Thi Thu Thuy Huynh

CAPACITY CONSTRAINTS IN MULTI-STAGE

PRODUCTION-INVENTORY SYSTEMS
APPLYING MATERIAL REQUIREMENTS
PLANNING THEORY

PROFIL 23
PRODUCTION-ECONOMIC RESEARCH IN LINKPING
LINKPING 2006

Production-Economcic Research in Linkping (PROFIL)

Box 10034 S-58010 Linkping, Sweden
affiliated to
The Department of Production Economics
Linkping Institute of Technology
S-581 83 Linkping, Sweden
Tel: 013-28 10 00
ISBN 91-974579-2-2
Copyright 2006 Thi Thu Thuy Huynh
LTAB Linkpings Tryckeri AB 2006.992

PREFACE
The objective of the PROFIL series is to provide information on research
and other developments within the field of Production Economics by
associates of Linkping Institute of Technology. Production Economics
is basically an engineering discipline. It focuses on topics treating the
interface between engineering and management and is therefore
interdisciplinary in nature. It attempts at a two-way scientific integration;
on the one hand to apply economic knowledge and reasoning to
engineering and manufacturing problems, on the other, to utilise the
arsenal of existing mathematical and quantitative engineering methods
for analysing economic and managerial issues. It focuses on various
allocation problems, in particular on the optimal use of productive
resources within manufacturing and other industries. It encompasses
developments in theory and application, wherever engineering and
technology meet the managerial and economic environment in which
industry operates.
From the economic science perspective, the methodological approach is
based on the theory of production, a branch of microeconomic theory,
and on methods of production and operations management. During the
last several decades this theory has been integrated with mathematical
and statistical models and methods from operational research and
management science. The quantitative economic approach has thereby in
a natural manner obtained a firm footing within the field a
development which has been strongly supported and encouraged by
many Swedish industrialists and others.
Among the multitude of problems covered by this subject area can be
found the development of principles for production planning and control
on different levels and with varying scope. Rules for scheduling and
sequencing work operations, the development of economic criteria for
maintenance routines, principles for quality and inventory control etc.
are other items of major interests, as well as methods, principles and
procedures for investment planning and financial decisions, and also
general theoretical frameworks. In this fascinating field of research, a
host of interesting and intricate problems are awaiting solution, and their
v

practical implementation may often be just round the corner. The field is
also experiencing considerable attention today from the academic as
well as the practical point of view. The competitive edge of many world
class companies is nowadays gained through manufacturing excellence,
for instance from lead time and inventory reductions. Education and
research in these areas are therefore important and rewarding, perhaps
more so now than ever before.
This twenty-third publication in the PROFIL series entitled Capacity
Constraints in Multi-Stage Production-Inventory Systems - Applying
Material Requirements Planning Theory has been written by Thi Thu
Thuy Huynh, who is presenting it as her doctoral thesis in Production
Economics at Linkping Institute of Technology.
Linkping in January 2006

Robert W. Grubbstrm FVR RI

Professor

vi

FOREWORD
I started my doctoral studies in February 2002 in the Department of
Production Economics at Linkping Institute of Technology. While
being a doctoral student for four years, I owe a lot to my teachers, family
and friends.
First of all, I would like to express my gratitude to my supervisor,
Professor Robert W. Grubbstrm, who has supported me throughout the
whole process. He has contributed to many of the basic ideas of this
dissertation. Without his guidance, I never could have finished this.
I am greatly indebted to Professor Marija Bogataj and Professor Ludvik
Bogataj, who have spent a lot of time with me for discussing suitable
models and approaches. My thanks to Professor Ludvik Bogataj are not
only for his valuable comments on my work, but also for his willingness
to act as Faculty Opponent for this thesis.
My appreciation is also expressed to Professor Christopher O'Brien,
Professor Lars-Erik Andersson and Professor Anders Segerstedt for their
kindness in taking on responsibility as Committee Members.
At Billerud Skrblacka AB, I have received enthusiastic help from Ivo
Fronzaroli, Marie Ardell and Mats Andersson. I greatly appreciate their
help and the time they generously spent with me.
I would like to show my deep thanks to Docent Ou Tang who has
supported me with several valuable pieces of advice in my work as well
as on my conference trips.
My thanks go to all my colleagues in Department of Production
Economics for making the department a nice place to work in.
Living in a foreign country, which is so far away from my home country,
is not easy. I would like to thank the family of Son, Tuyet and Viet Ha,

vii

the family of Bo, Gabriella and Filippa, and the family of Mrtha. They
have given me a lot of help making my life easier and more enjoyable.
I would also like to thank Lan, my room mate. We have spent a pleasant
time together, which will be remembered all my life. Many thanks go to
Phuong, who has helped me in programming the examples of this thesis.
I also wish to thank several friends, whom I cannot list here, for sharing
with me an interesting time in Sweden.
Finally, no word can express my deep gratitude to my parents, my sisters
and my brothers for their love and for their encouragement throughout
my long period of study.

Linkping in January 2006

Huynh Thi Thu Thuy

viii

CONTENTS
1
1.1
1.2
1.3
1.4

INTRODUCTION ......................................................................... 1
Background and Motives ............................................................... 1
Objectives ...................................................................................... 4
Limitations..................................................................................... 5
Outline and Scientific Contribution ............................................... 7

2
2.1

LITERATURE REVIEW AND RESEARCH FRAMEWORK.. 11

Capacity-Constrained Multi-Stage Production Planning and
Inventory Control......................................................................... 11
2.1.1 Deterministic Demand .................................................... 12
2.1.2 Stochastic Demand ......................................................... 14
2.1.3 Models Applied in Industry ............................................ 14
The Application of MRP Theory Employing Laplace Transform
and Input-Output Analysis to Multi-Level Multi-Stage Production
and Inventory Systems................................................................. 15
Capacity-Constrained Multi-Level Multi-Stage Production
Inventory Systems Some Notation and Explanations ............... 16

2.2

2.3

3
3.1

3.2

3.3
3.4
3.5
3.6

ANALYSIS OF STANDARD ORDERING POLICIES WITHIN

THE FRAMEWORK OF MRP THEORY .................................. 21
The Fundamental Equations of MRP Theory .............................. 23
3.1.1 Definitions ...................................................................... 23
3.1.2 Properties of Cumulative Requirements ......................... 24
Time Development of Production for Basic Ordering Policies ... 27
3.2.1 Lot-For-Lot (L4L) Policy ............................................... 27
3.2.2 Fixed Order Quantity (FOQ) Case.................................. 28
3.2.3 Fixed Period Requirements (FPR) Case ......................... 29
Solutions to Non-Negativity Conditions for Available Inventory
with Requirements as Discrete Events......................................... 30
Solution to Non-Negative Conditions for Available Inventory with
Requirements as Continuous Events............................................ 33
Optimal FOQ and Optimal FPR when External Demand is
Stochastic..................................................................................... 36
Summary...................................................................................... 41

ix

4.1
4.2

4.3
4.4
5
5.1
5.2
5.3
5.4
6
6.1
6.2
6.3
6.4
6.5

6.6

A HEURISTIC METHOD FOR THE CAPACITY

CONSTRAINED PROBLEM WITH NON-ZERO LEAD TIMES
..................................................................................................... 43
Problem Formulation ................................................................... 43
Heuristic Method ......................................................................... 45
4.2.1 Starting Point .................................................................. 46
4.2.2 Moving Procedure .......................................................... 46
4.2.3 Reduction Procedure....................................................... 51
4.2.4 Improvement Procedure.................................................. 52
Numerical Examples.................................................................... 53
Conclusion ................................................................................... 57
CAPACITATED PRODUCTION-INVENTORY SYSTEMS IN
DISCRETE TIME WITH NON-ZERO LEAD TIMES .............. 59
Assumptions and Notation........................................................... 60
Basic Model ................................................................................. 61
Numerical Examples.................................................................... 65
Summary...................................................................................... 71
THEORY FOR NON-ZERO LEAD TIMES EXTENDED TO
CONTINUOUS TIME FRAMEWORK...................................... 73
Assumptions and Notation........................................................... 74
Objective Function and Constrains.............................................. 75
Preliminary Example: One Product Case and Constant Demand ....
..................................................................................................... 78
Multi-Item Cases with Deterministic External Demand and Given
Capacity Limits............................................................................ 84
Numerical Examples.................................................................... 86
6.5.1 Two-level Serial Product Structure................................. 86
6.5.2 Three-level Product Structure......................................... 88
Summary...................................................................................... 90

CAPACITY-CONSTRAINED PRODUCTION-INVENTORY
SYSTEMS WITH NON-ZERO LEAD TIMES IN
CONTINUOUS TIME AND WITH STOCHASTIC DEMAND.....
...................................................................................................... 93

7.1
7.2

Objective Function and Constraints.............................................. 94

Dynamic Programming Solution Procedure ................................. 95
x

7.3
7.4

Interpretation of the State and Other Entities ............................... 98

Summary....................................................................................... 99

CAPACITY CONSTRAINTS IN A PAPER MILL (BILLERUD

SKRBLACKA AB) ................................................................. 101
Introduction................................................................................. 101
Production Planning and Capacity Constraint Problems ............ 104
Some Observation and Suggestions............................................ 110

8.1
8.2
8.3
9
9.1
9.2

CONCLUSIONS AND SUGGESTION FOR FURTHER

STUDIES.................................................................................... 113
Summary and Conclusions ......................................................... 113
Suggestions for Further Studies.................................................. 115

REFERENCES ..................................................................................... 119

xi

xii

INTRODUCTION

In a company, the role of production economics is to maximise the

companys economic result with respect to existing constraints.
Production-inventory control is one of the important techniques of
production economics.

1.1 Background and Motives

The objective of production-inventory control was stated by George W.
Plossl (1985) in the following way:
Production and inventory control is concerned basically with providing the
information needed for the day-to-day decisions required to reconcile these
objectives (maximum customer service, minimum inventory investment, and
low-cost plant operation) in plant operations. The fact that these objectives
are in basic conflict was readily apparent to the manager who owned his own
small manufacturing company. He had invested his money in the machines
and equipment in the plant, controlled his own manufacturing schedules and
was his own sales representative. When a customer demanded immediate
delivery, his alternatives was clear either spend money on breaking into
machine setups and working overtime or let the customer wait. He also had
the alternative of carrying inventory in the future finished products. Part or
raw materials so that he would be able to give his customer better service.
The basic conflicts among these objectives existed in this one manager
company and they were not easy to resolve, but at least the manger could see
the conflict and weigh the alternatives.

There are two techniques that a manufacturing enterprise may employ

for purposes of inventory management (Orlicky 1975). The first one is
stock replenishment, popularly known as statistical inventory control or
the order point system. Usually, it is applied for single item models.
Under this approach, the depletion in the supply of each inventory item
is monitored and a replenishment order is issued whenever the supply
drops to a predetermined quantity.
The second technique is Material Requirements Planning (MRP), which
is used for a multi-level, multi-period production planning and control
1

system. Multi-level production and inventory control is the subject of

this work. It is commonly much more difficult to analyse and to control
than a single-stage method.
MRP was introduced in the 1970s. Much of the credit goes to three
individuals by the names of Joseph Orlicky, George Plossl, and Oliver
Wight. The American Production and Inventory Control Society
(APICS), which was endorsed by Orlicky, Plossl, and Wight, was also
credited with the introduction of MRP.
MRP is a system that controls inventory levels, plans production, helps
to supply management with important information, and supports the
manufacturing control system with respect to the production of
assembled parts.
Figure 1.1 indicates an overview of how the MRP system works. The
Product Structure File, the Master Production Schedule (MPS), and the
Inventory Master File are the inputs of the MRP system. The output of
the MRP system provides which component items that have to be
produced and when, and this output can therefore be converted into the
capacities required to produce these items.
The MRP system does not, itself, plan capacity requirements, but it
provides an input to a capacity requirements planning system without
which the latter cannot possibly function effectively (Orlicky 1975).
In MRP systems, the MPS represent a plan for the production of all enditems over a given planning horizon. It specifies how much of each enditem that will be produced in each planning period, so that future
component production requirements and material purchases can be
calculated using the MRP component-explosion logic. As such, the MPS
has to be feasible so that components can be produced within the
capacity available in each time period.
Hence the production-inventory system is governed by the capacity
constraints. Capacity constraints are considered in inventory planning
for determining optimal target inventory positions.

Product
Structure
File

Master
Production
Schedule

Inventory
Master File

Material
Requirements
Planning

Manufacturing
Orders

Purchase
Orders

Various
Reports

Figure 1.1. An overview of how the MRP system works.

