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IEEE TRANSACTIONS ON ENGINEERING MANAGEMENT
The Impact of Raw Materials Price Volatility on Cost
of Goods Sold (COGS) for Product Manufacturing
Hadi Moheb-Alizadeh and Robert Handfield
Abstract—The supply chain ecosystem has become increasingly
volatile due to a host of different factors. In an unpredictable en-
vironment, the factors influencing decision-making fluctuate con-
stantly over time, and the effect of volatility on supply chain param-
eters such as cost, revenue, and working capital must be evaluated
periodically. This paper seeks to develop a set of mathematical pro-
gramming models for exploring the impact of price fluctuation of
raw materials on the cost of goods sold (COGS) of end products
relative to targets in manufacturing companies. The mathematical
programming problems proposed in this paper rationally minimize
the COGS of end products while satisfying a set of constraints re-
garding forecasting and physical conditions. The optimal solutions
of the proposed models provide guidelines on the optimal price at
which to purchase all raw materials, leading to the minimum the
overall COGS value for the enterprise. We also introduce a spe-
cial type of sensitivity analysis, in which we explore the conditions
where the optimal purchasing price of a raw material used to manu-
facture an end product changes within its feasibility range, and the
relative effect on how much the minimum COGS of end products
fluctuates. Finally, an empirical example presented in this paper
illustrates the practicality and usefulness of the proposed approach
in practice.
Index Terms—Cost of goods sold (COGS), mathematical
programming, price volatility, regression, sensitivity analysis.
I. INTRODUCTION
OLATILITY refers to the unpredictable fluctuations of a
V process observed over time. In economics and finance,
volatility is a criterion used to study the risks associated with
holding assets when uncertainty exists relative to the future value
of assets. In operations management, due to naturally occurring
uncertainty that exists in the operating environment, volatility
exists in almost every stage of material procurement, manufac-
turing, material planning, and distribution. Volatility analysis,
volatility modeling, and volatility forecasting have various ap-
plications intended to manage them, including risk management,
uncertain decision making, and option valuation in financial
markets and operational environments [1], [2].
Manuscript received January 5, 2017; revised June 27, 2017 and October 16,
2017; accepted December 5, 2017. Review of this manuscript was arranged by
Department Editor S. Talluri. (Corresponding author: Robert Handfield.)
H. Moheb-Alizadeh is with the Graduate Program in Operations Research,
North Carolina State University, Raleigh, NC 27695 USA (e-mail: hmoheba@
ncsu.edu).
R. Handfield is with the Department of Business Management, Poole College
of Management, North Carolina State University, Raleigh, NC 27695 USA
(e-mail: robert_handfield@ncsu.edu).
Color versions of one or more of the figures in this paper are available online
at http://ieeexplore.ieee.org.
Digital Object Identifier 10.1109/TEM.2018.2796447
0018-9391 © 2018 IEEE. Personal use is permitted, but republication/redistribution requires IEEE permission.
See http://www.ieee.org/publications standards/publications/rights/index.html for more information.
1
An often-mentioned source of volatility in the press involves
the price fluctuation of major commodities, including oil, corn,
hogs and beef, gold, steel, copper, and others. Since both sharp
fluctuations and long-run trend movements in commodity prices
are often tied to impacts on gross domestic product, balance
(GDP) of payments, and government budgetary positions, many
developing countries have faced serious challenges in this area
in recent decades. Common macroeconomic fundamentals such
as inflation, interest rates, and industrial production influence
commodity prices. Hence, it is not surprising that commodities
often move together in a general sense. In addition, commodities
may be viewed as complements (e.g., oil and metals), substi-
tutes (e.g., gold and silver), and inputs (e.g., petrochemicals,
ferrous and nonferrous metals) in production of products. Rises
in commodity prices have fueled expectations of increases in
inflation, leading to monetary policy tightening and increases in
interest rates.
The major impact of commodity movements in a manufac-
turing company involves the raw materials used to manufacture
a specific set of end products. It is clear that any volatility in
the price of raw materials (inputs) leads to fluctuation in end
products’ (outputs) price. This influence may be severe if the
price of end products is highly economically dependent on raw
materials’ price. Examples in this context include the price of
petrochemical products and automobiles, which are highly de-
pendent on crude oil and nonferrous metal prices, respectively.
Although there exists an abundant number of studies in the lit-
erature that examine the price fluctuation of input commodities
for an enterprise such as crude oil, ethanol, metals, and others,
the literature suffers from a lack of studies exploring the rela-
tionship between price volatility of input commodities and that
of output manufactured products. This paper seeks to fill this
gap by proposing a general mathematical framework, which en-
ables us to study the price fluctuation of output merchandise (end
products) once the price of input commodities (raw materials)
changes in the future. More precisely, the question addressed in
this paper is: If the price of an input commodity fluctuates in
the future, how much is the corresponding change in the cost of
goods sold (COGS) for an enterprise’s end products? This is an
important question faced by enterprises in a number of manu-
facturing and other industries. Answering this question can help
managers set prices for their products more effectively to en-
sure adequate returns. For instance, in the auto industry where
the future price prediction of nonferrous metals is provided by
analyzing the global market and statistical routines, it is of great
value to know that if the future price of Aluminum (Al) changes
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2 IEEE TRANSACTIONS ON ENGINEERING MANAGEMENT
by one dollar per ton, how much will the COGS of a specific car
model fluctuate? Moreover, this paper provides executives with
analytical tool to manage their supply chain contracts. The an-
alytical tool is an insensitivity interval obtained for purchasing
price of each input commodity. However, since the proposed
approach in this paper is grounded on the predictive models,
the volatility of input commodities’ prices should not be so un-
naturally high that the authenticity of such predictive models
is suspected. In other words, the market of input commodities
should be changing in a stable way without acute fluctuations.
In finance and economics, COGS is defined as the direct costs
attributable to the production of the goods sold by an enterprise.
This amount includes the cost of the materials used in creating
the good along with the direct labor costs used to produce the
good. In this framework, we define COGS in such a way as
to exclude indirect and overhead expenses such as distribution
costs and sales force costs.
The remaining of this paper is categorized as follows.
Section II gives a literature review on both pricing input com-
modities and analyzing COGS, separately. In Section III, the
mathematical formulation of the problem and its special sensi-
tivity analysis are elaborated. An empirical study is represented
in Section IV. Finally, Section V is devoted to conclusion and
future works.
II. LITERATURE REVIEW
As mentioned before, to the best of the authors’ knowledge,
there does not exist any study in the literature considering the
impact of raw materials’ price changes on the COGS of end
products. Meanwhile, there are a bunch of papers that explore
how to analyze various commodities’ prices and use the COGS
in the pricing management. In the following, a concise review
of these two categories is provided.
A. Analyzing Commodities’ Prices
The studies in this category primarily adopt statistical ap-
proaches to economically/financially analyze, predict, and ex-
tract appropriate models for pricing data. For instance, in the
oil and petrochemical market, Zhang et al. [3] first decomposed
three crude oil price series with different time ranges and fre-
quencies into several independent intrinsic modes. Then, the
intrinsic modes were composed into a fluctuating process, a
slowly varying component and a trend based on fine-to-coarse
reconstruction. Yang et al. [4] studied the price volatility of the
crude oil market by examining the market structure of OPEC,
the stable and unstable demand structure, and related elastic-
ity of demand. Narayan and Narayan [5] examined the volatil-
ity of crude oil price using daily data for the period 1991–
2006. Their main findings can be summarized as follows: 1)
across the various subsamples, there is inconsistent evidence
of asymmetry and persistence of shocks; and 2) over the full
sample period, evidence suggests that shocks have permanent
effects, and asymmetric effects, on volatility. Regnier [6] exam-
ined monthly producer prices for thousands of products over the
period January 1945 through August 2005. Their results showed
that crude oil, refined petroleum, and natural gas prices are more
volatile than prices for about 95% of products sold by domestic
producers. Relative to crude commodities, however, crude oil
prices are currently more volatile than about 65% of other prod-
ucts. Radchenko [7] analyze d the effect of volatility in oil
prices on the degree of asymmetry in the response of gasoline
prices to oil price increases and decreases. In this regard, several
time series measures of the asymmetry between the responses
of gasoline prices to oil price increases and decreases and sev-
eral measures of the oil price volatility were constructed. Cong
et al. [8] investigated the interactive relationships between oil
price shocks and Chinese stock market using multivariate vector
auto-regression. Based on their findings, oil price shocks do not
show statistically significant impact on the real stock returns of
most Chinese stock market indices, except for manufacturing
index and some oil companies. Serra et al. [9] assessed volatil-
ity spillover in Brazilian ethanol markets using a specific kind
of maximum likelihood estimator, which improved on previous
methods by jointly estimating the ECM and the multivariate
GARCH processes.
Worthington et al. [10] examined the transmission of spot
electricity prices and price volatility among the five regional
electricity markets in the Australian National Electricity Mar-
ket (NEM). They used a multivariate generalized autoregressive
conditional heteroskedasticity (MGARCH) model to identify
the source and magnitude of price and price volatility spillovers.
Zareipour et al. [11] conducted a comparative volatility analysis
for the Ontario market and its neighboring electricity markets.
The analysis was carried out in two scenarios: in the first sce-
nario, the volatility indices are determined for the entire price
time series. In the second scenario, the price time series are
broken up into 24 time series for each of the 24 h and volatility
indices are calculated for each specific hour separately. Garcia
et al. [12] provided an approach to predict next-day electricity
prices based on GARCH methodology that was already being
used to analyze time series data in general.
In the metal market, Hammoudeh and Yuan [13] used three
“two-factor” volatility models of the GARCH family to exam-
ine the volatility behavior of three strategic commodities: gold,
silver, and copper, in the presence of crude oil and interest
rate shocks. McMillan and Speight [14] examined the condi-
tional volatility of daily nonferrous LME settlement prices over
the period 1972-1995 in the context of an empirical model of
conditional volatility, which provides an explicit decomposition
of volatility into its long-run and short-run components, and
which is shown to be superior to the standard model of con-
ditional volatility widely applied in modeling financial market
volatility.
B. COGS Related Studies
There are not many papers in the literature that exploit COGS
analysis as a part of their analytical approaches. However, Carter
et al. [15] combined survey and archival data to show that envi-
ronmental purchasing is significantly related to both net income
and COGS, after controlling for firm size, leverage, and primary
earnings per share. Jack and Raturi [16] presented a theoreti-
cal framework for measuring volume flexibility and relating
these measures to firm performance. They developed four met-
rics using the principle that a volume flexible firm can handle
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MOHEB-ALIZADEH AND HANDFIELD: IMPACT OF RAW MATERIALS PRICE VOLATILITY ON COST OF GOODS SOLD 3

