs out of a product, it can place an emergency (vi) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we
order with the pharmaceutical company to replenish the product. obtain IETC (.) = $56 465.
However, the hospital would like to avoid emergency orders (vii) For L = 2, we obtain Q1 = 294, Q2 = 274, and Q3 = 324
because they are very costly for the organization. For this objective using Eq. (17).
we consider the service level θi for each product separately. We (viii) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we
consider that the service levels required by the hospital are 98.5%, obtain IETC (.) = $57 351. Inspection of the solutions
99%, and 95% for the three different products. obtained for all the L values reveal that the optimal
solutions for n = 2 are L = 3, Q1 = 269, Q2 = 250,
6.1. Computation for the numerical example Q3 = 297, and IETC (.) = $56 465.
3. Set n = 3.
Calculation of optimal inventory policies for multiple pharma-
Run step 2 of Algorithm 1 to determine the IETC (.) values.
ceutical products with multiple constraints in a multi-echelon in-
ventory system requires efficient solution procedures suitable for (i) For L = 5, we obtain Q1 = 195, Q2 = 185, and Q3 = 207
large-scale inventory systems with short computation time and using Eq. (17).
low model complexity. We proposed computational algorithms (ii) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we
based on a Lagrangian multiplier approach. The computational ef- obtain IETC (.) = $56 601.
fort and time are small for the proposed algorithm and it is simple (iii) For L = 4, we obtain Q1 = 198, Q2 = 187, and Q3 = 209
to implement. The algorithms were coded in MATLAB. using Eq. (17).
We performed computational testing to evaluate the algorithm (iv) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we
performance for our numerical example. Twelve different inte- obtain IETC (.) = $56 593.
grated expected total costs were computed using the algorithms (v) For L = 3, we obtain Q1 = 201, Q2 = 191, and Q3 = 213
to obtain optimal values. The procedure for the numerical exam- using Eq. (17).
ple as described in Section 5.1 is as follows.
(vi) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we
First, ignore both constraints and do the following:
obtain IETC (.) = $56 627.
1. Set n = 1. (vii) For L = 2, we obtain Q1 = 226, Q2 = 215 and Q3 = 237
Run step 2 of Algorithm 1 to determine the IETC (.) values.
using Eq. (17).
(i) For L = 5, we obtain Q1 = 433, Q2 = 383, and Q3 = 531
using Eq. (17). (viii) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we
(ii) Substituting the values of Q1 , Q2 , and Q3 in Eq. (9), we obtain IETC (.) = $57 865. Inspection of the solutions
obtain IETC (.) = $57 157. obtained for all the L values reveals that the optimal
(iii) For L = 4, we obtain Q1 = 436, Q2 = 391, and Q3 = 534 solutions for n = 3 are L = 4, Q1 = 198, Q2 = 187,
using Eq. (17). Q3 = 209, and IETC (.) = $56 593.
 R. Uthayakumar, S. Priyan / Operations Research for Health Care 2 (2013) 52–64 63

Table 4
Illustration of the solution for given parameters (lead time in days).
n L ∈ [Lj , Lj−1 ] j = 0, 1, 2, 3
j = 0, Lj = 5 j = 1, Lj = 4 j = 2, Lj = 3 j = 3, Lj = 2
Q1 Q2 Q3 IETC Q1 Q2 Q3 IETC Q1 Q2 Q3 IETC Q1 Q2 Q3 IETC

1 433 383 531 57 157 436 391 534 57 062 439 394 537 56 985 462 416 564 57 459
2 263 244 291 56 531 266 247 294 56 483 269 250 297 56 465a 294 274 324 57 351
3 195 185 207 56 601 198 187 209 56 593 201 191 213 56 627 226 215 237 57 865
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 (Q1 , Q2 , Q3 , L, n = 1) > IETC (Q1 , Q2 , Q3 , L, n = 2)
< IETC (Q1 , Q2 , Q3 , L, n = 3).
Hence, we can choose the optimal lot sizes of Q1 = 269, Q2 =
250, and Q3 = 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
f1 Q1 + f2 Q2 + f3 Q3 < 500
√
θ1 Q1 + θ2 Q2 + θ3 Q3 > L (σ1 Ψ (k1 ) + σ2 Ψ (k2 ) + σ3 Ψ (k3 )) .
Here, the optimal solutions are not affected by the constraints
as the lot sizes of Q1 = 269, Q2 = 250, and Q3 = 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 Algorithm 2.
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 Q1∗ = 269, Q2∗ = 250, and Q3∗ = 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 $56 465 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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