Adopted from Foster (2002).
Capacity decisions are related to the performance of the system, e.g. the
production lead time (Billington et al. 1983). Lead times are the times
required to produce or assemble the items.
The study of the MRP system has received a great deal of attention and
extensions have been made to connect these studies with other theory.
With the objective of obtaining optimal solutions, quantitative aspects of
planning and-inventory control have resulted in several pieces of
theoretical work on MRP and similar multi-level production-inventory
systems. One breakthrough in this direction is the application of Laplace
transform and Input-Output Analysis methodology. Combining
Laplace transforms and Input-Output Analysis has proved to be
advantageous for dealing with complex production-inventory systems
(Grubbstrm and Tang, 2000).
The useful relationship between the Laplace Transform and the Net
Present Value (NPV) has been known for a considerable time
3

(Grubbstrm, 1967) and the NPV principle, considered as a more correct

approach than the average cost measure, is being applied to productioninventory theory in a rapidly increasing number of articles (Grubbstrm
and Lundquist 1977, Grubbstrm 1980, Thorstenson 1988, Grubbstrm
and Jiang 1990). Here, we continue with this combined methodology.
The Input-Output methodology is used to generalise the product
structure as well as the timing relationship between items. The
fundamental equations of the production-inventory system are described
by the combination of transforms and Input-Output Analysis
(Grubbstrm and Ovrin 1992, Grubbstrm and Molinder 1994). These
equations are balance equations in the frequency domain explaining the
development of total inventory, available inventory, backlogs and
allocations (items reserved for production). The combined methodology
of Input-Output Analysis and Laplace (or z-) transforms applied to
production-inventory systems, we name MRP theory. More recent
outcomes are the dissertations by Molinder (1995), Tang (2000), and by
Wang (2002). Different directions of research within MRP theory have
been developed, such as by Horvat and Bogataj (1996), Martin (1997),
Bogataj (1999), Bogataj and Bogataj (2004).
This work treats the capacitated multi-level, multi-stage production
inventory problems within MRP theory. Input-Output Analysis and
Laplace transforms or z-transforms are then employed as the essential
tools.

1.2 Objectives
In this thesis, capacity-constrained aspects of multi-level, multi-stage
production planning are investigated. The aim has been to extend
Material Requirements Planning Theory (MRP Theory) to cover more
general problems dealing with capacity constraints, in particular when
non-zero lead times are present and the processes take place in
continuous time.
The methodology used in this book is the quantitative method, which is
based on the principles of Operational Research and Management
4

Science. The models are built on mathematically oriented production

planning and inventory theory.
In previous studies, the NPV objective function of multi-item
production- inventory system has been developed. The optimisation
conditions and capacity constraints have been generated. The problem is
easy to formulate but difficult to solve for the optimal solution,
especially when lead times are non-zero and external demand is
considered in continuous time.
Our aim is to extend our study to situations explaining how productioninventory system should works under capacity constraints when lead
times are non-zero. First we develop a heuristic approach to get an
inaccurate, but simple, result. Then, we state optimisation approaches for
the models in several steps.
This thesis also examines the fundamental equations of MRP Theory in
order to analyse the possibility to obtain closed-form expressions for the
time development of the system, when standard ordering policies of
MRP are applied. Input-Output Analysis is used for capturing the Bill of
Materials (the product structure) and Laplace transforms for describing
the advanced timing requirements (lead times).

1.3 Limitations
Multi-level production and inventory control causes several problems
and difficulties in practice. Hence we have simplified the models with
some assumptions.
The product structures which are used in our work are assembly type (left
part of Figure 1.2) only. Other types of production such as arborescent
structures (right part of Figure 1.2) are not treated in this thesis. The
assembly type of product structure is the prevailing type in
manufacturing industries, whereas extraction industries, such as mining,
often have product structures of the arborescent type. In various process
industries there are often different mixtures of these types of structures.
In a sequential structure, each item produced has only one predecessor

and only one successor. A sequential structure is therefore both of an

assembly and an arborescent type.

Assembly structure

Arborescent structure

Figure 1.2. The two basic types of product structures.

End products are represented by top-level boxes, and subassemblies or
semi-processed products by lower-level boxes.
We focus on the multi-period production planning and control system
applying MRP theory. Other alternative techniques such as inventory
control and order point systems is not the subject of this work.
We used the NPV instead of total or average cost as our objective
functions. NPV is useful when we apply the Laplace transform.
The only uncertain aspect considered here is stochastic demand. We
mostly assume that lead times are given constants, even if lead times
often can be stochastic in the real system. We also ignore other kinds of
uncertainty such as machine reliability and production costs changing
over time.
Other limitations will be explained in the chapters to follow. Often such
limitations are consequences of assumptions set forth.
6

1.4 Outline and Scientific Contribution

As mentioned above, the multi-stage, multi-level capacity-constrained
production-inventory problems have been treated in some previous
studies. In Table 1.1, we have described the contribution from previously
completed studies and the current contributions from this dissertation.
The systems considered are classified with respect to properties of
demand, properties of the time scale and with respect to whether or not
the lead times are zero (or unity) or not in discrete time, or zero or nonzero in continuous time. The papers relevant to this development are
listed in Table 1.1.

Deterministic
demand

Discrete time
Continuous time
Varying
Varying
GrubbstrmGrubbstrmHuynh(2005a)
Huynh (2006)
=0
1
Segerstedt (1996)
Varying

Varying
Huynh (2006)

Stochastic
demand
1
Grubbstrm-Wang (2003)

=0

Table 1.1. Contributions to the development of multi-stage, multi-level

capacity-constrained production-inventory theory with respect to
demand, time framework and lead times .

Segerstedt (1996) built a dynamic programming model to solve the

capacitated multi-level, multi-stage production-inventory problem under
the assumption that lead times either all are zero or all have a length of
one period in discrete time. Later, Grubbstrm and Wang (2003)
presented a model in discrete time when external demand is stochastic

and production lead times are zero. From 2002 until now, we develop the
other cases in turn.
This thesis consists of nine chapters. This first chapter is an introduction
to the report. Here is presented the background and motives, the
objectives, the limitations and the general contents of other chapters.
Chapter 2 discusses the major research framework of this work. It also
presents a literature review on the topics of multi-stage production
inventory planning which focuses on capacity constraints. Our basic
model for multi-level, multi-stage production inventory is also presented
in this chapter for providing the general formulas of the model and the
notation applied.
Chapter 3 examines the fundamental equations of MRP Theory. These
equations are balance equations in the frequency domain explaining the
development of total inventory, available inventory, backlogs and
allocations (items reserved for production). The objective is to analyse
the possibility to obtain closed-form expressions for the time
development of the system, when standard ordering rules of MRP are
applied. Standard ordering policies presented are Lot-For-Lot (L4L),
Fixed Order Quantity (FOQ), Fixed Period Requirements (FPR) which
are mostly used when demand is considered to be deterministic.
However, this chapter also analyses aspects of the Economic Fixed
Order Quantity policy and the Optimal Fixed Period Requirements when
assuming demand to be stochastic. The approaches analyse the problems
both in the time domain and in the frequency domain. This chapter is
based on Grubbstrm and Huynh (2005b).
In Chapter 4 we present a heuristic methodology for solving a capacity
constrained production-inventory model. This chapter extends the
Grubbstrm and Wang (2003) model to the case when lead times are
non-zero. It applies the heuristic method of Frana et al (1996) to solve
lot-sizing in a multi-stage system. Firstly, the uncapacitated model is
solved by dynamic programming to get an initial solution. If the initial
solution is capacity infeasible, a smoothing procedure and an
improvement procedure are applied to obtain feasible solution. This
gives an inaccurate, but simple solution. The contents of this chapter are
rewritten from Grubbstrm and Huynh (2002).
8

From Chapter 5 to Chapter 7, we solve the capacitated multi-level, multistage problems. The Laplace transform together with Input-Output
Analysis are employed as tools for modelling the production-inventory
system. This approach has been successfully used for formulating a
theoretical base for Material Requirements Planning. The development
follows the steps described below.
In Chapter 5, we assume that demand is deterministic. The model is
considered in discrete time and production lead times are non-zero. A
dynamic programming model is formulated for the purpose to solve the
optimisation of our objective function. The objective function is the NPV
in this and the two following chapters. Here is the first time we introduce
an efficient state space for dynamic programming, in which historical
values of cumulative production and cumulative demand are given state
variables. This chapter is based on Grubbstrm and Huynh (2006).
In Chapter 6, we turn to continuous time theory and develop the
corresponding methodology for the case that lead times are non-zero,
while keeping external demand deterministic. Our emphasis is on the
design of the state space, the properties of which depend on the product
structures (the input matrix), the distribution of lead times among the
production processes (the lead time matrix), and on the historical
sequences of production and demand vectors. Once an efficient state
space is designed, dynamic programming once again is applied as the
solution method. The Net Present Value Principle is applied. This
chapter is based on Grubbstrm and Huynh (2005a).
In Chapter 7, we cover a model with stochastic demand in continuous
time. The lead times are allowed to be non-zero. This is the most general
system treated, and all other theory referred to, may be considered as
special cases hereof. In Table 1.1, the thick-line triangle represents this
theory. Appropriate states for applying dynamic programming are also
designed. Once again, the Net Present Value is applied. The Laplace
transform together with Input-Output Analysis have been employed as
tools in constructing the model. The content of this chapter comes from
Huynh (2006).

In addition, in Chapter 8, the production planning procedures applied in

a paper mill have been studied, and they are here presented in the form
of a case study. We investigate the production planning and related
capacity-constraints of this plant.
Chapter 9 summarises our work and states some of our conclusions.
There we have also listed some further issues suggested for future
research.

10

LITERATURE REVIEW AND RESEARCH

FRAMEWORK

Production planning has a fundamental role in any manufacturing

operation. The problem is to decide what type of product, and how much
of each product that should be produced in future time periods. The
decisions should be based on many factors, including period machine
capacity, production lead times, holding costs, etc. Of primary
importance is the estimate of demand for manufacturer's products in
upcoming periods.
Multi-stage production planning and inventory control is one of the most
challenging problem areas in the field of manufacturing management
(Axster et. al., 1986). One of the problems concerned is the application
of MRP Theory to multi-stage lot sizing. MRP should be ranked at the
top for analysing multi-level production-inventory control (Axster and
Rosling, 1994). The widespread and popular use of MRP systems in
industry has also resulted in an increased interest in the topic of decision
making in capacitated multi-stage production-inventory system.
This chapter provides a literature review of work treating capacitated
multi-stage production-inventory systems and the application of MRP
theory and Input-Output Analysis together with Laplace transforms to
production-inventory systems.

2.1 Capacity-Constrained
Multi-Stage
Planning and Inventory Control

Production

We structure this section in the following areas:

- Deterministic demand, multi-stage production planning and inventory
control,
- Stochastic demand, multi-stage production planning and inventory
control.
- Multi-stage production planning and inventory models applied in
industry.
11

2.1.1 Deterministic Demand

Throughout this literature review of deterministic demand models, only
discrete-time approaches have been found. Billington et al (1983)
modelled the general MRP problem with capacity constraints. They
presented an integer linear programming model of a general capacityconstrained multi-level MRP system. They limited themselves to very
few constrained facilities (one or two), since they used a simple heuristic
optimisation method. In 1994, also Tempelmeier and Helber used a
heuristic for solving multi-item, multi-level lot-sizing problems with
multiple capacity constraints.
Frana et al (1996), have used a heuristic method for solving lot-sizing in
multi-stage systems. First, they used the Wagner-Whitin dynamic
lotsizing algorithm for each item of the system. Subsequently, a
smoothing procedure and an improvement procedure are introduced for
finding feasible capacity solutions.
Segerstedt (1996) dealt with an optimisation approach for the multilevel, multi-stage capacity problem. Demand was assumed to be
deterministic and the discrete production lead time either zero or unity.
Dynamic programming was applied to find the optimum solution using
the NPV as objective function.
Ip et al. (2000) solved the earliness and tardiness production scheduling
and planning problems. They applied a genetic algorithm in order to
obtain an optimal solution to the multi-product production environment.
Their objective was to find an optimal lot-size production schedule
within a production planning and scheduling horizon such that the total
cost of earliness and tardiness penalties could be minimised while
satisfying the manufacturing process capacity constraints. Both a genetic
and a linear programming approach were used and compared.
A heuristic genetic algorithm for capacitated lot-sizing problems was
developed by Xie and Dong (2002). With a zero lead time assumption,
they built a model to minimise the total cost for a multi-stage
production-inventory model. Their product structure could be a single
level system, or a serial or an assembly system, and other variants. The
capacity constraints could be of several types: uncapacitated, capacitated
12

single resources and/or capacitated multiple resources. It should be noted

that the cost of computations and computation time for this algorithm is
significant, since the complexity of problem is very high.
Recently, Clark has built some models for capacity-constrained multilevel MRP systems with deterministic demand. In Clark (2003), three
mixed integer programming (MIP) models and solution methods were
developed to assists in identifying a capacity feasible MPS in MRP
systems. An optimisation of capacity utilisation model was formulated
and then solved using two approaches based on model approximation
and sequential decomposition. The objective function applied was the
traditional cost principle. Lead times were here assumed to be zero. In
contrast, not avoiding lead times, Clark and Armentano in their report
(1993) explicitly dealt with lead times in their multi-stage lot sizing
problems treated.
The limited capacity manufacturing system also was treated by Bouhia
and Abernathy (2003). In this paper, they defined a list of ordering and
scheduling policies in a multiple product, multiple plant case to
maximise profits subject to capacity limits of the system. Their solution
method was based on simulation methodology.
Pongcharoen et al. (2002) introduced a genetic algorithm for the finite
capacity scheduling of complex products with multiple levels in the
product structure. Their algorithm including problem encoding,
chromosome representation and initialisation, genetic operation, repair
process, fitness measurement and chromosome selection is described in
detail. A statistical analysis showed that the size of the problem has a
major influence on the penalty costs concerned.
Jolayemi and Oloruniwo (2004) developed a deterministic model for
planning production and transportation quantities in a multi-plant and
multi-warehouse environment, where opportunities to increase capacity
levels were available. A mixed integer linear programming model was
applied to analyse this model.