similar levels of uncertainty (as measured by sales variability) capj : Holding capacity of purchasing firm for the jth raw
with smaller fluctuations in inputs (as measured by variability material in the first level of material flow; j = 1, . . . , c1 .
in COGS and variability in inventory levels). Criner et al. [17] purj : Minimum amount of the jth raw material in the first
employed scanner data for 36 fresh produce items analyzing level of material flow to keep the manufacturing pro-
the relationship between costs of goods sold and retail prices to cesses operative; j = 1, . . . , c1 .
provide further insight into retail pricing behavior. Swamidass
Decision variables
et al. [18] developed an empirically valid neural model of U.S.
factories in a range of industries producing discrete products Pji : The purchasing price associated with the component
and used the model to test the effect of changes in product line lji , i.e., the purchasing price of the jth raw material in
width on plant performance variables. The sensitivity analysis the ith level.
of their neural factory shows that, as the product line increases, P̄jik : The purchasing price associated with the component
it does not affect COGS. s̄ij k , i.e., the purchasing price of the kth raw material of
Besides the papers reviewed in former two subsections, there the jth material in the ith level of material flow.
exist several other papers that explore the relationship among μr : The COGS of the rth end product, i.e., the value of
upstream and downstream markets, e.g., [19]–[21]. However, direct costs attributable to the production of one unit
they do not precisely model the relationship between raw mate- of the rth product manufactured by a company; r =
rials’ prices and end products’ COGS. 1, . . . , s.
Yr : The amount of the rth end product sold; r = 1, . . . , s.
III. MODEL DEVELOPMENT ϑj : The purchasing volume of material j in the purchasing
firm; j = 1, . . . , c1 .
In order to characterize the relationship among all raw ma- Hj : The inventory level of material j held in the purchasing
terials from beginning to end, which are used to produce the firm; j = 1, . . . , c1 .
end products in a purchasing firm, we describe a special rep- The COGS of a product is naturally a dynamic quantity be-
resentation called material flow. A material flow illustrates a cause it most likely varies over time as a function of its influ-
structure of levels of raw materials and their interrelationships. ential factors. To encounter such a dynamic quantity, from a
It is known that any raw material of a product needs its own statistics standpoint, we need to define a statistic for COGS,
raw materials to be produced. We specify the raw materials of such as expected value, variance, minimum/maximum value,
any raw material and their relationship in a material flow till we summation, etc. Kluge [22] asserted that a successful company
reach the very beginning raw materials, which do not have raw should rationally reduce the cost of its goods sold. In this regard,
materials anymore. Fig. 1 depicts a material flow of m levels he introduced three activities that a successful company needs
of raw materials; i = 1, . . . , m. Level zero, i.e., i = 0, indicates to employ for decreasing its COGS. Following this declaration,
the manufacturing firm. Let li ; i = 0, 1, . . . , m be the set of minimum of COGS sounds a sensible quantity (statistic) to de-
all nodes located in the ith level of material flow with |li | = ci , fine in the present study. Furthermore, this also enables us to
where || denotes the cardinality of the set inside. formulate the underlined problem as a mathematical program-
In addition, lji ; i = 0, 1, . . . , m and j = 1, . . . , ci , indicates ming model in which the COGS is minimized as the objective
the jth node of the ith level of material flow. As illustrated in function.
Fig. 1, a specific node located at any level might point to several
nodes in its preceding level. To characterize the later nodes, A. Mathematical Formulation
we define sij ; i = 2, . . . , m and j = 1, . . . , ci , with |sij | = cij
as the set of all nodes placed in the (i−1)th level of material Using the aforementioned notations, we propose the follow-
flow to which the jth node of the ith level points. On the other ing mathematical programming model. Then, using a variant of
hand, to any particular node in material flow, some nodes in the this mathematical model, we explain how to evaluate the fluctu-
proceeding level might point. To describe such nodes, we define ation in the minimum COGS as the purchasing price of at least
s̄ij ; i = 0, 1, . . . , (m − 1) and j = 1, . . . , ci , with |s̄ij | = c̄ij as one raw material changes
the set of all nodes located in the (i + 1)th level, which points to 
s
the jth node in the ith level of material flow. The kth component Min Z = Yr μr (1)
in the set s̄ij is presented as s̄ij k , i.e., s̄ij = {s̄ij 1 , s̄ij 2 , . . . , s̄ij c̄ i }. r =1
j
Since any node in the material flow represents a particular raw s.t.
material, the set sij characterizes all materials that have lji as one
Yr = Qr (ϑ1 , . . . , ϑc 1 , H1 , . . . , Hc 1 ) ∀r (2)
of their raw materials. On the other hand, the set s̄ij contains all
raw materials of lji that can be also served as the bill of materials μr = Fr (P11 , P21 , . . . , Pc11 , P11 P21 , . . . , P11 Pc11 , P21 P31 ,
for lji . . . . , P21 Pc11 , . . . , Pc11 −1 Pc11 , . . . , P11 P21 . . . Pc11 , ωr ) ∀r
We define the following notations toward developing the
mathematical model. Pji = Gij (P̄ji1 , P̄ji2 , . . . , P̄jic̄ i , P̄ji1 P̄ji2 , . . . , P̄ji1 P̄jic̄ i , P̄ji2 P̄ji3 ,
j j
Parameters
. . . , P̄ji2 P̄jic̄ i i
, . . . , P̄j,c̄ i
i −1 P̄j c̄ i , . . . , P̄ji1 P̄ji2 . . . P̄jic̄ i , ji )
demr : Required amount (demand) of the rth end product in j j j j

the following period of time; r = 1, . . . , s. (3)

