Exact time-discounting and heuristics for the EOQ model with random yield

Abstract

In inventory management, accurately estimating the financing costs is crucial, particularly in systems with random yield, where supply process uncertainties make determining the optimal order quantity and the safety stock challenging. In a quest for a more applicable economic order quantity (EOQ) model for scenarios involving uncertain supply, we develop an exact time-discounting formulation for two EOQ models with random yield variants, involving stochastically proportional and binomial supply processes. Additionally, we propose heuristics based on the traditional undiscounted cost framework, designed to derive near-optimal ordering policies through simple, closed-form adaptations of the basic EOQ model. In particular, our average cost (AC) heuristic, which adjusts the unit cost up to account for wasted supply, offers improved performance over the literature with minimal added complexity. We find that accounting for the time value of money is more critical in a random yield than in classical settings having a reliable supply.