13

2.1.2 Stochastic Demand

In practice, almost every production-inventory is subject to influences
with uncertainty. This may be external demand, the supply lead time or
other operational parameters (Tang, 2000). Here, we will be dealing with
the uncertainty of external demand only.
Albritton, M., et al (2000) considered a multi-product system in a single
stage model, each resource having a finite capacity. The demand for each
product was stochastic with log-normal distributions. When demand for
a product exceeded the available inventory for that product, the
manufacturer would lose sales. They solved this problem with two
variants of Monte Carlo sampling-based optimisation techniques, to
which they refer as simulation-based optimisation methods. However,
they did not consider any multi-stage aspect.
Grubbstrm and Wang (2003) have developed a capacity-constrained
multi-level multi-stage production-inventory system with stochastic
demand and zero lead times. Their optimisation methodology was
dynamic programming. In their results stated, a comparison was made
between the capacitated and uncapacitated problems indicating the value
of adding new capacity.
Brander et al (2005) have presented a simulation study under stationary
stochastic demand. They used a heuristic approach to calculate the lot
size for the economic lot scheduling problem. In this study, the actual
demand had a uniform distribution. The purpose of this paper was to
examine if a deterministic model could be used when demand has a
stationary stochastic distribution. The authors concluded that the model
used for determination of lot size was of lesser importance than the
decision rule used for identifying the item to produce and, in particular,
when to produce it.

2.1.3 Models Applied in Industry.

There are some papers dealing with multi-product multi-period problems
in industrial systems. Yan (2000) presented a hierarchical stochastic
production planning for flexible automation workshops. Their software
14

package, named as stochastic interaction/ prediction algorithm, was

developed as a result of this study.
A capacity planning system that considered both the capacity and the
capability of equipment was developed for multi-product semiconductor
fabs (Chen et al, 2005).
Recently, Mula et al (2006) presented a new linear programming model
for medium term production planning in a capacity constrained MRP,
multi-product, multi-level and multi-period manufacturing environment.
This paper provided three fuzzy models with flexibility in the objective
function. The paper demonstrated the usefulness and significance of
MRP modelling with flexible constraints under uncertainty in demand.
Their model was tested using real data from an automobile seat
manufacturer.

2.2 The Application of MRP Theory Employing

Laplace Transform and Input-Output Analysis to
Multi-Level Multi-Stage Production and Inventory
Systems
The idea of applying Input-Output Analysis to MRP and multi-level
production and inventory systems has been studied for some years in the
Department of Production Economics at Linkping Institute of
Technology.
In Grubbstrm and Lundquist (1989), the relationships between InputOutput Analysis, MRP and production function were discussed. They
concluded that there was an obvious relationship between master
production scheduling, MRP, the bill of material (BOM), manufacturing
resource planning (MRP II), and a general linear production-economic
system interpreted in terms of an input-output model.
The useful relationship between the Laplace Transform and the Net
Present Value (NPV) was presented by Grubbstrm (1967). Moreover,
the NPV principle, considered as a more correct approach than the
average cost measure, has been applied to production-inventory theory in
15

an number of articles (Grubbstrm and Lundquist 1977, Grubbstrm

1980, Thorstenson 1988, Grubbstrm and Jiang 1990), Van der Laan
(2003), and Teunter (2003).
Applying the combination of transforms and Input-Output analysis to
production-inventory was presented in Grubbstrm and Ovrin (1992)
and Grubbstrm and Molinder (1994), and was further developed in
Molinder (1995). In Grubbtrm and Ovrin (1992), the theory was
originally introduced using the z-transform for application in discrete
time. In Grubbstrm and Molinder (1994) and Molinder (1995), the
theory was converted from discrete time to continuous time by
introducing the Laplace transform. The advantages from combining the
Laplace transform and Input-Output Analysis when dealing with
complex production-inventory systems have been argued in Grubbstrm
and Tang (2000).
Grubbstrm and Tang (1997) have reviewed some early writings related
to the topics of MRP and Input-Output Analysis. They also presented
simple examples to further explain the interrelationship between these
two methodologies.
Recently, a few publications on capacitated multi-stage productioninventory applying MRP theory have appeared (Grubbstrm and Wang
(1999), Grubbstrm and Wang (2000a), Grubbstrm and Wang (2000b),
and Grubbstrm and Wang (2003)). There are also other recent outcomes
such as the theses of Molinder (1995), Tang (2000), and of Wang (2002).

2.3 Capacity-Constrained Multi-Level Multi-Stage

Production Inventory Systems Some Notation and
Explanations.
We now describe the capacity-constrained multi-level multi-stage
production inventory systems. Our basic notation is introduced for the
application in all chapters to follow.

16

time until given horizon.

T
N

number of all items in the system.

number of end items

number of resources constraining production.

complex Laplace frequency.

ni

number of set-ups for the production of batches of item i.

tij

time at which batch no j of item i is completed (decision

variable), i = 1, 2, ... , ni .
lead time for the production of item i.

i
 s)
(

ij

( N N ) -dimensional lead time matrix with a lead time

operator e s i in its ith diagonal position and zeros
elsewhere.
jth set-up of the production of item i referred to completion
time tij . As a time function ij may be written as a
sequence of Dirac impulses (t tij ) , j = 1, 2, ... ni .

 ( s )
Ki

hij
hkj
ri
ci
wk
Ck(t)

vector of all completion times in Laplace transform

notation
set-up cost for producing a batch of item i,.
continuous interest rate per time unit.
number of units of item i required to produce one unit of
its immediate successor j. Collected into the input matrix
H .
capacity of resource k needed to produce one unit of item j
collected into the input matrix H . H and H make up
the joint input matrix H.
sales price per unit of end product i collected into the row
vector r.
echelon production cost per item i collected into the
column vector c.
variable cost for using resource k per time unit collected
into the column vector w.
Available capacity of resource k at time t.

17

Di

external demand rate of item i at time t.

Di (t )

external cumulative demand per time unit of item i from

t

time 0 to t, Di (t ) = Di ( ) d .
0

Pij

number of units of item i (lotsize of batch no j) completed

at time tij .

Pi (t )
Bi(t)

cumulative number of units of item i produced from time 0

to t.
level of stockouts of item i at time t.

Ri(t)

Available inventory of item i at time t.

NPV

Net Present Value, objective function.

E ()

expectation operator.

x (t )

short-hand notation for a time derivative of x(t).

Tildes or the operator { } are used to denote Laplace transforms of the

corresponding time functions, i. e.

f ( s ) = { f (t )} =

f (t )e

st

dt =

fe
n=0

stn

for a continuous f (t ) or a discrete

time function f n ,
t

respectively, and bars for cumulative functions, like f (t ) =

f ( )d

or

fn =

k =0

In Grubbtrm (1999), an NPV approach for the general model of multilevel multi-stage production-inventory problem was presented. The
following expression is the NPV of the cash flow,

( (

 ( ) E B ( ) E ( B(T ) ) e T
E ( NPV ) = r E D

(c + w )P ( ) K ( ) ( ) ,

)
(2.1)

18

where r and K are N-dimensional row vector containing the components

rj (sales prices) and Kj (set-up costs), respectively, and (c + w) an
(N + M)-dimensional row vector with components ci + wi. The lead time
matrix  ( ) appearing in the last term accounts for allocating the set-up
costs to the beginning of the lead time, since  ( ) is defined from the
completion dates. The production costs have been allocated to the
completion dates by using the (N + M)-dimensional column production
vector P ( ) .

 ( ) is an N-dimensional column vector of component

In (2.1), E D

presenting expected external demand discounted to time zero with no

consideration to stockouts, E B ( ) is a similar vector of discounted

changes in backlogs, and E ( B(T ) ) e contains correction terms for the

sake of backlogs not being satisfied at the horizon T, since the process
then terminates and no more production is planned.
T

To get the optimal solution, we search for the maximal value of (2.1)
subject to the following constraints.
 ( s ) is cumulative production P ( s ) less
The available inventory R
 ( s ) and cumulative internal demand
cumulative demand D

H ( s )P ( s ) and must be non-negative.

+



 ( s ) = R (0) B(0) + (I H ( s))P( s) D( s) ,
R

(2.2)

[]

 ( s ) is the total
is the maximum operator Max{0, } , P
production of all items and H ( s )P ( s ) is the internal demand. In (2.2),
all vectors are N-dimensional

where

If external demand cannot be satisfied, we assume that this demand is

backlogged and satisfied at the time available inventory starts to become
positive one again.
19

 (s) + D
 (s) +

B
(0)
R
(0)
(
I
H

(
s
))
P
B ( s ) =

(2.3)

Regarding end items (the N first components), the non-negativity is

taken care of by the backlogging opportunity.
For lower-level items, the backlogs are only allowed for external
demand, but internal demand must always be met in order for the
production plan to be feasible (the available inventory constraint):


 ( s) = 1 R (0) B(0) + (I H ( s ))P( s ) 0 ,
1 R
s

(2.4)

where 1 { } denote the inverse Laplace transform.

The second constraint is that of the capacity limitations,

H(  ( s ) I )P ( s )
1 C
(s)
0.
s

(2.5)

In the next chapters, we will search for the optimal solution to (2.1)
subject to constraints (2.4) and (2.5) following several steps of
development.

20

ANALYSIS OF STANDARD ORDERING

POLICIES WITHIN THE FRAMEWORK
OF MRP THEORY

In MRP theory the time development of the production-inventory system

is determined by a set of fundamental equations on the one hand, and
external demand and production decisions, on the other. The
fundamental equations are balance equations applicable to available
inventory, total inventory and backlogs, using Input-Output Analysis for
capturing the Bill of Materials and Laplace transforms for describing the
advanced timing requirements (lead times).
This chapter aims to examine the fundamental equations of MRP Theory
into in order to obtain closed-form expressions for the time development
of the system, when standard ordering policies of MRP are applied.
The fundamental equations of MRP Theory have been developed in
several earlier papers, beginning with Grubbstrm and Ovrin (1992) and
in some earlier unpublished studies. These equations are balance
equations in the frequency domain explaining the development of total
inventory, available inventory, backlogs and allocations. Input-Output
Analysis is used for capturing the Bill of Materials and Laplace
transforms for describing the advanced timing requirements (lead times)
In Grubbstrm and Tang (2000) an overview is presented. This chapter
analyses the question of developing closed-form expressions for
production when applying basic ordering rules. Order sizes are to be
decided in time when inventories are zero or near to zero.
In Grubbstrm and Ovrin (1992) the problem treated here was touched
upon. In that paper the processes took place in discrete time, and the ztransformation was applied. Grubbstrm and Molinder (1994) and
Molinder (1995) also followed up some research into this issue in the
continuous time case.

21

In Orlicky (1975), some standard ordering policies such as Lot-For-Lot

(L4L), Fixed Order Quantity (FOQ), Fixed Period Requirements (FPR)
are defined.
The L4L rule, being the simplest (also called as required) involves an
order to be placed exactly large enough to cover requirements. This
means that available inventory is kept at a zero level (assuming no initial
inventories). In L4L, both the size of the order and the interval between
orders will vary over time in a general case. Production, by this rule, is
therefore adapted directly to requirements.
With the FOQ policy, the order size is always the same. An order is
placed as soon as there is not enough available inventory to cover
requirement. If demand fluctuates, the interval between orders also must
fluctuate. In general, available inventory will only reach a zero level on
occasion.
Applying the FPR policy, the interval during which total demand is
generated and which the order should cover is constant. An order is
placed just large enough to cover the total requirements during each such
interval. At the end of these intervals, available inventory will have
dropped to zero.
We present a brief overview of the fundamental equations of MRP
Theory in Section 3.1. This is followed by deriving the basic properties
of production for the three ordering policies in relation to this theory in
Section 3.2. Sections 3.3 and 3.4 are devoted to solving for the
production development. In Section 3.5, the optimal FOQ and optimal
FRP are presented when demands are stochastic.