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4 IEEE TRANSACTIONS ON ENGINEERING MANAGEMENT
Fig. 1. Material flow of a purchasing firm with m levels.
i = 1, . . . , (m − 1) ∀j
μLr ≤ μr ≤ μUr ∀r
Pji,L ≤ Pji ≤ Pji,U ∀i, j
P̄ji,L i i,U
k ≤ P̄j k ≤ P̄j k ∀i, j, k = 1, . . . , c̄i−1
j (7)
Yr ≥ demr ∀r
Hj ≤ capj , j = 1, . . . , c1
ϑj + Hj ≥ purj , j = 1, . . . , c1 .
Objective function (1) minimizes the total COGS. Constraint
(2) gives the production level of each end product as a function of
purchased amount of raw materials and inventory level of each
raw material held in the purchasing firm. In this constraint, one
might regard Qr as a production function, e.g., Cobb–Douglas
production function, Leontief production function, linear pro-
duction function, etc., where ϑj and Hj are factor inputs. In
constraint (3), the value of μr is estimated by function Fr of the
following: 1) the purchasing price of the raw materials located in
the first level of material flow; 2) the interaction factors of such
purchasing prices; and 3) if autocorrelated, the COGS of respec-
tive end product in some previous periods. In this constraint, we
indeed define the function Fr as a forecasting function for μr
with the aforementioned three input factors. We also assume
that ωr is the corresponding white noise. Meanwhile, if the au-
tocorrelation function (ACF) and partial autocorrelation func-
tion (PACF) of the residuals from the respective ordinary least
squares (OLS) fit for expression (3) suggestautocorrelation of
COGS of an end product, then ωr = wr + z =1 φz ωrz , where
ωrz is the residual of the OLS fit for expression (3) z periods
prior to the current period, φz is the appropriate autocorrelation
coefficient,  is the autocorrelation lag which is derived from
analysis of ACF and PACF, and wr is the white noise. Other-
wise, ωr is purely with noise [23]. Furthermore, we know that
the price of the jth raw material located in the ith level, i.e.,Pji , is
a function of the following: 1) the price of its own raw materials
(4) characterized by the components of s̄ij , i.e., s̄ij k ’s; 2) the interac-
(5) tion factors of such prices; and 3) if autocorrelated, Pji in some
previous periods. Constraint (4) implies this requirement, where
(6) Gij can be again regarded as a forecasting function of Pji with
the aforementioned three input factors. Recall that ji is the pure
noise if there is no autocorrelation of Pji based on analysis of
(8) ACF and PACF of the residuals from the respective OLS fit for
¯
expression (4). Otherwise, ji = w̄ji + z =1 φ̄ij z ji z , where
(9)
ji z is the residual of the OLS fit for expression (4) z periods
(10) prior to the current period, φ̄ij z is the appropriate autocorrelation
coefficient, ¯is the autocorrelation lag derived by analyzing ACF
and PACF, and w̄ji is the white noise. However, the price of any
raw material can be estimated to be within a prediction interval
in the next period of time. Taking such prediction intervals into
account that can be calculated using time series analyses [23],
[24] results in more precise estimates in practice. In this regard,
constraints (5)–(7) provide prediction intervals for COGS of the
rth end product and raw materials’ purchasing prices, where μLr ,
μUr , pi,L i,U i,L i,U
j , pj , p̄j k , and p̄j k represent the lower and the upper
bounds of the corresponding 100(1 − α)% prediction intervals,
respectively. Constraint (8) indicates that production level of
the rth end product in purchasing firm satisfies its demand re-
quirement. Constraint (9) implies the inventory level of the jth
raw material should be less than or equal to the corresponding
holding capacity in purchasing firm. Ultimately, constraint (10)
guarantees proper amount of jth raw material is available in the
following period of time to keep the manufacturing processes
operative.
In order to characterize constraints (2)–(4), one might need
to investigate various functional relationships, i.e., linear and
nonlinear, to derive the most statistically proper functions for
Qr , Fr and Gij . Furthermore, it is worth noting that the pre-
dictive functions Fr and Gij might not necessarily include all
their arguments when being characterized. In other words, the
most statistically suitable functions for Fr and Gij might in-
clude only a subset of their respective arguments or the whole
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MOHEB-ALIZADEH AND HANDFIELD: IMPACT OF RAW MATERIALS PRICE VOLATILITY ON COST OF GOODS SOLD 5

of them. That which input arguments are statistically significant products that lead to the minimum value of COGS, but also
when defining the functions Fr and Gij can be drawn based on it provides a tool to evaluate how much the minimum COGS
user’s experiment in the field and/or the result of some statisti- changes if the purchasing price of one raw material fluctuates
cal routines such as standardized coefficient in linear regression in future. To accomplish this objective, we propose an approach
models. that is grounded on a sensitivity analysis of the developed math-
Since the tth node in the (i + 1)th level, i.e., lti+1 , points to ematical model. In this sensitivity analysis, we relax the decision
i+1
ct nodes in the ith level of material flow, we are able to find variable that the impact of its purchasing price changes on the
ci+1
t different j and k subscripts for s̄ij k , which in fact denote the minimum COGS in future is going to be evaluated by substi-
same lti+1 . Let’s define a new set Hti+1 ; i = 1, . . . , (m − 1) and tuting it with its real value after fluctuation. The steps of the
t = 1, . . . , ci , as the set of all s̄ij k that equivalently represent the proposed sensitivity analysis are described as follows.
particular node lti+1 . In other words, although the components of 1) The mathematical programming model (11)–(19) with re-
Hti+1 have different j and k subscripts, they indistinguishably duced decision variables is solved using the initial pa-
refer to the particular lti+1 . Due to this equivalence property rameters to derive the optimal values of raw materials’
between lti+1 and the components of Hti+1 , we can substitute purchasing prices and production level of end products
purchasing prices of the components belonging to Hti+1 , i.e., resulting in the minimum value of COGS.
P̄jik , with purchasing price of the corresponding equivalent lti+1 , 2) Regarding the optimal values derived in step 1 for purchas-
∗i+1
ing prices as p∗i
j , we assume pj  which is the optimal
i.e., Pti+1 , in all respective constraints, and subsequently reduce 
purchasing price of the j th raw material located in the
the number of decision variables. In this case, we derive the
(i + 1)th level of material flow is going to change by Δ
following mathematical programming problem:
in future to reach pi+1
j = p∗i+1
j + Δ, where Δ can be a

s positive or negative quantity. Therefore, if i = 0 in p∗i+1
j ,
Min Z = Yr μr (11) then we optimize the following programming model:
r =1

s
s.t. Min Z̄ = Yr μr (20)
r =1
Yr = Qr (ϑ1 , . . . , ϑc 1 , H1 , . . . , Hc 1 ) ∀r (12)
s.t.
μr = Fr (P11 , P21 , . . . , Pc11 , P11 P21 , . . . , P11 Pc11 , P21 P31 , . . . ,
Yr = Qr (ϑ1 , . . . , ϑc 1 , H1 , . . . , Hc 1 ) ∀r (21)
P21 Pc11 , . . . , Pc11 −1 Pc11 , . . . , P11 P21 . . . Pc11 , ωr ) ∀r
μr = Fr (P11 , . . . , P(j1  −1) , p1 1 1 1 1
j  , P(j  +1) , . . . , Pc 1 , P1 P2 , ..,
Pji = Gij (Pti+1

1
, Pti+1

2
, . . . , Pti+1

i
, Pti+1

1
Pti+1

2
, . . . , Pti+1

1
Pti+1

i
,
P11 P(j1  −1) , P11 p1 1 1 1 1
c̄ c̄
j  , P1 P(j  +1) , . . . , P1 Pc 1 , . . . ,
j j

Pti+1 Pti+1 , . . . , Pti+1 Pti+1 , . . . , Pti+1 Pti+1 ,...,

p1 1 1 1 1 1
     
j  Pj  +1 , . . . , pj  Pc 1 , . . . , Pc 1 −1 Pc 1 , . . . ,
2 3 2 c̄ i c̄ i −1 c̄ i
j j j

Pti+1

1
Pti+1

2
. . . Pti+1

i
, ji ) (13) P11 . . . P(j1  −1) p1 1 1
j  P(j  +1) . . . Pc 1 , ωr ) ∀r (22)
c̄
j

Pji = Gij (Pti+1 , Pti+1 , . . . , Pti+1 , Pti+1 Pti+1 ,...,

i = 1, . . . , (m − 1), j, tk = {t; s̄ij k ∈ Hti+1 ≈ lti+1 } (14) 
1

2

i

1
c̄

j
2

μLr ≤ μr ≤ μUr ∀r (15) Pti+1


1
Pti+1
 , Pti+1

2
Pti+1

3
, . . . , Pti+1

2
Pti+1
 ,...,
c̄ i c̄ i
j j

Pji,L ≤ Pji ≤ Pji,U ∀i, j (16)

Pti+1
 Pti+1
 , . . . , Pti+1

1
Pti+1

2
. . . Pti+1
 , ji )
c̄ i −1 c̄ i c̄ i
Yr ≥ demr ∀r (17) j j j

i = 1, . . . , (m − 1) ∀j, t k = {t; s̄ij k ∈ Hti+1 ≈ lti+1 }

Hj ≤ cap1j , j = 1, . . . , c1 (18)
(23)
ϑj + Hj ≥ pur1j , j = 1, . . . , c1 . (19)
μLr ≤ μr ≤ μUr ∀r (24)
In constraint (14), tk
returns the subscript for which Hti+1 Pji,L ≤ Pji ≤ Pji,U ∀i, j/{i = 1, j = j  } (25)
containing s̄ij k is equivalent to lti+1 . In this constraint, ≈ indi-
cates the equivalence property between lti+1 and the components Yr ≥ demr ∀r (26)
of Hti+1 . In this case, purchasing price of any raw material in Hj ≤ cap1j , j = 1, . . . , c1 (27)
a specific level is characterized as a function of the price of its
own raw materials located in the next level of material flow. ϑ j + Hj ≥ pur1j , j = 1, . . . , c1 . (28)
In the current programming model, p1j  is excluded from
B. Sensitivity Analysis the set of decision variables because it is relaxed by substi-
Not only does the mathematical programming model tuting with p1 ∗1
j  = pj  + Δ in the first constraint. In other
(11)–(19) assist us with determining the optimal values of all words, the purchasing price of lj1 , i.e., p1j  , is not regarded
raw materials’ purchasing prices and production level of end anymore as a decision variable after changing by Δ be-
 This article has been accepted for inclusion in a future issue of this journal. Content is final as presented, with the exception of pagination.