22

3.1 The Fundamental Equations of MRP Theory

3.1.1 Definitions

Figure 3.1. Flowchart of the fundamental equations

of MRP Theory (Grubbstrm and Tang 2000).
The fundamental equations of MRP Theory are balance equations
describing the time development of total inventory, available inventory,
backlogs, and allocations (see Grubbstrm and Tang, 2000). With the
policies we are studying, backlogs will not occur in deterministic
demand cases. In such cases, the fundamental equations for total
inventory and available inventory may be written:

 (s)
S(0) + ( I H ) P ( s ) D
,
S ( s ) =
s

(3.1)




 ( s ) = R (0) + ( I H ( s ) ) P ( s ) D( s) ,
R
s

(3.2)

where S is the column vector of items in inventory (including

 is the column vector of items in available inventory
allocations), R
 is the vector of external demand, P
(total inventory less allocations), D
is the vector of items produced, H is the input matrix (the Bill of
Materials), and I is the identity matrix. The lead time matrix  ( s ) is a
matrix with lead time operators in its diagonal positions:

23

 e s1

0
 ( s ) =
#

0
e

s 2

#
0

" 0

" 0
.
% #

" e s N

(3.3)

Internal (dependent) demand is given by H ( s )P ( s ) , since the input

matrix and lead time matrix together determine all advanced
requirements of sub-components in amount and timing, given a
production schedule P ( s ) .
The main problem treated in this chapter, is how production P is
determined by each of the policies, when facing a given external
 .
(independent) demand D
In one-item systems, there is no internal (dependent) demand and, thus,
independent and dependent demand, on the one hand, and available and
total inventory, on the other, will coincide. The fundamental equations
(1)-(2) then collapse into:
R (0) + P ( s ) D ( s )
.
R ( s ) =
s

(3.4)

3.1.2 Properties of Cumulative Requirements

The minimum necessary production to meet external (independent)
requirements is always given by

( I H )1 D ( s ) = I + H +( H )2 +( H )3 + ... D ( s ) ,

(3.5)

where the Neumann expansion has been used. This expansion is valid as
long as the numerical values of all characteristic roots of H are less than
unity. For assembly systems, in which H is triangular with zeros along
its main diagonal and above, this is indeed so. The expansion will
converge in at most N terms, where N is the dimension of H.
24

Assuming only one end product at the top level, we have

D1

 (s) = 0 ,
D
#

0

(3.6)

and minimum cumulative requirements become

I H 1 D / s = I + H + H 2 + H 3 + ... D / s
) 1
( ) ( )
(

col 1 1
col 1

(3.7)

The triangular nature of H for an assembly system creates the following

first elements
I H 1
) D1 / s = D1 / s
(
row1
(3.8)
I H 1
(
) D1 / s = e s1 H 21D1 / s

row 2

(3.9)

I H 1
(
) D1 / s = e s1 H13 + H 32 H 21e s 2 D1 / s

row 3
(3.10)
I H 1
(
) D1 / s

row 4

= e s1 H14 + H 42 H 21e s 2 + H 43 H 31e s 3 + H 43 H 32 H 21e s ( 2 + 3 ) D1 / s (3.11)

This reveals that requirements occur at times in advance of external
demand in such a way that steps are generated sums of lead times ahead
of top-level requirements. The further down in the product structure tree,
the more opportunities for additional steps exist. For instance, on level 4,
if all relevant H ij are non-zero, then, generated by an external demand

25

event at t , items will be required at the points in time t 1 , t 1 2 ,

t 1 3 , and t 1 2 3 , whereas on level 3, items may be required
only at t 1 and t 1 2 . The total number of possible times
increases geometrically, but all need not exist. One may also note that all
possible times at a higher level are repeated again at all lower levels.
Therefore the set of possible times for the entire system can be found by
studying the lowest level in the system. But zeros in the matrix below the
diagonal will rule out some combinations.
A sequence of external demand events together with the set of lead times
will thus generate a sequence of possible internal demand events. On
levels above the lowest level, the sequence will be a subset of the
sequence at the bottom level. Certain points in time may be covered
more than once at least two reasons, (i) if external demand includes
events at distances equal to combinations of lead times, and (ii) if
combinations of lead times happen to be equal (such as if 2 were equal
to 3 above).

Figure 3.2. Cumulative requirements as a staircase.

In total, we can therefore regard cumulative requirements on any level
(including the top level) to be made up of a staircase of steps occurring at
the times t0 , t1 , t2 , , of which several steps may have a zero height.

26

These requirements are given by


( s ) = H ( s )P ( s ) + D
 /s,
D

(3.12)

for a general production policy, and in the general L4L case by (see
Section 3.2.1 below)

 /s
( s ) = ( I H ( s ) )1 D
D

(3.13)

When there is only one end item in the L4L case, we have

( s ) = ( I H ( s ) )1 D / s
D

col 1 1
The staircase is illustrated in Figure 3.2 for an individual item.

(3.14)

3.2 Time Development of Production for Basic

Ordering Policies
3.2.1 Lot-For-Lot (L4L) policy

Figure 3.3. The Lot-for-Lot Policy. Production of an item (thick

staircase) follows exactly total requirements (sum of independent and
dependent demand, thin staircase).
27

In the L4L case, with zero initial available inventory R(0) = 0, the
solution is perfectly simple, also in the multi-item case with non-zero
lead times. It is then just a matter of keeping available inventory at a zero
level. This means



 ( s ) = R (0) + ( I H ( s ) ) P( s ) D( s ) = 0 ,
R
s

(3.15)

from which production is determined as

1
( s) ,
 (s) = D
P ( s ) = ( I H ( s ) ) D

(3.16)

as is illustrated in Figure 3.3. If there are non-zero initial available

inventories, the expression needs to be adjusted slightly.
3.2.2 Fixed Order Quantity (FOQ) case
A fixed order quantity policy may be specified for any item in an MRP
system. However, in practice it would be applicable to items with
ordering cost sufficiently high to rule out ordering in net requirement
quantities, period by period. The replenishments occur as available
inventory approaches to zero.
With the FOQ policy, having Q as the fixed order size, production for an
individual item will behave according to
n 1

P ( s ) = Q e sTn ,

(3.17)

n =0

where Tn is the time when the nth batch is completed (made available),
see Figure 3.4. These are the variables that need be determined by the
policy. When production is other than L4L, the requirements on lower
levels will depend on production on levels above. This implies, in the
general case, that new sets of possible times of requirement events might
be introduced.

28

Figure 3.4. The Fixed Order Quantity Policy (FOQ). Production of an

item is made in equally-sized batches as late as possible when avoiding
negative available inventory.

Available inventory of this individual item will then be

n 1


R ( s ) = R(0) + Q e sTn D ( s ) s 1 ,
n =0

(3.18)

and the policy is to make all Tn as late as possible without causing R(t)
to become negative.

3.2.3 Fixed Period Requirements (FPR) case

Under the FPR policy, the ordering interval is constant and the quantities
are allowed to vary. Production of a certain item will thus obey
n 1

P ( s ) = Qn e snT

(3.19)

n =0

29

where T denotes the constant time interval between orders and Qn is the
batch size at time Tn = nT . The FPR policy is demonstrated in
Figure 3.5.

Figure 3.5. The Fixed Period Requirements Policy (FPR). Production of

an item is made in as small batches as possible to cover future
requirements during a constant period, without creating a negative
available inventory.
The FPR policy requires the Qn to be made as small as possible without
violating the non-negativity condition for available inventory. This
implies that available inventory is likely to take on a zero value during
finite time intervals, which is not the case, other than by chance (or at the
end), with the FOQ policy, as seen when comparing Figures 3.4 and 3.5.

3.3 Solutions to Non-Negativity Conditions for

Available Inventory with Requirements as Discrete
Events
As shown above, the L4L policy provides an immediate explicit
expression for the production on all levels. For the other two policies,
this is not equally simple.

30

In the FOQ case we need to solve for the latest as possible batch times
T0 , T1 , T2 , , such that available inventory R(t) is kept non-negative.
The solution in the time domain is simple for the individual item, given
(t ) at the times when there are steps t , t , t ,
the requirements D
0

Examining,
for
successive
values
of
n,
arg max D (ti 1 ) nQ < D (ti ) 0 , there will be a unique index i
ti

assigned to each n, which we denote in . So, Tn = tin will be the latest

time that batch n can be produced. Hence, the solution to the FOQ
production staircase is:
n 1

sT
P ( s ) = Q e in / s .

(3.20)

n =0

In the FPR case instead, we need to solve for the smallest possible batch
size at times 0, T, 2T, , not violating the non-negativity of available
inventory. The sequence of batches Qn generated by
n 1

Qn = D (( n + 1)T ) Qi ,

(3.21)

i =0

or, equivalently,
Qn = D (( n + 1)T ) D ( nT ) ,

(3.22)

for successive values of n = 0, 1, 2, , will uniquely determine the

production staircase satisfying the conditions. Hence, the production
staircase becomes:
n 1

P ( s ) = D (( n + 1)T ) D (nT ) e snT / s .

n =0

(3.23)

Until now, we have investigated consequences of the non-negativity

requirements in the time domain.
31

A corresponding set of non-negativity conditions in the frequency

domain is given in Feller (1971) as the following provisions. If a time
function f (t ) having the transform f ( s ) is non-negative in the time
domain, then the following property must hold

( 1)

d j f ( s )
j
= ( 1) f ( j ) ( s ) 0 ,
j
ds

(3.24)

for all integers j > 0 and all real s.

In our case, we are looking at available inventories which for the FOQ
policy are given by (assuming initial available inventory to be zero)
n 1

R (t ) = 1 R ( s ) = 1 Q e sTn D ( s) s 1 =

n = 0

n 1
= 1 Q e sTn D (tl ) D (tl 1 ) e stl
l =1
n = 0

s 1 0

(3.25)

Choosing the situation for the interval of the ith requirements step and
mth batch, and writing
m 1

f ( s ) = Q e sTn D (tl ) D (tl 1 ) e stl ,

n =0
l =1

(3.26)

g ( s ) = s 1 ,

(3.27)

we apply Eulers formula

f ( s ) g ( s )

( j)

j
j
= f ( s )( k ) g ( s)( j k )
k =0 k

(3.28)

to Eq. (3.26). Differentiating f ( s ) and g ( s ) the number of times

required, we obtain

32

m 1

n=0

l =1

k
k
f ( s )( k ) = Q ( Tn ) e sTn ( tl ) D (tl ) D (tl 1 ) e stl ,

(3.29)

g ( s ) j k = (1) j k ( j k )!s 1 j + k ,

(3.30)

and thus

( 1)

f ( s ) g ( s )

( j)

= ( 1)

j!

k !( j k )! f (s)

(k )

g ( s )( j k ) =

k =0

k
j
i
j ! m 1 sTn j ( sTn )
(t ) D (t ) e stl ( stl )

Q
e
D

l
l 1
k!
s j +1 n =0
k!
k =0
l =1
k =0

j!
j +1 mQ D (tl ) 0 ,
s
k

(3.31)

for large values of j. This again provides the result in (3.20).

3.4 Solutions to Non-Negativity Conditions for

Available Inventory with Requirements as
Continuous Events
In cases when the cumulative requirements are assumed to be a
continuous time function given by an analytical expression, we may
apply Cauchys Residue Theorem for solving for production in the FOQ
and FPR policy cases. A residue is the coefficient of the first negative
power in a Laurent expansion around a pole, i. e. where the numerator of
an expression evaluates to zero.
For the FOQ policy, we need to solve for the points in time when
available inventory drops to zero.

R (t ) = R ( s )

n 1

= Q e sTn D ( s ) s 1 .

n = 0

33

(3.32)

Assuming zero initial inventories and writing the Laurent expansion of


D ( s ) as


D ( s ) =

ds

j =

(3.33)

for the nth batch, we have

R (t ) =

1 + i
wt

nQ / w D( w) e dw ,

w
=

2 i

(3.34)

which evaluated by the Residue Theorem will be


1 + i

nQ / w D ( w) e wt dw =

w
i
2 i

nQ
= Res
D ( w)e wt =

w=0
w residues

( wt ) k
= nQ d j w j
= 0.
k!
residues j =
k =0
R (t ) =

(3.35)

As an example, when requirements increase linearly and cumulative

requirements therefore increase quadratically, cumulative requirements

behave according to D ( s ) = as 3 ,
where a is the slope of the linearly increasing requirements. Then, the
Laurent expansion collapses into

d w

j =

= aw3 ,

(3.36)

with the only non-zero coefficient d 3 = a . In this case, the only pole is
at w = 0, so

34

( wt ) k
( wt ) k
Res d j w j
= Res aw3

w=0
k ! w=0
k!
k =0
k =0
j =

2
= at / 2! ,

(3.37)

and
R (T ) = nQ aT 2 / 2 = 0 .

(3.38)

The time of the nth batch will be T = 2nQ / a . Hence, cumulative

production in the FOQ case will follow
P ( s ) = Q e s

2 nQ / a

/s.

(3.39)

In the FPR case instead, production has the structure

n 1

P ( s ) = Qn e snT ,

(3.40)

n =0

and available inventory will be

R (t ) = R ( s )

n 1

= Qn e snT D ( s ) s 1 .

n = 0

(3.41)

At the end of the nth step of the production staircase (at t = nT), we have
R (nT ) =


1 + i n 1

Qm / w D ( w) e wnT dw ,

w
i

2 i
m=0

which evaluated by the Residue Theorem will be

R (nT ) =


1 + i n 1

Qm / w D ( w) e wnT dw =

w
i

2 i
m=0

n 1

= Res Qm / w D ( w)e wnT =

w=0

m=0
residues
35

(3.42)

n 1

= Qm
m=0

( wt ) k
j
d
w
= 0.

j
k!
residues j =
k =0

(3.43)

In the quadratically increasing requirement case with cumulative

requirements D ( s ) = as 3 , we thus obtain

n 1

( wnT ) 2
R (nT ) = Qm Res d 3 w3
w=0
2!
m=0

n 1
( nT ) 2
= Qm a
=0.
2!
m=0

(3.44)

The size of the nth batch is therefore

( (n + 1)T ) ( nT )
2

Qn = a

= ( n + 1/ 2 ) aT 2 ,

(3.45)

and the cumulative production staircase becomes:

n 1

n 1

n =0

n =0

P ( s ) = Qn e snT = aT 2 ( n + 1/ 2 ) e snT .

(3.46)

3.5 Optimal FOQ and Optimal FPR when External

Demand is Stochastic
We now assume that external demand is a stochastic process D(t) of the
renewal type, i.e.
D (t ) =

j =1

k =1

(t k ) ,

(3.47)

which is made up of sequence of unit impulses () , i.e. Dirac delta

functions. Here k is the stochastic interval between the (k-1)th and kth

36

demand event, k 0 , k = 1, 2, 3... These are considered stochastically

independent for different values of k.

Let { f (t )} = f ( s ) be the Laplace transform of the probability density

function of any individual k . From Grubbstrm (1996), we then obtain
the probability of demand during any given interval t to have the value:
Q

Pr(

k =1

= t )dt = 1 f Q ( s ) dt .

(3.48)

The transform of expected cumulative demand is therefore

1
E( D ( s )) =
s

j
j =0

1 f
.
f j (1 f ) =
s 1 f

(3.49)

Assuming a zero safety stock, the FOQ policy implies that Q is ordered
at Ti +1 , whenever Q D(Ti +1 ) D (Ti ) .
Total production will now have the transform;
P ( s ) = Q

sTi

= Q + Qe sT1 + Qe sT1 sT2 + Qe sT1 sT2 sT3 + ... .

(3.50)

i =0

Because the Ti are independent, we may drop the index i:

E e

sT j

= E e sTk = E e sT .

(3.51)

We also have
E e sT =

T =0

Pr(

= T )e sT dT =

k =1

37

{ f (s) }
1

e sT dT = f ( s )Q ,

T =0

(3.52)

so that expected total production obeys:

E P ( s ) = Q 1+E e sT1 + E e sT1 E e sT2 + ...

Q
Q
=
=
.
Q
sT
1 E e 1 f ( s )

)
(3.53)

Let (t ) denote the setup frequency (Molinder, 1996, p. 41),

(t ) = t T j ,
i =0

j =0

(3.54)

where ( ) again denotes the Dirac delta function. Then we have the
expected setup frequency:
E [ ( s ) ] =

1
1
=
.
Q
sT

1 E e 1 f ( s )

(3.55)

By multiplying E P ( s ) by s and taking the limit s 0 , we obtain the

long-term average of production:

sQ
Q
= lim
.
Q


s 0 1 f ( s )
s 0 f ( s )Qf ( s )Q 1

Paverage = lim s E P ( s ) = lim

s 0

(3.56)

But from the moment generating property of the transform (Grubbstrm

and Tang, 2006), we also have
f (0) = 1,

38

f (0) = lim f ( s ) = lim

s 0

f (0) = lim
s 0

s 0

(t ) f (t )e

st

t =0

= E j = ,

( t )

f (t )e st = 2 + 2 ,

t =0

where and 2 are the mean value and variance of respectively.

Then, the average production and setup frequency may be written:
Paverage =

(3.57)

average = lim s E [ ( s )] =
s 0

1
.
Q

(3.58)

Assuming the net present value (NPV) of out payments to be minimised,

we investigate the optimal value of Q = FOQ . The NPV of the cash
flow can be written:
cQ + K
cQ + K
=
=
NPV= cE P ( s ) + KE [ ( s ) ]
,

s = 1 E e T 1 f ( )Q

(3.59)

where c is unit production cost and K is setup cost. On differentiating

NPV with respect to Q we obtain

( cQ + K ) f ( )Q ln f ( ) =
NPV
c
+
=
2
Q
1 f ( )Q
1 f ( )Q
=

c 1 f ( )Q + ( cQ + K ) f ( )Q ln f ( )

(1 f ( ) )
Q

39

=0.

(3.60)

which is the necessary optimisation condition. Using a second-order

approximation of f ( ) provides us with the following optimal order
quantity:
EOQ =

2 KDaverage
2K
=
,
c
c

(3.61)

which has the standard format.

Instead, in the fixed period requirement (FPR) case, the quantity
Qn = D(tn + T ) D(tn ) is ordered at the beginning of each interval of
length T.
Expected production will then be:

E P ( s ) = E ( D(tn + T ) D(tn ) ) e stn =

n =0

T
1
.
= E D(T ) 1 + e sT + e s 2T + ... =
1 e sT

(3.62)

Average production is obtained as:

Paverage = lim s E P ( s ) = lim
s 0

s 0

sT

1
T
1
=
,
=
sT
sT
1 e

Te

(3.63)

and the average setup frequency

s
1
= .

sT
s 0 1 e
T

average = lim s E [ ( s) ] = lim

s 0

(3.64)

The net present value of the cash flow will be:

T
1
K
=c
+
.
NPV= cE P ( s ) + KE [ ( s ) ]
T

s=
1 e
1 e T
40

(3.65)

To find the optimum interval T, we take the derivative of NPV with

respect to T:
c
NPV
=
T

(1 e

T e T K e T

(1 e )
T

=0.

(3.66)

Using again a second-order approximation of e T , the following

optimal interval is obtained:
T* =

2 K
=
c

2K
.
cDaverage

(3.67)

This shows that in both of the cases FOQ and FPR, the optimal policies
are obtained as when using the traditional average inventory approach
with the inventory holding cost interpreted as c , i.e. interest rate times
unit production cost.

3.6 Summary
The objective of this chapter has been to analyse the previously
developed fundamental equations of MRP Theory concerning the basic
ordering policies Lot-For-Lot (L4L), Fixed Order Quantity (FOQ) and
Fixed Period Requirements (FPR). Our aim has been to find closed-form
Laplace transform expressions for the time development of production,
when given external demand. When leaving the L4L policy, it is shown
that the expressions are possible to derive, but they become considerably
more complicated.

41

42

A HEURISTIC METHOD FOR THE

CAPACITY CONSTRAINED PROBLEM
WITH NON-ZERO LEAD TIMES

This chapter extends Grubbstrm and Wang (2003) by proposing a

heuristic method to solve the case when lead times are non-zero. The
model is stochastic demand and the lead times are assumed to be
constant. The model is treated in a discrete time framework.
As before, and in several other publications, the Laplace transform
together with Input-Output Analysis are employed as tools for modelling
the production-inventory system. This approach has been successfully
used for formulating a theoretical base for Material Requirements
Planning (MRP). The use of the transform in this chapter is limited to
formulating the objective and constraint functions, but the method, as
such, operates in the time domain.
The objective function is chosen as in Grubbstrm (1999), and we now
search for the optimum solution. The results are decisions concerning the
produced amounts and production timing. The objective is to maximise
the net present value (NPV) of the cash flow associated with production
and demand.

4.1 Problem Formulation

In continuous time, the objective function to be maximised is suggested
in Grubbstrm (1999)

 ( )) E(B ( )) E(B (T ))e T c ( ) K ( ), (4.1)

E(NPV) = r E( D

subject to capacity constraints

{}

 ,
  1 C
1 HP

(4.2)

43

where, as before, H is the part of the input matrix capturing

capacity requirements and C is the transform of capacities

available.
Available inventory is non-negative

 (s) 0 .
1 R

(4.3)

In discrete time instead, Grubbstrm and Wang (2003) have presented

the objective function
T

E ( NPV ) =
n =1

i =1

ri E

(D (B
in

in

Bi ( n 1) )

e n

(ci Pin + K i in ) + wk ckn e stn ,

k =1

n =1 i =1
s=
T

(4.4)

and suggested the available inventory in discrete time to be written

 =
R

1
 ,
 = R 0 + (I H)P
R + (I H)P
  D
  D
s 0
1 e s
1 e

(4.5)

where is the length of the discrete period, since for our discrete
process we have cumulative production P = P / 1 e s and and

 =D
 / 1 e s , and where R is the vector of
cumulative demand D
0

initial available inventory.

The capacity constraints (4.2) are reformulated as:

  Cn (t n ) ,
1 HP

(4.6)

where () is the Dirac impulse function.

44

4.2 Heuristic Method

The procedure we propose to use follows Frana et al (1996). This is a
heuristic method for finding the best solution for the production quantity
of each item in each period. The method involves four procedures, of
which the first is finding a starting solution. The three others are named
Moving, Reduction and Improvement and are explained after the
outline of the algorithm is described.
We introduce some additional notation:
m = iteration counter
S[m] = set of solution variables obtained at iteration m
NPV(S[m]) = expected net present value of S[m]
mmax = maximum number of iterations of the heuristic.
S* = incumbent solution.
We have the pseudo-code:
m=0
S[m] = starting solution

{procedure P1}

For m = 1 to mmax
If S[m] is infeasible then
S[m] = Moving
{procedure P2}
If S[m] is still infeasible then
{procedure P3}
S[m] = Reduction
End If
End If
If S[m] is feasible then
{procedure P4}
S[m] = Improvement
If NPV (S[m]) > NPV (S*) then S* = S[m]
End If
Next m.
The four procedures are explained in the following sections.

45

4.2.1 Starting Point

The starting solution is the solution for the uncapacitated problem which
is obtained by optimising (4.4) by dynamic programming as WagnerWhitin algorithm applied to each component of the product structure.
First, the algorithm is applied to the end item which has only external
demand. Next, the algorithm is applied to lower-level items which have
both internal and external demand. The results are the production
quantities of each item at each period.
If such a solution is capacity feasible, then procedure P4 (Improvement)
is called, otherwise, the Moving procedure P2 is applied.

4.2.2 Moving Procedure

If procedure P1 yields a capacity infeasible solution and total capacity
requirements is smaller than total available capacity, then the Moving
procedure P2 tries to find a feasible solution by moving production from
an infeasible period to some other period.
The period is infeasible if a capacity requirement exceeds capacity
available.
Given an infeasible period t, an attempt is made to transfer a production
quantity qi , t + i of the production Pi , t + i of component i in period

t + i to another period tl + i . For each component i that is produced in

an infeasible period t + i , two alternative quantities are considered for
possibly being moved to period tl + i :
(i) Wi , tl + i = the maximum quantity of the production Pi , t + i that ensures
that the available inventory constraints still are satisfied.
(ii) Qi , t + i ,k =

the exact quantity of the production Pi , t + i which

eliminates the overload of resource k in period t.

46

Qi , t + i ,k =

h P
jk

j =1

j ( t + i )

Ckt / hjk ,

(4.7)

where a + = max {a,0} .

The amount Qi , t ,k indicates if there is a quantity less than Wi , tl + i which
can reduce the overuse of resource k in period t to zero.
We define the moving quantity as follows

qi , t + i = Qi , t + i , k , Wi , tl + i

(4.8)

where {a, b} = min {a, b} .

Backward shifts
Production shifts from period t = T, T - 1, ..., 2 are analysed. Portions of
production, which affect an infeasible period t, are moved to earlier
periods until period t becomes feasible. If, after having repeated these
moves, period 1 is feasible, then we have a feasible solution.
For a given infeasible period t, we consider moving a quantity qi , t + i of
the production Pi , t + i of each item i from period t + i to earlier target
periods tl + i . These periods are such that tl + i t + i 1 , where
= max {1, the latest period in which there is production of item i prior
to period t}.
The inventory constraint shows that if qi , t + i is moved from period t + i
to earlier periods tl + i , then the available inventory Rij, j =

tl + i , ... , t 1 will increase by an amount qi , t + i . We must ensure that

the constraints (4.3) are satisfied after such a move:

47

Pi (tl +ti ) hij P j (tl + j ) 0

(4.9)

j =1

Thus, we have
N

qi , t + i Wi , tl = min Pi (tl +ti ) hij P j (tl + j ) , Pi , t + i

j =1

(4.10)

The choice of quantity, item, and target period ( q, i, tl + i ) is based on

a ratio test, (described below), which takes into account the NPV
variation and the use of resources, if the quantity qi , t + i were moved to

tl + i .
If, after these moves, period 1 is still infeasible, then we apply a step
consisting of forward shifts. Otherwise, an improvement step is
considered.
Forward shifts
Production shifts from periods t = 1, 2, , T - 1 are considered in that
order. Portions of the production which affect an infeasible t are moved
from period t + i to later target periods tl + i . For a given infeasible
period t, we consider moving a quantity qi , t + i of the production Pi , t + i
of each item i to later target periods tl + i . These periods are such that

t + i + 1 tl + i , where = min {T, the first period in which there

is production of item i after period t}.
The moving procedure must ensure that the inventory constraints are
satisfied as mentioned above.

48

Ratio test
This test is used to choose the quantity, item and target period
( q, i, tl + i ) , i.e., the quantity qi , t +i of the production Pi , t + i of item i
in period t + i to target periods tl + i .
chosen for smallest ratio test:

Ratio 1(t ) =

The triple

NPV Decrease Value + Penalty(t )

Excess Capacity Reduction

( q, i, tl + i )

is

(4.11)

The term Penalty(t) and its factor are defined in (4.16) and below.
The NPV Decrease Value is the ratio between the change in NPV and
total NPV, where the change in NPV is the NPV variation caused
shifting quantity qi , t + i from period t + i to periods tl + i .
The expression for NPV follows (4.4). When we move amount qi , t + i in
period t + i to target periods tl + i , the cumulative production changes
from E(Pt + i ) to E(Ptl + i ) by an amount qi , t + i . It causes a decrease of
the net present value NPV:

NPV = NPVbefore moving NPVafter moving ,

which is calculated as:

49

 E ( ( D
t + i

NPV = r

n =tl +

in

((

+r

n = tl + i +1

ci q + K i i1 + wk ckt e t
k =1

r E Di (tl + i ) ( Pi (tl + i ) + q )

t + i 1

Pin ) ( Di ( n 1) Pi ( n 1) ) e n

) (D

((

E Di (tl + i ) ( Pi (tl + i ) + q )

((

+ r E Di (t + i ) ( Pi ( t + i ) q )

Pi (tl + i )

i ( tl + i )

) (D

) (D

i ( t + 1)

i ( n 1)

)e

( tl + i )

( Pi ( n 1) + q ) ) e n

( Pi (tl + i 1) + q )

)e

( t + i )

ci q + K i i 2 + wk ckt e tl ,
k =1

(4.12)
with

1, if qit = Pit ,

i1 =

(4.13)

0, otherwise,
1, if Pi tl = 0,

and i 2 =

(4.14)

0, otherwise.