6 IEEE TRANSACTIONS ON ENGINEERING MANAGEMENT

cause its precise value is now known as p∗1 j  + Δ. Thus,

we place the value pj  into any function Fr containing p1j 
1

and then solve the later programming problem with the

new function Fr obtained.
On the other hand, if the optimal purchasing price of the
j  th raw material in the (i + 1)th level (i > 0) of material
flow is expected to change by Δ in future, then we solve Fig. 2. Representation of different purchasing prices and their respective min-
the following programming problem: imum value of COGS.


s
Min Z̄ = Yr μr (29) not be realistic because it may never be available in practice.
r =1 Meanwhile, we are able to reach the current or actual purchasing
s.t. price of lji+1
 , say pc,i+1
j , by selecting an appropriate value for
Δ, say Δ . If the current price is greater than or equal to the op-
c
Yr = Qr (ϑ1 , . . . , ϑc 1 , h1 , . . . , hc 1 ) ∀r (30) timal price, i.e., pc,i+1
j ≥ p∗i+1
j , then Δc = pc,i+1 j − p∗i+1
j ; oth-
∗i+1 c,i+1
μr = Fr (P1 , P2 , . . . , Pc 1 , P1 P2 , . . . , P1 Pc 1 , P2 P3 , . . . , erwise, Δ = pj  − pj  . Assuming the minimum COGS in
1 1 1 1 1 1 1 1 1 c

the current purchasing price of lji+1  to be equal to Zc∗ , Zc∗ − Z ∗

P21 Pc11 , . . . , Pc11 −1 Pc11 , . . . , P11 P21 . . . Pc11 , ωr ) ∀r indicates how much the minimum COGS varies if the optimal
Pji = Gij (Pti+1  , Pti+1
 , . . . , P(ji+1  −1) , pj 
i+1
, P(ji+1  −1) , . . . ,
purchasing price of lji+1  alters by Δc to reach its current purchas-
1 2
ing price. After rescaling to the current price, if pc,i+1 j changes
Pti+1 , P i+1 i+1
P , . . . , P i+1 i+1
P , P i+1 i+1
p , c,i+1

c̄ i
j
t 
1 t 
2 t 
1 (j  −1) t 
1 j 
by Δ̂ to obtain a new price for lj  , i.e., p̂j  = pj 
i+1 i+1
+ Δ̂, with
∗ ∗ ∗
i+1 i+1 i+1 i+1 the minimum COGS of Ẑ , then Ẑ − Z denotes the changes
Pti+1

1
P(ji+1  −1), . . . , Pt 
1
Pt  i , pj  Pj  +1 , .., c
c̄
j in the minimum COGS with respect to the current purchas-
i+1 i+1 i+1 i+1 ing price, whereas Ẑ ∗ − Z ∗ indicates this change with respect
pj  Pt  i , .., pt  i pt  i , . . . , to the optimal purchasing price. Fig. 2 illustrates how the mini-
c̄ c̄ −1 c̄
j j j
mum COGS is compared with respect to the optimal and current
Pti+1  −1) . . . Pt  i , j )
i+1 i+1 i+1 i+1 i+1 i

1
P t 
2
. . . P (j  −1) pj  P (j purchasing prices, where the corresponding minimum value of
c̄
j

(31) COGS is represented beneath each type of purchasing price.

Remark 2: Starting from the optimum value, we enumer-
i = 1, . . . , (m − 1) ∀j, tk = {t; s̄ij k ∈ Hti+1 ≈ lti+1 } ate different values for Δ such that the whole prediction inter-
(32) val of the corresponding purchasing price is covered. However,
it might be likely that the mathematical programming models
μLr ≤ μr ≤ μUr ∀r (33) (20)–(28) and (29)–(37) become infeasible before reaching the

Pji,L ≤ Pji ≤ Pji,U ∀i, j; excluding pi+1 j (34) end points of the respective prediction interval. In such a circum-
stance, we acquire a subinterval of the corresponding prediction
Yr ≥ demr ∀r (35) interval within which the mathematical models (20)–(28) and
(29)–(37) retain their feasibility. We call such a subinterval the
Hj ≤ cap1j j = 1, . . . , c1 (36) feasibility interval of the respective optimum purchasing price.
ϑj + Hj ≥ pur1j , j = 1, . . . , c1 . (37)
IV. EMPIRICAL STUDY
Recall that since the precise value of purchasing price
of raw material lji+1  (i > 0) is disclosed once its opti- We present an empirical study in this section to illustrate
mal value is changed by Δ, it is regarded no longer how the proposed mathematical programming models work in
as a decision variable. Accordingly, the initial decision a practical context. In this regard, we implement the developed
variable Pj  (i > 0) is substituted by the precise value
i+1 approach in an American corporation that manufactures agri-
i+1 ∗i+1 cultural, construction, and forestry machinery, diesel engines,
pj  = pj  + Δ in all corresponding functions Gj con- i
drivetrains used in heavy equipment and lawn care equipment.
taining Pji+1  . The objective of this empirical study is to examine the impact
3) In both cases i = 0 and i > 0, since we retain all other pa- of price fluctuation of raw materials on the minimum COGS of
rameters fixed but only alter the optimal purchasing price two shafts manufactured by this company—primary shaft (PS)
of lji+1
 by Δ, any change in the objective function min- and secondary shaft (SS). The shafts are assembled together
imizing COGS can be viewed as the impact of changing to produce a gearbox of one special model of an agricultural
the optimal purchasing price of lji+1  by Δ. In other words, equipment. The main reasons why these two shafts are chosen
if the optimal price of lji+1  changes by Δ in future, then to be examined in this study are as follows.
the minimum COGS fluctuates by Z̄ ∗ − Z ∗ . 1) The company directly spends around 4.13% of its annual
Remark 1: Z̄ ∗ − Z ∗ indicates how much the minimum budget to produce them.
COGS volatiles if the optimal purchasing price of lji+1  changes 2) Their raw materials’ market has been somewhat volatile,
by Δ. However, working with an optimal purchasing price may which makes pricing of these two shafts too difficult.
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MOHEB-ALIZADEH AND HANDFIELD: IMPACT OF RAW MATERIALS PRICE VOLATILITY ON COST OF GOODS SOLD 7