When the amount qi , t + i is moved from period t + i to periods tl + i ,

there will be a variation in the use of the resource in such a period. Let,
N

Ckt
h P
K kj j ( t + j )
j =1

Excess(t ) =

Ckt
k =1

50

(4.15)

denote the proportion of overuse of the resource in period t. The Penalty

term in (4.11) considers the variation of the use of resources caused by
the quantity qi , t + i being moved from period t + i to periods tl + i .
Defining as:

Penalty = Excess after (t ) + [ Excess after (tl ) Excess before (tl ) ] ,

(4.16)
where

Excess after (t ) = Excess (t ) after the move ,

Excess before (t ) = Excess (t ) before the move ,
and,

Excess Capacity Reduction = Excess before (t ) Excess after (t ) .

Let a cycle denotes a sequence of a backward step and a forward step in
the moving procedure. In the first cycles, we set = 1 . If a feasible is
not found in the first cycle, we consider a second cycle with = 2 . In
general, in cycle n, we set = n . The increase of the factor at each
cycle reflects a greater importance to the overuse of a resource. The
maximum number of cycles is specified. If this number is reached and a
feasible solution not found, then we change to the Reduction procedure
P3.
If the solution P2 is infeasible, then the external demand cannot be
satisfied. Because backlogs are allowed for end items, we can reduce a
production amount of end items. We now turn to the Reduction
procedure.

4.2.3 Reduction Procedure

For a given infeasible period t, we consider reducing a quantity qi , t + i of
the production Pi , t + i of each item i at period t + i . The reducing
51

amount qi , t + i is defined as in (4.8). We choose the item and target

period ( q, i, tl + i ) , by applying a smallest second ratio test:

NPV Decrease
Excess Capacity Reduction

Ratio 2 (t ) =

(4.17)

with NPV Decrease defined by:

NPV = NPVbefore reduction NPVafter reduction ,

calculated by
NPV = r

E ( ( D
T

n = tl +

in

((

n = tl + i +1

ci q + K i i1 + wk ckt e t
k =1

Di ( t + i ) ( Pi ( t + i ) q)
r E

Pin ) ( Di ( n 1) Pi ( n 1) ) e n

(( D

i ( tl + i )

) (D

i ( t + 1)

( Pi ( tl + i +1) q)

Pi ( tl + i 1)

) (D

i ( n 1)

)e

( t + i )

( Pi ( n 1) q ) ) e n .

(4.18)

After the reduction procedure, if all periods are feasible, we have a

feasible solution and we turn to the improvement procedure P4.
Otherwise, we conclude that the model is infeasible.
4.2.4 Improvement Procedure
Starting from a feasible solution this procedure tries to find a lower cost
by moving production to earlier or later periods. The procedure is similar
to the moving procedure, also has a backward and a forward step.
However, we allow only feasible and improving moves. That means the
moving neither causes any capacity restriction to be violated, nor any
decrease of the NPV.
52

The procedure ends, when no improved solution which is feasible, can

be found.

4.3 Numerical Examples

A

1* B

1* C

2* X
1*

1* X

2* X

Figure 4.1. The three-level product structure, one resource requirement

In this section, we provide numerical examples to explain our heuristic
method. Consider the genaral structure as Fig. 4.1 (N = 3) constrained by
one resource (M = 1), over a 10-period planning horizon with the
parameters as in Table 4.1. The lead times of A, B and C are 1, 1 and 0,
respectively.

Planning hoizon T
Interest rate
Demand outcome dL, dH
Outcome probability
Average demand E[DA]
Sale revenue rA
Set up cost KA, KB, KC
Unit production costs cA, cB, cC
Variable capacity cost wX
B

10
0.05
2, 8
0.3, 0.7
6.2
800
50, 50 , 20
100, 50, 50
20

Table 4.1. Parameters of the example

53

Available capacity Cx is constant in each period. We change this level in

different cases of the example.
From figure 4.1, we have input and lead time matrices:

A 0 0 0
A 0 0 0
A e s 0 0
1 0 0

B
,  = B
H = B 1 0 0 ; H = X [1 1 1] , H =
s
0 e 0 .
C 1 0 0

C 0 0 1
C 1 0 0

X 1 1 1
The initial solution is shown in Table 4.2, which was obtained by
applying a dynamic programming method to the uncapacitated model.
T
Item A
Item B
Item C
X

2
0

52

0
26
26
78

3
26
0
0
32

4
0
16
16
48

5
16
0
0
20

6
0
10
10
30

7
10
0
0
28

8
0
14
14
42

9
14
0
0
0

10
0
0
0
0

Table 4.2. Initial solution (infeasible, NPV = 203,487)

The step of moving procedure are show in table 4.3. Firstly, we choose
Cx = 38

t = 10
t=9
t=8

Moving procedure, backward

Excess(t) = 0
Excess(t) = 0
Excess(t) = 0.105.
Consider PA,9, PB,9, PC,8
Item A: PA,9=14, WA,9 = 0, WA,8 = 0, WA,7 = 0, WA,6 = 0, WA,5
= 0, WA,4 = 0, WA,3 = 0, WA,2 = 0.
Hence no production of item A can be transferred to any
previous periods.
Item B: PB,9 = 0.
No production of item B can be transfered to previous periods
item C: PC,8= 14.

54

tl + 0 = 7 WC,7 = 14, QC,8 = 4, q = 4, ratio = 5.929

tl + 0 = 6 WC,6 = 14, QC,8 = 4, q = 4, ratio = 4.935
tl + 0 = 5 WC,5 = 14, QC,8 = 4, q = 4, ratio = 11.488
tl + 0 = 4 WC,4 = 14, QC,8 = 4, q = 4, ratio = 12.139
tl + 0 = 3 WC,3 = 14, QC,8 = 4, q = 4, ratio = 17.990
tl + 0 = 2 WC,2 = 14, QC,8 = 4, q = 4, ratio = 18.166
tl + 0 = 1 WC,1 = 14, QC,8 = 4, q = 4, ratio = 26.170
Hence, we transfer q = 4 of item C from t +0= 8 to tl +0 = 6.
t=7
t=6
t=5
t=4

Excess(t) = 0
Excess(t) = 0
Excess(t) = 0
Excess(t) = 0.026. Consider PA,5, PB,5, PC,4
Item A: PA,5=16, WA,5 = 0, WA,4 = 0, WA,3 = 0, WA,2 = 0.
Hence, no production of item A can be transferred to previous
periods.
Item B: PB,5 = 0.
Hence, no production of item B can be transferred to previous
periods.
Item C: PC,4= 16
tl + 0 = 3 WC,3 = 16, QC,3 = 10, q = 10, ratio = 11.900
tl + 0 = 2 WC,2 = 16, QC,3 = 10, q = 10, ratio = 16.818
tl + 0 = 1 WC,1 = 16, QC,3 = 10, q = 10, ratio = 19.693
We transfer q = 10 of item C from t +0= 4 to tl + 0 = 3.

t=3

Excess(t) = 0.105.
Consider PA,4 , PB,4, PC,3
Item A: PA,4=0.
Item B: PB,4 = 16
tl +1= 3 WB,3 = 16, QC,3 = 4, q = 4, ratio = 15.537
tl +1= 2 WB,2 = 16, QC,3 = 4, q = 4, ratio = 8.749
Item C: PC,3= 0
We transfer q = 4 of item B from t+1 = 4 to tl +1= 2.

t=2

Excess(t) =2.158. Consider PA,3 , PB,3 , PC,2

Item A: PA,3=26, WA,3 = 0, WA,2 = 0

55

Item B: PB,3 = 0
Item C: PC,2 = 30
We transfer q = 30 of item C from t +0 = 2 to tl +0 = 1.

After 6 cycles of backward and forward steps, we obtain a feasible

solution as listed in Table 4.3.
T
Item A
Item B
Item C
X

1
0
0
0
38

2
0
19
19
37

3
9
0
6
38

4
0
16
5
37

5
9
7
26
38

6
6
0
0
38

7
9
10
0
38

8
5
14
10
38

9
14
0
0
28

10
14
0
0
0

Table 4.3. A feasible solution ( NPV = 18,708).

Next, we make some backward and forward cycles to find improvement
solutions. In our case, no new improved solution could be found.
Therefore, we choose the solution from Table 4.3 as a final solution.
The results are shown in Table 4.4 where we compare four levels of
available capacity:

Tight capacity: available capacity Cx = 33

Normal capacity: available capacity Cx = 38
Loose capacity: available capacity Cx = 45
And uncapacitated model.
Uncapacitated
model

NPV
Ratio =NPV/CX
%

20 348
100

Tight
capacity
Cx= 33
16 425
497.73
80.7%

Normal
capacity
Cx= 38
18 708
492.32
91.9%

Loose
capacity
Cx= 45
20 052
445.60
98.5%

Table 4.4. NPV from four levels of available capacity.

56

In Table 4.4, the NPV is compared for cases when the capacity level is
varied from 33 to 45 units of capacity and when model is uncapacitated.

4.4 Conclusion
In this chapter, we have proposed a model for a capacity-constrained
production-inventory system extended with non-zero lead times. The net
present value is employed as the objective function. The solution
procedure applies a heuristic method, which we applied to three-level
product structure.
The results in Table 4.4 show that the NPV increases, when the available
capacity increases, but with a small degressive element showing
"diminishing returns to scale" (Table 4.4 and Figure 4.2).
800

NPV

20000

Ratio

NPV
18000

700

16000
600

14000
12000

Ratio

10000

500

8000
400
6000
4000

300

2000
0
32

34

36

38

40

42

44

200
46

Capacity

Figure 4.2. NPV and NPV over Capacity as Functions of Capacity

57

58

CAPACITATED PRODUCTIONINVENTORY SYSTEMS IN DISCRETE

TIME WITH NON-ZERO LEAD TIMES

This chapter deals with the non-zero lead time problem. The
developments are presented within a discrete time framework. Lead
times are assumed to be given constants and the Net Present Value
Principle is applied.
In some previous papers (Segerstedt (1996), Grubbstrm and Wang
(2003)), although the theory developed concerned situations in which the
lead times could be any non zero constants, in order to design an
analytical solution procedure, the assumption was made that lead times
were zero, in order to be able to apply dynamic programming.
Cumulative production and cumulative demand were taken as state
variables.
In this chapter, we remain in the discrete time framework and develop a
methodology for the case that lead times are non zero, whereas demand
is deterministic. Our emphasis is on the design of the state space, the
properties of which depend on the product structures (the input matrix),
the distribution of lead times among the production processes (the lead
time matrix), and on the historical sequences of the production vectors.
We also now apply a dynamic programming procedure in order to solve
the non-zero lead time problem. The objective is to choose the best
production plan maximising the net present value of the cash flow
associated with production and demand. We thus extend the treatment
from Grubbstrm and Wang (2003) in one dimension, at the same time
limiting our attention to deterministic demand situations.
The main novelty in this chapter is the design of the state space
necessary to handle arbitrary non-zero lead times. Whereas cumulative
production of all items, at the point when production decisions were to
be taken, could be used in the zero-lead time solution procedure as a
state description, we now extend the state space to include a sequence of
prior cumulative production vectors. This sequence has a sufficient
59

number of elements to cover all opportunities that decisions might have

had to limit future opportunities and affect the economic outcome. This
chapter is based on Grubbstrm and Huynh (2006). However, the
example in Section 5.3 is more extensive (four levels) as compared to
the example included in Grubbstrm and Huynh (2006) (three levels).

5.1 Assumptions and Notation

We consider a complex production-inventory system operating within a
discrete finite time horizon T. The following assumptions are made:

Demand is deterministic and assumed to take place at discrete

points in time.
Production of all items concerned take place in batches of
arbitrary size at the same discrete points in time.
For each item, external demand is deterministic
No backlogs are allowed for internal demand.
For externally demanded items, backorders are allowed and are
satisfied whenever a replenishment takes place.
Capacity constraints are assumed to be of the momentary kind,
meaning that capacity may neither be borrowed, nor lent,
between different periods, see Grubbstrm and Wang (2000b).
Only assembly-type product structures are considered.
No setup times are considered

In addition to the notation previously introduced in Section 2.3, the

following symbols are introduced:

lead time for the production of item i,

maximum lead time of all items,

w i

variable cost for each unit of item i to use capacity resources

determined by the requirements H , collected in the row
, w
= wH ,
vector w
available capacity of resource k in period n, collected in a
column vector Cn ,

Ckn

60

ckn
Wn
Q n 1

amount of capacity of resource k used in period n, collected in

a column vector c n ,
maximum expected NPV contributed from stage n onwards,
when all subsequent decisions are chosen optimally,
state array immediately prior to production decisions at stage n.

5.2 Basic Model

In the capacity-constrained multi-level production-inventory problem
treated in this paper, non-zero lead times are considered. The decision
variables are Pin , i =1, 2, ... , N, n =1, 2, ... ,.T. However, since, at time n,
previous cumulative production Pn 1 is known, we might equally well
choose the elements of current cumulative production Pn = Pn 1 + Pn as
decision variables.
Our objective is to maximise the net present value of the total cash flow
involved, subject to non-negative available inventory constraints and to
limits on the available capacities of different resources.
The cash flow is generated by a cash-inflow and a cash-outflow. The
cash-outflow is calculated from the production costs for all items and the
cash-inflow from the sales revenues of products (as in Grubbstrm and
Wang (2003)).
The NPV of the cash-outflow is thus obtained as
M
T N

NPVproduction = ( ci Pin + K i in ) + wk ckn e stn

k =1

n =1 i =1
s=

and the NPV of the cash-inflow as

NPVsales = ri Din ( Bin Bi ( n 1) )

T

n =1 i =1

61

e n

(5.1)

 (1 e s ) B B e s (T +1)
= r D
T
s= ,

(5.2)

where the deferred revenues due to backlogs are taken care of. This
provides the objective function:
NPV = NPVsales + NPVproduction .