As mentioned before, Pji and P̄ji denote the correspond-

ing prices of lji and any component in s̄ij , respectively.
Moreover, the value of other parameters in the model are
as follows: demPS = 4045, demSS = 4850, capBF = capMF =
capSF = 1256, purBF = 7235, purMF = 6854, and purSF =
6045. After characterizing all sets and their components and
parameters, we have the following initial mathematical pro-
gramming model:
Min Z1 = YPS μPS + YSS μSS
Fig. 3. Material flow for the empirical study.
s.t.
Hence, our proposed approach helps the company know how
to appropriately set the selling price of these shafts so as to obtain YPS = QPS (ϑBF , ϑMF , ϑSF , HBF , HMF , HSF )
as much marginal profit as possible, where profit = selling price YSS = QSS (ϑBF , ϑMF , ϑSF , HBF , HMF , HSF )
− COGS. In other words, once the company knows how the
minimum COGS of these two shafts would fluctuate in future, μPS = FPS (PBF , PMF , PSF , PBF PMF , PBF PSF , PMF PSF ,
it is able to properly set their selling prices resulting in more PBF PMF PSF , ωPS )
profit in the volatile market.
μSS = FSS (PBF , PMF , PSF , PBF PMF , PBF PSF ,
A. Data Acquisition and Model Configuration PMF PSF PBF PMF PSF , ωSS )
To manufacture the aforementioned shafts, this company pur- PBF = G1BF (P̄11
1 1
, P̄12 1
, P̄11 1
P̄12 , BF )
chases three types of major raw materials, including big forge
(BF), medium forge (MF), and small forge (SF), which are com- PMF = G1MF (P̄21
1 1
, P̄22 1
, P̄21 1
P̄22 , MF )
bined together with different percentages under different man-
PSF = G1SF (P̄31
1 1
, P̄32 1
, P̄33 1
, P̄31 1
P̄32 1
, P̄31 1
P̄33 1
, P̄32 1
P̄33 ,
ufacturing processes. Moreover, these first-level raw materials
1 1 1
are themselves produced by combining three different metals: P̄31 P̄32 P̄33 , SF )
Fe30 (FE), Me48 (ME), and Al32 (AL). Particularly, Fe30 (FE)
and Al32 (AL) are combined to make big forge (BF), Me48 μLPS ≤ μPS ≤ μUPS , μLSS ≤ μSS ≤ μUSS
(ME), and Al32 (AL) are blended to make medium forge (MF), L
PBF ≤ PBF ≤ PBF
U
, L
PMF ≤ PMF ≤ PMF
U
Fe30 (FE), Me48 (ME), and Al32 (AL) are all mixed together
1,L 1 1,U
to make SF. Fig. 3 depicts material flow of the underlined study, L
PSF ≤ PSF ≤ PSF
U
, P̄11 ≤ P̄11 ≤ P̄11
which represents the relationships among all raw materials. 1,L 1,U 1,L 1,U
1 1
Having such a material flow and following our discussion P̄12 ≤ P̄12 ≤ P̄12 , P̄21 ≤ P̄21 ≤ P̄21
given formerly, the next step is to define all introduced sets and 1,L 1 1,U 1,L 1 1,U
P̄22 ≤ P̄22 ≤ P̄22 , P̄31 ≤ P̄31 ≤ P̄31
their components. Since there are only two levels of raw materi-
1,L 1 1,U 1,L 1 1,U
als in material flow, we first characterize the set of components P̄32 ≤ P̄32 ≤ P̄32 , P̄33 ≤ P̄33 ≤ P̄33
located in each level as follows:
YPS ≥ 4045, YSS ≥ 4850
l1 = {BF, MF, SF}, |l1 | = c1 = 3
HBF ≤ 1256, HMF ≤ 1256
l2 = {FE, ME, AL}, |l2 | = c2 = 3.
HSF ≤ 1256, ϑBF + HBF ≥ 7235
Consequently, we describe the raw materials located in the ϑMF + HMF ≥ 6854, ϑSF + HSF ≥ 6045.
first level as l11 = BF, l21 = MF, and l31 = SF, and those placed
in the second level of material flow as l12 = FE, l22 = ME, and In order to modify the aforementioned model and reduce its
l32 = AL. We also define two sets sij and s̄ij as follows: decision variables, we derive the set Hti+1 ; i = 1, . . . , (m − 1)
and t = 1, . . . , ci introduced before as follows:
s21 = {BF, SF}, |s21 | = c21 = 2
H12 = {s̄111 , s̄131 }, H22 = {s̄121 , s̄132 }, and H32 = {s̄112 , s̄122 , s̄133 }.
s22 = {MF, SF}, |s22 | = c22 =2
Therefore, the modified programming model with reduced
s23 = {BF, MF, SF}, |s23 | = c23 = 3 decision variables is formulated as
s̄01 = {s̄011 , s̄012 , s̄013 } = {BF, MF, SF}, |s̄01 | = c̄01 = 3 Min Z1 = YPS μPS + YSS μS S
s̄11 = {s̄111 , s̄112 } = {FE, AL}, |s̄11 | = c̄11 =2 s.t.
s̄12 = {s̄121 , s̄122 } = {ME, AL}, |s̄12 | = c̄12 =2 YPS = QPS (ϑBF , ϑMF , ϑSF , HBF , HMF , HSF )
s̄13 = {s̄131 , s̄132 , s̄133 } = {FE, ME, AL}, |s̄13 | = c̄13 = 3. YSS = QSS (ϑBF , ϑMF , ϑSF , HBF , HMF , HSF )
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8 IEEE TRANSACTIONS ON ENGINEERING MANAGEMENT

TABLE I
PURCHASING VOLUME, INVENTORY LEVEL OF FIRST-LEVEL MATERIALS, AND PRODUCTION LEVEL OF END PRODUCTS

Period Purchasing Volume (103 kg) Inventory Level (103 kg) Production Level (103 kg)

BF MF SF BF MF SF PS SS

1 31.725 18.308 13.907 10.922 10.742 13.45 37.525 42.144

2 29.726 25.988 14.913 11.346 8.666 11.17 35.048 39.917
3 42.521 19.119 15.655 11.234 9.427 10.68 38.636 44.913
4 32.782 20.723 10.984 12.239 8.031 8.224 35.236 40.674
5 26.791 18.698 18.081 10.602 9.461 11.17 34.854 41.889
6 33.868 11.539 14.810 11.658 8.567 11.49 34.238 43.464
7 35.873 12.754 14.298 13.393 9.931 8.350 35.453 41.754
8 43.112 19.432 14.798 9.482 10.945 12.12 34.080 43.136
9 27.956 19.521 12.669 13.383 8.668 10.23 39.212 43.279
10 35.661 23.795 13.329 12.296 13.449 10.78 39.716 39.659
11 32.542 21.321 18.772 9.358 12.029 10.73 34.832 40.875
12 21.317 26.842 13.117 13.471 9.177 13.46 38.176 42.357
13 29.559 20.249 11.921 13.015 9.740 12.65 35.860 42.562
14 30.133 19.139 12.631 12.551 12.795 13.43 37.300 44.678
15 36.017 19.351 13.602 10.831 11.921 12.94 36.379 42.525
16 32.030 15.997 17.571 8.886 12.860 11.53 39.532 40.745
17 29.190 14.811 15.739 10.118 8.756 8.170 35.700 44.395
18 28.854 20.267 14.742 10.397 8.748 10.84 35.676 39.519
19 34.014 22.931 14.431 13.447 10.211 8.392 39.264 43.567
20 35.029 17.583 11.441 9.123 10.512 12.67 38.411 39.077
21 34.380 15.826 14.440 8.226 12.250 9.685 39.353 44.228
22 36.941 25.560 18.060 8.192 12.944 12.94 33.008 43.369
23 34.346 20.936 12.858 11.041 10.909 10.40 35.166 41.050
24 36.815 27.167 17.305 8.030 11.209 12.01 36.153 43.925
25 32.178 18.525 14.888 8.987 11.827 10.10 37.669 43.710
26 34.926 9.522 15.775 11.494 9.499 11.43 38.983 40.832
27 29.508 23.404 12.319 10.044 11.226 10.01 36.435 44.843
28 37.259 20.176 10.166 11.165 13.191 10.66 38.187 43.235
29 30.541 21.690 4.206 11.281 9.880 12.60 33.085 43.118
30 33.995 22.903 14.728 10.487 8.057 9.961 35.452 40.643
31 36.984 18.011 12.710 11.499 8.518 9.279 33.963 39.156
32 38.883 21.997 16.885 10.250 12.086 10.88 36.912 40.979

It is observed that we have decreased four decision variables

μPS = FPS (PBF , PMF , PSF , PBF PMF , PBF PSF , PMF PSF , in the later programming model in comparison with the former
PBF PMF PSF , ωPS ) one. In large scale problems, this modification certainly dimin-
ishes the problem complexity and can assist with finding more
μSS = FSS (PBF , PMF , PSF , PBF PMF , PBF PSF , effective and efficient solution procedures.
PMF PSF PBF PMF PSF , ωSS ) The next step is to derive the production functions QPS and
QSS and also the forecasting functions FPS , FSS , G1BF , G1MF , and
PBF = G1BF (P12 , P32 ) = G1BF (PFE , PAL , PFE PAL , BF ) G1SF using the historical data available. We exploit the historical
PMF = G1MF (P22 , P32 ) = G1MF (PME , PAL , PME PAL , MF ) data for purchasing volumes and inventory levels of raw mate-
rials located in the first level of material flow for 32 previous
PSF = G1SF (P12 , P22 , P32 ) = G1SF (PFE , PME , PAL , PFE PME , periods, presented in Table I, and explore various functional re-
PFE PAL , PME PAL , PFE PME PAL , SF ) lationships to find out the most appropriate production functions
QPS and QSS . In this regard, the linear functional relationship
μLPS ≤ μPS ≤ μUPS , μLSS ≤ μSS ≤ μUSS sounds sufficient approximation to model the production func-
tions QPS and QSS , as follows:
L
PBF ≤ PBF ≤ PBF
U
, L
PMF ≤ PMF ≤ PMF
U