(5.3)

Our choice of solution procedure is dynamic programming. Since the lot

sizes are possible to choose arbitrarily, there is never more than one setup of a particular item in any period.
As pointed out above, the decision variables in period n are chosen as
cumulative production Pn .
In order to define our state space, we introduce the symbol for the
maximum of all production lead times:

= Max ( i ) .

(5.4)

We then define the array Q n 1 as a sequence of previous cumulative

production vectors:

P1( n ) P1( n +1) .... P1( n 1)

P2( n ) P2( n +1) .... P2( n 1)

Q n 1 =
#

PN ( n ) PN ( n +1) .... PN ( n 1)

(5.5)

This array represents the state prior to taking the nth production decision
Pn . The transition from state Q n 1 to state Q n may then conveniently be
written:

62

 P1( n ) P1( n +1) .... P1( n 1) 0 0 ... 0 0 0 ... P1n

P2( n ) P2( n +1) .... P2( n 1) 1 0 ... 0 0 0 ... P2 n

+
,
Qn =

#
#
.... #

0 1 0 0 0 ... PNn
PN ( n ) PN ( n +1) .... PN ( n 1) 

 
Q n1

square matrix (,

(5.6)

N rows, columns

0 0 ... 0
1 0 ... 0
,
where the post-multiplication by the ( )-matrix
#
....

0 1 0
having unit elements in the diagonal below the main diagonal, moves the
columns in Q n 1 one step to the left, discarding the left-most column and
emptying the right-most column to be filled with Pn in the summation.
Using this formula for the transition from Q n 1 to Q n shows the
transition to be dependent on the current decision variables Pin alone,
making the transition equation suitable for dynamic programming.
The available inventory constraints are written:

{ }

 0,
1 R

(5.7)

with
1
 = R 0 + (I H)P
 ,
R + (I H)P
  D
  D
(5.8)
s 0
1 e s
1 e
since for our discrete process we have P = P / 1 e s
and
 =
R

 =D
 / 1 e s , and where R is the vector of initial available
D
0
inventory.
The capacity constraints are formulated as:

63

  Cn (t n) ,
1 HP

(5.9)

  (during
which are interpreted as internal demand for resources HP
any period) being limited to available given capacity levels collected in
  is the inverse transform of HP
 .
the vector Cn , and where 1 HP

The comparison in (6.9) is interpreted as a comparison of the coefficients

of the impulses. As shown in Grubbstrm and Wang (2000), all
constraints (available inventory as well as capacity) may be collected
 0 by extending R with M additional
into a single relation R = 1 R
n

{ }

rows in a suitable way.

We let NPVn be the contribution to the NPV from the nth stage, when
given Q n 1 . Furthermore, let Wn be the maximum NPV contributed from
stage n onwards, when all subsequent decisions are chosen optimally.
Adopting the NPV as our objective function, thus leads us to the
recursive equation:
Wn (Q n 1 ) = Max [ NPVn + Wn +1 (Q n )]

(5.10)

Pn , R n 0

where NPVn depends on the given Q n1 and the decision Pn :

NPVn = ri Din ( Bin Bi ( n 1) ) e n

N

i =1

M
N

ci + w ki e s i ( Pin Pi ( n 1) ) + K i vin
k =1

i =1

+ e n ,

(5.11)

with
1, if Pin > Pi ( n 1) ,
vin =
0, if Pin = Pi ( n 1) .

(5.12)

Since the process ends after stage T, we have WT +1 = 0 , and therefore:

64

WT (QT 1 ) = Max NPVT .

(5.13)

PT , RT 0

Working backwards in time, at each stage determining an argument Pn

that maximises NPVn + Wn +1 (Q n ) , given the state Q n 1 , provides us
with the optimum policy:
Pn* = Pn (Q n 1 ) .

(5.14)

If we depart from the initial situation Q 0 , we thus choose the following

optimal production plan constituted by a sequence of decisions obeying
this policy:
P1 (Q 0 ) , P2 (Q1 ) , ..., PT (QT 1 ) .

(5.15)

Since we are dealing with processes constrained by capacity limitations,

the choice of decision Pn is restricted by available capacity (5.9), this
having an impact on the set of available opportunities to choose from.

5.3 Numerical Examples

In this section, we provide a few numerical examples to explain and
illustrate our basic model in Section 5.2. Consider the four-level product
structure shown in Figure 5.1.
With A, B and C being items and X a resource with limited momentary
capacity, the input matrices and the lead time matrix will be the
following:
A 0 0 0
H = E 1 0 0 ,
C 1 1 0

A 1 0 0

2s
H = X [ 2 1 1] ,  = B 0 e 0 ,
C 0 0 e s

assuming that the top-level item A has a zero lead time, item B has a lead
time of two periods and that item C has a lead time of one period.
65

1* B

1* C

2* X

1* X
1*

1*

1*

Figure 5.1. Four-level product structure with one type of capacity

requirement.
A computer program was developed to solve the recursive equations
(5.10) with parameters given values according to Table 5.1. On the one
hand, available capacity was varied between three constant levels, on the
other, a separate run with varying demand was carried out. When solving
the dynamic programming recursion, a complete enumeration procedure
for integral values of the feasible production volumes was used.

planning horizon (time periods) T

initial inventory RA0 , RB0 , RC0
interest rate per time period
demand outcomes DA
sales revenue rA
set-up costs K A , K B , K C
unit production costs cA , cB , cC
variable capacity cost wX
variable product capacity costs w A , w B , w C

10
0, 6, 3
0.05
3
1000
50, 50, 50
100, 50,50
20
40, 20, 20

Table 5.1. Parameter values for the numerical examples

66

Item
n=0 n=1 n=2 n=3 n=4 n=5 n=6 n=7 n=8 n=9 n=10
A External
3 3
3
3
3
3
3
3
3
3
demand
3 6
9 12 15 18 21 24 27 30
Cumulative
demand
Cumulative
2 4
6
8 10 12 14 17 19 21
production
-1 -2 -3 -4 -5 -6 -7 -7 -8
-9
Net
inventory
4 4
4
4
4
4
4
6
4
4
Capacity
requirement
B Internal
2 2
2
2
2
2
2
3
2
2
demand
2 4
6
8 10 12 14 17 19 21
Cumulative
demand
Cumulative
0 0
0
4
5
7
9 11 13 15
production
6 4 2
0
2
1
1
1
0
0
0
Net
inventory
0 4
1
2
2
2
2
2
0
0
Capacity
requirement
C Internal
2 6
3
4
4
4
4
5
2
2
demand
2 8 11 15 19 23 27 32 34 36
Cumulative
demand
Cumulative
0 5
7 11 15 19 23 27 29 31
production
5 3 2
1
1
1
1
1
0
0
0
Net
inventory
5 2
4
4
4
4
4
2
2
0
Capacity
requirement
9 10
9 10 10 10 10 10
6
4
Total capacity
requirements
Table 5.2. Results from example with constant demand DA =3 and
constant capacity CX = 10. Resulting NPV=10503.12

67

Item
n=0 n=1 n=2 n=3 n=4 n=5 n=6 n=7 n=8 n=9 n=10
A External
3 3
3
3
3
3
3
3
3
3
demand
3 6
9 12 15 18 21 24 27 30
Cumulative
demand
Cumulative
2 5
8 11 14 17 20 23 27 30
production
-1 -1 -1 -1 -1 -1 -1 -1
0
0
Net
inventory
4 6
6
6
6
6
6
6
8
6
Capacity
requirement
B Internal
2 3
3
3
3
3
3
3
4
3
demand
2 5
8 11 14 17 20 23 27 30
Cumulative
demand
Cumulative
0 0
3
6
9 12 15 18 21 24
production
6 4 1
1
1
1
1
1
1
0
0
Net
inventory
3 3
3
3
3
3
3
3
0
0
Capacity
requirement
C Internal
5 6
6
6
6
6
6
6
4
3
demand
5 11 17 23 29 35 41 47 51 54
Cumulative
demand
Cumulative
0 6 12 18 24 30 36 42 46 49
production
5 0 0
0
0
0
0
0
0
0
0
Net
inventory
6 6
6
6
6
6
6
4
3
0
Capacity
requirement
13 15 15 15 15 15 15 13 11
6
Total capacity
requirements
Table 5.3. Results from example with constant demand DA =3 and
constant capacity CX = 15. Resulting NPV=13468.56

68

Item
n=0 n=1 n=2 n=3 n=4 n=5 n=6 n=7 n=8 n=9 n=10
A External
3 3
3
3
3
3
3
3
3
3
demand
3 6
9 12 15 18 21 24 27 30
Cumulative
demand
Cumulative
2 6
9 12 15 18 21 24 27 30
production
-1 0
0
0
0
0
0
0
0
0
Net
inventory
4 8
6
6
6
6
6
6
6
6
Capacity
requirement
B Internal
2 4
3
3
3
3
3
3
3
3
demand
2 6
9 12 15 18 21 24 27 30
Cumulative
demand
Cumulative
0 0
3
6
9 12 16 21 21 24
production
6 4 0
0
0
0
0
1
3
0
0
Net
inventory
3 3
3
3
4
5
0
3
0
0
Capacity
requirement
C Internal
5 7
6
6
7
8
3
6
3
3
demand
5 12 18 24 31 39 42 48 51 54
Cumulative
demand
Cumulative
0 7 13 19 26 34 37 46 46 49
production
5 0 0
0
0
0
0
0
3
0
0
Net
inventory
7 6
6
7
8
3
9
0
3
0
Capacity
requirement
14 17 15 16 18 14 15
9
9
6
Total capacity
requirements
Table 5.4. Results from example with constant demand DA =3 and
constant capacity CX = 20. Resulting NPV=13857.21

69

Item
n=0 n=1 n=2 n=3 n=4 n=5 n=6 n=7 n=8 n=9 n=10
A External
3 4
0
5
0
4
3
5
3
3
demand
3 7
7 12 12 16 19 24 27 30
Cumulative
demand
Cumulative
2 5
8 11 14 17 20 23 27 30
production
-1 -2
1 -1
2
1
1 -1
0
0
Net
inventory
4 6
6
6
6
6
6
6
8
6
Capacity
requirement
B Internal
2 3
3
3
3
3
3
3
4
3
demand
2 5
8 11 14 17 20 23 27 30
Cumulative
demand
Cumulative
0 0
3
6
9 12 15 18 21 24
production
6 4 1
1
1
1
1
1
1
0
0
Net
inventory
3 3
3
3
3
3
3
3
0
0
Capacity
requirement
C Internal
5 6
6
6
6
6
6
6
4
3
demand
5 11 17 23 29 35 41 47 51 54
Cumulative
demand
Cumulative
0 6 12 18 24 30 36 42 46 49
production
5 0 0
0
0
0
0
0
0
0
0
Net
inventory
6 6
6
6
6
6
6
4
3
0
Capacity
requirement
13 15 15 15 15 15 15 13 11
6
Total capacity
requirements
Table 5.5. Results from example with varying demand DA and constant
capacity CX = 15. Resulting NPV=13017.10

70

Type of
demand

NPV

Available
capacity CX
10
15
20
15

Constant
DA=3
Varying DA

Ratio = NPV/ CX

10503.12
13468.56
13857.21
13017.10

1050.31
897.90
692.86
867.81

Table 5.6. Ratio of NPV and available capacity.

The resulting production plans in these four numerical cases are depicted
in Tables 5.2 5.5. Table 5.6 shows the NPV and the ratio of NPV per
available capacity level as functions of the capacity level. The
production levels PA, PB, PC are defined according to completion times
(as in current theory). The similarity with traditional MRP tableaus is
apparent, as one would have expected.
B

5.4 Summary
When introducing non-zero lead times into the capacitated lot-sizing
problem, the complexity of the model grows significantly. However, as
shown in Section 5.2, the theoretical analysis is still manageable and
requires only small additional conditions, when choosing an appropriate
definition of the state space. Therefore, we can conclude the existence of
a non-zero lead time extension of MRP Theory.
But from a numerical perspective, the volume of computations and
associated memory requirements increases substantially, when leaving
the zero (or unit) lead time assumption. Still, for some limited structures
the problems are still solvable such as three-level product structure
(Grubbstrm and Huynh (2006)) and four-level product structure
(Section 5.3).

The four cases chosen have all given solutions that essentially used up all
available capacity and produced hardly any inventory or backlogs. The
NPV, resulting from these examples, behaves as one might have
71

expected intuitively, namely a close to linear relation between available

capacity and NPV, but with a small degressive element showing
"diminishing returns to scale" (Table 5. 6 and Figure 5.2).
1100
14000

1050

NPV
1000

12000

950
900

10000

Ratio

850

8000

800

NPV

Ratio

750

6000

700
4000

650
600

2000

550
500

0
10

12

14

16

18

20

Capacity
constant demand
varying demand

Figure 5.2. NPV and NPV over Capacity as Functions of Capacity (fourlevel product structure).