L
PSF ≤ PSF ≤ PSF
U
, L
PFE ≤ PFE ≤ PFE
U
YPS = 0.1341ϑBF + 0.012ϑMF + 0.385ϑSF + 1.307HBF
L
PME ≤ PME ≤ PME
U
, L
PAL ≤ PAL ≤ PAL
U + 0.87HMF + 0.369HSF (38)
YPS ≥ 4045, YSS ≥ 4850 YSS = 0.26ϑBF + 0.118ϑMF + 0.38ϑSF + 1.226HBF
HBF ≤ 1256, HMF ≤ 1256 + 0.574HMF + 0.575HSF . (39)
HSF ≤ 1256, ϑBF + HBF ≥ 7235
Linear regression models (38) and (39) have R-squared of
ϑMF + HMF ≥ 6854, ϑSF + HSF ≥ 6045. 99.60% and 99.62%, respectively, and regression p-value of
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MOHEB-ALIZADEH AND HANDFIELD: IMPACT OF RAW MATERIALS PRICE VOLATILITY ON COST OF GOODS SOLD 9

TABLE II TABLE III

PURCHASING PRICES OF RAW MATERIALS IN THE FIRST LEVEL AND THE PURCHASING PRICES OF RAW MATERIALS IN THE SECOND LEVEL AND THE
ASSOCIATED COST OF PRODUCTS SOLD SELLING PRICES FOR RAW MATERIALS IN THE FIRST LEVEL

Period Purchasing Prices ($/kg) COGS ($) Period Purchasing Prices ($/kg) COGS ($/kg)

BF MF SF PS SS FE ME AL BF MF SF

1 80.5 63.5 49.2 146.0 185.0 1 13.0 39.6 23.1 80.5 63.5 49.2
2 89.8 63.7 40.7 147.9 185.4 2 7.5 24.6 38.8 89.8 63.7 40.7
3 77.8 54.4 43.4 153.0 199.0 3 3.8 20.0 35.3 77.8 54.4 43.4
4 75.1 55.1 41.9 159.1 187.1 4 8.4 23.4 30.6 75.1 55.1 41.9
5 78.6 52.1 45.5 147.4 194.9 5 6.2 14.9 37.3 78.6 52.1 45.5
6 81.9 59.2 43.5 146.9 185.1 6 10.7 33.2 27.0 81.9 59.2 43.5
7 75.9 61.1 41.5 143.3 192.1 7 6.7 28.5 31.6 75.9 61.1 41.5
8 80.0 63.0 43.8 157.1 194.3 8 8.0 28.9 35.0 80.0 63.0 43.8
9 80.9 64.4 45.0 149.9 188.4 9 10.2 31.0 32.4 80.9 64.4 45.0
10 79.5 60.6 44.6 155.8 198.1 10 13.1 36.2 24.5 79.5 60.6 44.6
11 77.8 64.4 44.4 159.1 192.4 11 8.0 30.7 34.5 77.8 64.4 44.4
12 84.8 62.5 46.8 149.8 186.4 12 12.2 36.4 27.2 84.8 62.5 46.8
13 84.1 52.2 48.7 147.0 191.9 13 16.4 31.3 19.8 84.1 52.2 48.7
14 78.9 61.8 44.9 153.9 198.0 14 8.4 28.2 32.5 78.9 61.8 44.9
15 75.6 61.0 44.2 148.8 196.1 15 6.5 27.4 33.5 75.6 61.0 44.2
16 87.4 59.3 44.0 144.3 194.8 16 7.1 19.5 39.6 87.4 59.3 44.0
17 81.3 56.1 48.1 154.7 185.4 17 14.1 32.7 22.5 81.3 56.1 48.1
18 89.3 50.9 48.0 161.7 197.5 18 11.7 20.9 29.1 89.3 50.9 48.0
19 77.6 64.5 48.5 160.5 197.4 19 5.7 29.9 33.5 77.6 64.5 48.5
20 76.1 52.0 40.6 164.2 190.6 20 6.4 16.5 35.5 76.1 52.0 40.6
21 83.4 50.9 44.8 151.0 199.5 21 5.7 12.6 37.5 83.4 50.9 44.8
22 88.4 64.4 42.8 156.2 185.8 22 12.9 35.0 28.5 88.4 64.4 42.8
23 80.4 63.5 43.7 146.6 192.5 23 10.8 37.5 26.1 80.4 63.5 43.7
24 88.9 64.9 42.7 159.0 190.5 24 12.9 36.3 29.7 88.9 64.9 42.7
25 76.2 60.9 48.5 163.7 186.5 25 4.6 24.0 37.6 76.2 60.9 48.5
26 81.5 64.2 44.5 151.0 198.8 26 7.2 27.4 36.5 81.5 64.2 44.5
27 86.9 57.2 49.2 155.2 197.7 27 6.7 16.8 40.2 86.9 57.2 49.2
28 89.6 53.0 40.7 144.1 190.4 28 9.9 19.6 34.5 89.6 53.0 40.7
29 82.1 58.5 44.3 159.5 189.5 29 5.1 22.3 37.0 82.1 58.5 44.3
30 77.9 60.5 46.5 156.7 194.3 30 4.6 23.2 37.1 77.9 60.5 46.5
31 80.1 59.6 49.6 155.5 197.8 31 4.9 18.8 39.6 80.1 59.6 49.6
32 84.7 63.5 45.3 156.9 190.3 32 13.3 39.4 23.3 84.7 63.5 45.3

zero, which attest the appropriateness of linear relationship to We follow the same procedure as mentioned earlier to attain
characterize the production functions QPS and QSS . the forecasting functions G1BF , G1MF , and G1SF . In this regard,
To obtain the predictive functions FPS and FSS , we obtained Table III presents the purchasing prices of very beginning raw
the purchasing data of raw materials BF, MF, and SF from the materials FE, ME, and AL, and the respective COGS of raw
purchasing planning department of this company. Moreover, materials BF, MF, and SF, which were provided by suppliers of
associated with these purchasing data, the COGS of the pri- raw materials BF, MF, and SF. Exploring various functional re-
mary and secondary shafts were given by the accounting and lationships, we derive the following regression models to define
financial department. Table II presents 32 purchasing prices of the predictive functions G1BF , G1MF and G1SF :
raw materials BF, MF, and SF, and the corresponding COGS of PBF = 3.965PFE + 1.797PAL − 0.0421PFE PAL (42)
primary and secondary shafts. Following a fixed-order interval
(FOI) inventory system, the company has been purchasing these PMF = 3.5 + 0.96PME + 0.935PAL (43)
raw materials per two months. Therefore, the data presented in PSF = −165.26 + 18.364PFE + 6.478PME + 5.646PAL
Table II are related to past 64 months.
Recall that we need to examine various functional relation- − 0.526PFE PME − 0.499PFE PAL − 0.168PME PAL
ships to derive the most proper functions for FPS and FSS . We + 0.013PFE PME PAL . (44)
characterize the following linear regression models:

μPS = 0.556PBF + 0.5564PMF + 1.659PSF
μSS = 1.095PBF + 1.599PMF + 2.622PSF − 0.0005PBF PMF PSF
(41)
where R-square of models (40) and (41) are equal to 99.74%
and 99.95%, respectively, and their regression p-values are both
zero.
(40) The R-square of the current regression models are 99.89%,
97.19%, and 99.79%, respectively. Their regression p-values are
also all equal to zero.
Fig. 4 depicts ACF with 5% significance limits for the residu-
als from the OLS fit of the regression models (40)–(44). Examin-
ing this figure reveals that there is no significant autocorrelation
for purchasing price of PS, SS, BF, MF, and SF.
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10
Fig. 4. ACF of the residuals for regression models (a) 40, (b) 41, (c) 42, (d) 43, and (e) 44.
In the next step, we determine the 99% prediction intervals for
two shafts’ COGS and all raw materials’ purchasing price. We
start doing so from the raw materials placed in the second level
of material flow. According to thedata given in Table III and
the general interval x̄ ± tn −1,α /2 s 1 + 1/n [25], we are able
to derive 99% prediction intervals for their corresponding pur-
chasing prices as: 0 ≤ PFE ≤ 19.166, 3.845 ≤ PME ≤ 50.323
and 14.833 ≤ PAL ≤ 49.6. In the aforementioned general in-
equality, x̄ and s are the sample mean and standard deviation
of n = 32 purchasing prices of raw materials FE, ME and AL,
and t31,0.005 = 3.022. For the next period of time, i.e., n = 33,
we regard the center of these intervals as the observation for
IEEE TRANSACTIONS ON ENGINEERING MANAGEMENT
predictors of their corresponding raw materials’ purchasing
prices. Using the later quantities, the 99% prediction intervals
for purchasing prices of raw materials BF, MF, and SF are
derived as 74.878 ≤ PBF ≤ 90.9045, 57.215 ≤ PMF ≤ 61.716,
and 36.886 ≤ PSF ≤ 49.358. Again, the centers of the cur-
rent intervals are regarded as the observation for predictors
of their respective raw materials’ purchasing prices. In this
case, we obtain the 99% prediction intervals for COGS of
end products PS and SS as: 127.472 ≤ μPS ≤ 173.933 and
177.801 ≤ μSS ≤ 205.155. All computations associated with
the aforementioned prediction intervals are carried out by re-
gression module of Minitab statistical software [26].
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MOHEB-ALIZADEH AND HANDFIELD: IMPACT OF RAW MATERIALS PRICE VOLATILITY ON COST OF GOODS SOLD 11

Having all these defined, we are able to construct the proposed price of raw material BF, it is not regarded as a decision variable
mathematical programming model (11)–(19) for this case study anymore and we substitute the quantity 75.878 wherever the
as follows: decision variable PBF appears in the model to obtain the follow-
ing programming problem with the optimal objective function
Min Z1 = YPS μPS + YSS μSS value of $1 564 316:
s.t.
Min Z1 = YPS μPS + YSS μSS
0.1341ϑBF + 0.012ϑMF + 0.385ϑSF + 1.307HBF + 0.87HMF
s.t.
+ 0.369HSF − YPS = 0
0.1341ϑBF + 0.012ϑMF + 0.385ϑSF + 1.307HBF + 0.87HMF
0.26ϑBF + 0.118ϑMF + 0.38ϑSF + 1.226HBF + 0.574HMF
+ 0.369HSF − YPS = 0
+ 0.575HSF − YSS = 0
0.26ϑBF + 0.118ϑMF + 0.38ϑSF + 1.226HBF + 0.574HMF
0.556PBF + 0.5564PMF + 1.659PSF − μPS = 0
+ 0.575HSF − YSS = 0
1.095PBF + 1.599PMF + 2.622PSF − 0.0005PBF PMF PSF
0.556(75.878) + 0.5564PMF + 1.659PSF − μPS = 0
− μSS = 0
1.095(75.878) + 1.599PMF + 2.622PSF
3.965PFE + 1.797PAL − 0.0421PFE PAL − PBF = 0
− 0.0005(75.878)PMF PSF − μSS = 0
3.5 + 0.96PME + 0.935PAL − PMF = 0
3.965PFE + 1.797PAL − 0.0421PFE PAL − 82.00 = 0
− 165.26 + 18.364PFE + 6.478PME + 5.646PAL
3.5 + 0.96PME + 0.935PAL − PMF = 0
− 0.499PFE PAL − 0.168PME PAL + 0.013PFE PME PAL
− 165.26 + 18.364PFE + 6.478PME + 5.646PAL
− PSF = 0
− 0.526PFE PME − 0.499PFE PAL − 0.168PME PAL
0 ≤ PFE ≤ 19.166, 3.845 ≤ PME ≤ 50.323
+ 0.013PFE PME PAL − PSF = 0
14.833 ≤ PAL ≤ 49.6, 74.878 ≤ PBF ≤ 90.905
0 ≤ PFE ≤ 19.166, 3.845 ≤ PME ≤ 50.323
57.215 ≤ PMF ≤ 61.716, 36.886 ≤ PSF ≤ 49.358
14.833 ≤ PAL ≤ 49.6, 57.215 ≤ PMF ≤ 61.716
127.472 ≤ μPS ≤ 173.933, 177.801 ≤ μSS ≤ 205.155
36.886 ≤ PSF ≤ 49.358, 127.472 ≤ μPS ≤ 173.933
YPS ≥ 4045, YSS ≥ 4850
177.801 ≤ μSS ≤ 205.155, YPS ≥ 4045, YSS ≥ 4850
HBF ≤ 1256, HMF ≤ 1256
HBF ≤ 1256, HMF ≤ 1256
HSF ≤ 1256, ϑBF + HBF ≥ 7235
HSF ≤ 1256, ϑBF + HBF ≥ 7235
ϑMF + HMF ≥ 6854, ϑSF + HSF ≥ 6045.
ϑMF + HMF ≥ 6854, ϑSF + HSF ≥ 6045.
B. Results
It turns out that increasing the optimal purchasing price of raw
The later model is a type of nonlinear programming prob- material BF by unit leads to increasing the minimum COGS of
lem that can be effectively solved via the constrained vari- this company by $2410. In addition, if we set Δ = −1 and
able metric method and generalized reduced gradient method follow the same procedure by replacing $73.878 wherever PBF
in theory of optimization [27]. Meanwhile, we utilize GAMS appears in the model, then the model is infeasible because the
24.1.2 optimization language [28] with BARON solver on respective prediction interval, i.e., 74.878 ≤ PBF ≤ 90.905, is
a computer with CPU of 2.5 GHz and 6.0 GB RAM violated. We implement this type of analysis for various values
to achieve its optimal solution as: μ∗PS = $134.65, μ∗SS = of Δ in prediction interval of PBF , for which the obtained pro-
∗ ∗ ∗
$190.48, PBF = $74.878, PMF = $57.215, PSF = $36.886, gramming problem retains its feasibility. Therefore, according
∗ ∗ ∗ ∗
PFE = $1.699, PME = $17.487, PAL = $39.494, YPS = 4045, to Remark 2, we are able to derive a feasibility interval for Δ
∗
and YSS = 5340.5. The minimum COGS associated with these by enumerating different quantities for it. In the case of PBF ,
optimal values is calculated as $1 561 906. such a feasibility interval is [0, 16.027]. In other words, we
Now, we examine how the minimum COGS fluctuates if the alter the purchasing price of raw material BF in the interval
optimal purchasing price of each raw material changes by Δ [74.878, 90.905], which is identical to the corresponding pre-
units in future. As mentioned before, we implement a sensitiv- diction interval, for investigating its impact on the minimum
ity analysis to accomplish this goal. For instance, we suppose COGS. Fig. 5(a) depicts how the optimal value of the mini-
the optimal purchasing price of raw material BF will increase mum COGS changes once optimal PBF increases from 74.878
by Δ = 1 unit in the following period of time, i.e., it goes up to 90.905. In this figure, the red perpendicular line represents
from the present optimal value $74.878 to $75.878. Therefore, the current purchasing price of raw material BF incurred by this
since we presently know the precise value of the purchasing company, which is equal to $81.60 per part, i.e., Δc = $6.722.
 This article has been accepted for inclusion in a future issue of this journal. Content is final as presented, with the exception of pagination.
12
Fig. 5. Sensitivity of the minimum COGS based on changes in raw materials’ prices.
We understand that the minimum COGS will increase by
$2410 if the optimal purchasing price of raw material BF in-
creases by unit in future. However, according to Remark 1, this
comprehension might not be of interest because it is grounded
on an optimal purchasing price, which might never be achiev-
able in practice. Hence, we instead bring the current purchasing
price of raw material BF to our attention and quantify the mini-
mum COGS fluctuation based on the changes of current PBF in
its respective feasibility interval for the next period of time. In
this regard, examining Fig. 5(a) reveals that the minimum COGS
increases by $2410 from $1 578 106 to $1 580 516 if the current
PBF increases by unit to $82.60. Therefore, the company real-
izes that its minimum COGS is somewhat sensitive to increasing
the current PBF . We are also able to draw such a conclusion by
exploring the curve slop at the current purchasing price of raw
material BF. In other words, as Fig. 5(a) delineates an exactly
linear relationship between the minimum COGS and PBF with
a slop of 2410, we conclude the minimum of COGS increases
(decreases) by $2410 if PBF increases (decreases) by unit.
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In the following, we carry out the same procedure for all
other raw materials in material flow. In this case, Fig. 5(b) to
5(f) represent how the minimum COGS changes once the pur-
chasing price of each raw material volatiles in its corresponding
feasibility interval in future. In all these figures, recall that the
red perpendicular lines illustrate the current purchasing prices
of the respective raw materials.
Exploring Fig. 5(a) to (c), we notice that the minimum COGS
generally volatiles in the same fashion once the purchasing
prices of raw materials located in the first level of material
flow fluctuate in their corresponding feasibility intervals, i.e.,
the relationship between the minimum COGS and the purchas-
ing price of such raw materials is exactly linear. Accordingly,
we conclude that the minimum COGS rises (reduces) by exactly
$2410, $3347, and $9165 if PBF , PMF , and PSF grows up (dimin-
ishes) by unit, respectively. Consequently, we understand that
the minimum COGS of this company is quite sensitive to fluc-
tuations of PBF , PMF , and PSF . On the other hand, as Fig. 5(d)
to (f) represents, the minimum COGS changes somewhat
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MOHEB-ALIZADEH AND HANDFIELD: IMPACT OF RAW MATERIALS PRICE VOLATILITY ON COST OF GOODS SOLD 13

TABLE IV
PERCENTAGE OF MINIMUM COGS CHANGE BASED ON DIFFERENT PURCHASING PRICES OF RAW MATERIALS

Δ FE ($12.4) ME ($17.76) AL ($44.00) BF ($81.6) MF ($60.55) SF ($38.88)

−7 – 6.86% – – – –
−6 – 2.36% – – – –
−5 – 1.95% – – – –
−4 – 1.55% – – – –
−3 – 1.15% – – – –
−2 – 0.76% – – – –
−1 6.81% 0.38% – – – –
0 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
1 1.16% 0.23% 0.37% 0.15% 0.21% 0.59%
2 2.11% 0.45% 0.74% 0.31% 0.43% 1.17%
3 2.81% 0.68% 1.12% 0.46% 0.64% 1.76%
4 3.54% 0.90% 1.51% 0.62% 0.86% 2.35%
5 4.22% – 1.90% 0.77% – 2.93%
6 4.80% – 2.30% 0.93% – 3.52%
7 5.40% – 2.72% 1.08% – 4.11%
8 5.98% – 8.82% 1.23% – 4.69%
9 6.59% – – 1.39% – 5.28%
10 7.08% – – 1.54% – 5.87%
11 7.56% – – 1.70% – 6.45%
12 8.02% – – 1.85% – 7.04%
13 8.05% – – 2.01% – 7.63%
14 8.18% – – 2.16% – –
15 8.59% – – 2.31% – –
16 – – – 2.47% – –
Average 5.35% 1.44% 2.17% 1.23% 0.43% 3.81%

differently with respect to volatilities of PFE , PME , and PAL
in their corresponding prediction intervals. In particular, once
PFE and PME increase through their respective prediction in-
tervals, the minimum COGS first lessens and then grows up.
Meanwhile, the minimum COGS is increasing with respect to
PAL . If the current PFE , PME , and PAL that are, respectively,
equal to $12.4, $17.76, and $44.00 raise (reduce) by unit, then
the minimum COGS increases (declines) by $2187 ($7477),
$3538 (−$3315), and $6163 ($6083), respectively.
In order to perceive why the minimum COGS increases while
optimal PFE and PME reduce, we examine interrelationships
among PFE , PME , and PAL . For instance, exploring various re-
gression models, we obtain
2 3
PME = 38.02 − 7.976PFE + 1.11PFE − 0.039PFE
2
PAL = 39.02 + 0.0377PFE − 0.08PFE .
The derivative of PME and PAL with respect to PFE at its op-
timal solution, i.e., $1.699, is equal to −$4.55 and −$0.235,
respectively. In other words, reducing PFE by unit from its op-
timal solution leads to increasing PME and PAL by $4.55 and
$0.235, respectively. According to the coefficient of PFE , PME ,
and PAL in the functional relationships G1j ; j = BF, MF, SF, the
latter growths result in increasing PME and PSF , while PBF keeps
unchanged. Consequently, μPS and μSS grow up that themselves
result in raising the minimum COGS. One can follow the same
argument to comprehend why the minimum COGS surges once
the optimal value of PME diminishes.
Table IV presents the change percentage in the minimum
COGS based on various values of Δ for all raw materials. In
this table, the current purchasing price of each raw material is
given in parenthesis underneath its respective abbreviated name.
Furthermore, the feasibility interval for Δ associated with each
raw material is derived in this table. Examining Table IV reveals
that the minimum COGS does not change significantly once the
price of raw materials fluctuates in some particular interval. If
we regard an alteration under 1% as negligible for the minimum
COGS, then the underlined italic values in Table IV indicate
quantities of Δ for which the change of minimum COGS is
insignificant. In other words, if such quantities of Δ define an
interval called insensitivity interval, then the minimum COGS
is insensitive to the change of a raw material’s price as long as
the price fluctuates within its respective insensitivity interval.
If the current purchasing price of a raw material is within its
corresponding insensitivity interval, then the company can be
safe against its volatilities. In addition, having known about the
insensitivity interval of each raw material in material flow, the
company is able to negotiate with its suppliers to set its raw
(45)
materials’ prices to be ideally within the respective insensitivity
(46) intervals. Hence, it turns out that the developed approach in
this paper helps the company manage its supply chain contracts.
Among the raw materials of the company in this empirical study,
ME and MF are within their corresponding insensitivity ranges.
Table IV also gives the average percentage of changes in
the minimum value of COGS while the price of each raw ma-
terial volatiles in its respective feasibility interval. Examining
the average values discloses that the raw materials located in
the second level of material flow yield more fluctuations to the
minimum COGS, rather than those placed in the first level. To
comprehend this observation, we again investigate the interre-
lationships among raw materials’ prices located in each level of
material flow. Alongside the cubic and quadratic polynomial re-
gression models (45) and (46), the following cubic polynomial
regressions appropriately model the relationship among prices
of raw materials in the second level:
2 3
PAL = 22.96+2.02PME −0.0822PME +0.000797PME (47)
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14
2 3
PFE = −21.24+4.696PAL −0.1871PAL +0.00217PAL
2 3
PME = −165.4+20.9PAL −0.691PAL +0.00709PAL .
The R-square associated with regression models (45)–(49) is
equal to 86.3%, 81.2%, 94.0%, 81.3%, and 96.1%, respectively.
It turns out that there exist relatively strong relationships among
the raw materials’ prices located in the second level of the ma-
terial flow. Such strong interrelationships in the second level
imply that once the price of one particular raw material changes
to some extent, then the price of other associated raw materials
in that level is also perturbed to some degree. The latter implica-
tion itself indicates that the impact of price fluctuation of a raw
material in the second level of material flow on the company’s
COGS is intensified by alteration in prices of other interrelated
raw materials, which have their own specific influences on the
company’s COGS. Hence, the company’s COGS becomes far
sensitive to price fluctuation of interrelated raw materials. Ac-
cordingly, it needs to be vigilant about such a volatility in order
to become robust against it.
However, we notice that there don’t exist any interrelation-
ships among the prices of raw materials in the first level of
material flow. It implies that any fluctuation in the company’s
COGS is solely the impact of price volatility in such raw
materials.
V. CONCLUSION
In the present study, we developed an approach to explore how
the minimum COGS of a manufacturing company fluctuates if
the purchasing price of its raw materials changes in future. In this
regard, all raw materials used to manufacture the end products
were first structured as a material flow to capture the relationship
among them. Because of the dynamic nature of COGS quantity,
we defined its minimum value as the most reasonable statistic to
investigate, which helped formulate the underlined problem as a
mathematical programming model. Hence, a sensitivity analysis
of the proposed programming problem assisted with quantifying
the amount of changes in the minimum COGS.
Providing a good understanding of the minimum COGS
volatilities in the next period of time, the proposed approach
in this paper posed to be a practical apparatus to effectively set
the selling price of end products in a purchasing firm, which led
to further profit. Moreover, it helped a purchasing firm manage
its supply chain contracts by giving useful insights into the in-
sensitivity intervals of raw materials required to manufacture its
end products.
Instead of investigating the minimum COGS fluctuations, one
could work with its expectation as a desirable statistic and try to
quantify changes in the expected value of COGS as the purchas-
ing price of raw materials alters. In this case, a well-defined dis-
crete time Markov chain (DTMC) might be a sensible approach
to characterize the expected value of COGS. Determining all
possible values for COGS in the next period of time as the state
space to derive the corresponding transition matrix is the initial
step to implement a DTMC study. Under this approach, a com-
pany would be able to set the selling price of its end products so
as to characterize the expected value of its profit.
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Authors’ photographs and biographies not available at the time of publication.