72

THEORY FOR NON-ZERO LEAD TIMES

EXTENDED TO CONTINUOUS TIME
FRAMEWORK

The solution methodology concerning capacity constraints has been

developed in the following steps. In Grubbstrm and Wang (2003) the
problem with stochastic demand, with or without non-zero lead times,
was addressed in the discrete time case. In order to find a solution
methodology (dynamic programming), lead times were then assumed to
be zero. This zero lead time assumption was relaxed in Chapter 5, at the
same time limiting the treatment to deterministic demand. The main
problem treated below, is to turn from the discrete time deterministic
case into the continuous time deterministic case.
We thus attempt to find amounts to produce of each item in a multilevel/multi-stage capacity-constrained production-inventory system,
which has a known development of external demand. As before, in this
chapter we also apply a dynamic programming procedure in order to
solve the non-zero lead time problem. The objective is to choose the best
production plan maximising the net present value of the total cash flow
associated with production and demand. We thus extend our treatment
from Chapter 5 in one dimension, still limiting our attention to
deterministic demand situations.
This extension to include the continuous timing of production adds to
complexity, in particular a need to extend the design of the state space to
handle arbitrary non-zero lead times embedded in continuous time.
As objective function, the Net Present Value (NPV) has often been
chosen. Combining Laplace transforms and Input-Output Analysis has
proved to be advantageous for dealing with complex productioninventory systems (Grubbstrm and Tang, 2000). Here, we continue
with this combined methodology.
Whereas cumulative production of all items, at the point when
production decisions were to be taken, could be used in the zero-lead
time solution procedure as a state description, the state space was needed
73

to include a sequence of prior cumulative production vectors when

enabling non-zero lead times. This sequence had a sufficient number of
elements to cover all opportunities that decisions might have to limit
future opportunities and affect the economic outcome. In the current
study the state space needs to be slightly modified, but, since we are
retaining the assumption that production takes place at discrete points in
continuous time, the modification required is limited.

6.1 Assumptions and Notation

In this chapter we extend the theory from chapter 5 from discrete to
continuous time. A complex production-inventory system operating
within a finite time horizon T is considered. Basic assumptions are:
External demand is deterministic and is assumed to take place as
known processes in continuous time.
Production of all items concerned take place in batches of arbitrary
size at discrete points embedded in continuous time.
No backlogs are allowed for internal demand.
For externally demanded items backorders are allowed.
Capacity constraints are assumed to be of the momentary kind,
meaning that capacity may neither be borrowed, nor lent, at any time,
see (Grubbstrm and Wang, 2000).
Only assembly-type product structures are considered.
We introduce some additional notation for the current continuous time
model:
w i

Q j 1

variable cost per time unit for each unit of item i to use
capacity resources determined by the requirements H ,
, w
= wH . This notation
collected in the row vector w
in Chapter 5,
differs slightly from w
number of cumulative production vectors used for
describing state of system.
state of system immediately prior to jth decision. Q j is
chosen as a matrix made up of a sequence of n
consecutive cumulative production vectors.
74

6.2 Objective Function and Constraints

Using the convention that no time functions are truncated at the horizon t
= T, when computing the Laplace transforms, we state the following
expression for the Net Present Value of the payments concerned. This is
the continuous version of Eq. (5.1) in Chapter 5.
T

NPV = ri
i =1

c P

i =1

j =1

t =0

i ij

ni

( D (t ) B (t ) ) e dt r B (T )e
M

+ K i ij + wk hki
k =1

e i 1

) (

t
Pij e ij =

 sB ( c + wH(  I ) / s ) P + K
= r D
s= .

(6.1)

The terms of this expression are explained as follows. The following part
is the net present value of revenues taking backlogs into account:
n

ri
i =1

( D (t ) B (t ) )e
i

t =0

 sB .
dt ri Bi (T )e T = r D
s=

(6.2)

During an interval in which there is a stockout of item i, the backlog

changes as demand, and we have Bi (t ) = Di (t ) , and during the interior of
this interval there will be no revenues. If there is a momentary
replenishment Bi at t , reducing or eliminating Bi (t ) , revenues
having the NPV of Bi e t will be obtained. When Bi (t ) at t is
interpreted as B (t ) = B (t t ) (where (t t ) is a Dirac impulse
i

function at t ), the contribution to the NPV from the sudden change in

Bi (t ) will thus be accounted from the reduction in backlog
t

ri

t =t 0

Bi (t )e t dt = ri

Bi (t t )e t dt = ri Bi e t . If there is a

t =t 0

remaining backlog at the horizon Bi (T ) , there has been no, or at least not
a sufficient, replenishment at the horizon. This will account for lost sales

75

at T creating a reduction in the NPV by ri Bi (T )e T as compared to

when all demand at the end is satisfied.
The production cost term ci Pij + K i ij is easily interpreted and this cost is
timed at tij . It may be questioned if this is the correct timing for the setup, but a modification locating the set-up to the beginning of the lead
time rather than at the completion time, would be straightforward and
would only add slightly to notational complexity. The variable capacity
M
e i 1
Pij is explained below.
cost term wk hki
k =1

There are two types of constraints involved in this problem. On the one
hand, available inventory must be non-negative, in order for the
production plan P to be feasible. Available inventory, before external
 , may be written as cumulative production less internal
demand D
 )/s
demand. In transform terms, this will be written (R (0) + P HP
= (R (0) + (I H )P ) / s , where I is the identity matrix. Here, R (0) / s is
  is internal (dependent)
the vector of initial available inventory, HP
demand of subcomponents required by the production plan P ,
appropriately timed the relevant lead times in advance of the completion
times defining P . Dividing (I H )P ) by s, represents a time
integration of the difference between production and internal demand.
This difference, together with initial available inventory, may be used to
satisfy external demand and must be non-negative as a time function.
Secondly, there is the set of capacity constraints. The demand for
capacity is always internal (not considering any external sales of surplus
capacity) and, in transform terms, the momentary capacity requirements
  . If the capacity of different resources is given
may be expressed as HP
as a vector of time functions C(t), the capacity constraint will be the
condition

 ( s) H ( s )P ( s ) 0 .
1 C

(6.3)

76

This representation is useful in a discrete time case, when C(t) can be

interpreted as a sequence of existing capacities at each point in discrete
time. Then H would contain the number of capacity units required per
unit of items completed. However, for a continuous time case, it appears
more natural to consider capacity requirements to be spread out over the
lead time of the production process, rather than located as a spike at the
beginning of the lead time. With such an interpretation, H would
contain requirements of various types of resources per unit time and per
item unit completed. With this representation, the capacity requirements
from a resource k for a given completed production Pi of item i at time
tij would be hki Pi per time unit during the interval tij i , tij . In
transform terms, this requirement can be written:
hki

s ( ti j i )

sti j

Pi = hki

e s i 1 sti j
e s i 1 

Pi .
Pe
=
h
i
ki
s
s

(6.4)

Considering all capacity requirements from a total plan P , these would

H(  ( s ) I ) P ( s )
, where I is the identity
be given by the expression
s
matrix, rather than by H ( s )P ( s ) . The two input matrices H in (6.3)
and (6.4) have different dimensions, the former having resource units per
item unit alone, and the latter, resource units per item unit and time unit.
The overall capacity constraints when given C(t), are thus

H(  ( s ) I )P ( s )
1 C
(s)
0.
s

(6.5)

Our basic problem is to choose values of the components of P including

their timing properties tij , such that the objective function NPV in (6.1)
is maximised subject to the available inventory (6.3) and available
capacity (6.5) constraints.

77

6.3 Preliminary Example: One Product Case and

Constant Demand
As an introductory example, we choose a very simplified case with only
one item and a constant demand rate D(t ) = D . At first, capacity is
unlimited, and backlogging is not allowed, B(t)=0. Because there is only
one item, the subscript i may be dropped and the remaining subscript j
refers to the stage. Variable capacity cost may be included in the unit
production cost c. The net present value is
T

t dt
NPV = r De
j =1

r D (1 e T )

j =1

( cP + K ) e

t j

( cP + K ) e

t j

(6.6)

where Pj refers to the jth batch completed at time t j . Our problem is to

choose all values of Pj and t j that maximise the NPV. Without loss of
generality, we define tn +1 = T (although there might be a production
decision at tn = tn +1 = T ). The production decision at stage j is thus the
pair of decision variables Pj = Pj Pj 1 and t j .
Just before a production set-up at time t j , cumulative production is Pj 1
and this level may be chosen as the state variable. Taking a production
decision at that time, the contribution to the NPV (disregarding the
constant revenues) will be
NPVj ( Pj 1 , Pj , t j ) = ( cPj + K ) e

t j

(6.7)

Since, in this example with unlimited capacity, there is never any

advantage to produce more than what is demanded until the next
replenishment, cumulative production will always equal cumulative
demand just before each such point in time (the so called "inner corner
condition" when viewing cumulative production as a staircase function
78

in the same diagram as cumulative demand),

Pj 1 = D(t j ) = D t j ,

(6.8)

so the timing decision t j is forced to be t j = Pj 1 / D . The contribution to

NPV from stage j may therefore be written

NPVj ( Pj 1 , Pj ) = ( cPj + K ) e

Pj 1 / D

(6.9)

and the transition between the states

Pj = Pj 1 + Pj .

(6.10)

Let W j +1 ( Pj ) be the contribution from stage (j + 1) and onwards, when

optimal decisions are chosen based on the state Pj . At stage j we
therefore choose Pj so that
NPVj ( Pj 1 , Pj ) + W j +1 ( Pj ) = NPV j ( Pj 1 , Pj ) + W j +1 ( Pj + Pj 1 )

is maximised,
W j ( Pj 1 ) = max NPVj ( Pj 1 , Pj ) + W j +1 ( Pj + Pj 1 ) .

(6.11)

Pj

At the final set-up at tn , the remaining contribution to the NPV is

P ) + K e Pn1 / D .
NPVn ( Pn 1 , Pn ) = ( cPn + K ) e Pn1 / D = c( DT
n 1

(6.12)
Since T is given, and Pn 1 is the current state determined from past
decisions, this contribution is given by the state variable and not subject
to any maximisation procedure, so

79

P ) + K e Pn1 / D .
Wn ( Pn 1 ) = NPVn ( Pn 1 , Pn ) = c( DT
n 1

(6.13)

The solution to this recursive equation is not so simple as it might seem

at first glance. The equation stated here offers a multitude of
opportunities. Details of the structure of the solution are found in
Grubbstrm and Kingsman (2004).
We now introduce the opportunity of backlogging. This means that the
inner corner condition may be violated. At time t j , just before a possible

production decision Pj , cumulative demand is Dt

j and cumulative

P if
production Pj 1 , and there might be a backlog B (t j 0) = Dt
j
j 1
> P . A batch completion of P will reduce the backlog, possibly
Dt
j
j 1
j
eliminate it.
The state at t j , just before the decision is interpreted as the pair of
variables Pj 1 and its timing t j 1 . There are now also two decision
variables, when to produce t j and how much to produce Pj . The
contribution to the NPV from this decision at t j will be
NPV j (t j 1 , Pj 1 , t j , Pj ) = ( cPj + K ) e

( (

))

P
+ r min Pj , max 0, Dt
e
j
j 1

t j

t j

+ D e

t j 1

) )

e t / ,

(6.14)

))

where t = max t j 1 , min t j , Pj 1 / D . The terms are explained as

follows. Production costs account for a negative contribution to the NPV
t
t
P
e j is the
by ( cP + K ) e j . The term r min P , max 0, Dt

contribution from when there is a backlog max ( 0, Dt

j

))
P ) just before
j 1

j 1

t j to be satisfied by the replenishment Pj . If Pj does not suffice to

cover the whole backlog, the revenue contribution to the NPV will be
t
P e t j .
r Pj e j ,
otherwise
r max 0, Dt
The
term
j
j 1

80

t
D e j 1 e t / accounts for the revenue contribution to the NPV

from current sales between t j 1 and t , the latter time being when a new
backlog is incurred. The time t is at least t j 1 and at most t j and
depends on the state ( t j 1 , Pj 1 ) .
Introducing W j +1 (t j , Pj ) as the contribution to the NPV from stage (j + 1)
and onwards, when optimal succeeding decisions are chosen based on
the state ( t j , Pj ) , we have the recursive optimisation problem to
maximise NPVj (t j 1 , Pj 1 , t j , Pj ) + W j +1 (t j , Pj ) by a suitable choice of t j
and Pj :
W j (t j 1 , Pj 1 ) = max ( NPVj (t j 1 , Pj 1 , t j , Pj ) + W j +1 (t j , Pj 1 + Pj ) ) . (6.15)
t j , Pj

( t , P ) together
determines the new state ( t , P ) = ( t , P

The pair of decisions

j 1

with the old state

+ Pj ) .

(t

j 1

, Pj 1 )

Let us now introduce capacity constraints into this problem including a

fixed lead time . Let C(t) be available capacity of one resource required
in the amount of h per item unit and time unit during the lead time. A
completion of Pj units at time t j will therefore require the availability
of hPj units of capacity per time unit during the interval [ t j , t j ].
The condition on Pj from capacity limitations will then be hPj C (t )
for t j < t t j . However, if the lead time is sufficiently long (or the
completion times short apart), there might have been one or more other
earlier set-ups during the interval [ t j , t j ] also requiring capacity.
Then the limitations on the choice of Pj will be more restrictive and
need take into consideration earlier capacity commitments. In order to
determine the state at t j , prior to the decision Pj , the history of the

81

production decisions (including their timing) during the lead time need
to be included.
In the discrete time case treated in Chapter 5, a matrix Q j 1 was
introduced to represent the state immediately prior to the jth production
decision. This matrix (in our current one-item example, a row vector)
was defined as the sequence of the preceding cumulative production
levels Q j 1 = Pj , Pj +1 , ..., Pj 1 . In Chapter 5, the maximum of all

lead times was used for the definition, but with only one item
considered in this example, the maximum will be the single lead time .
The transition from state Q j 1 to state Q j could then conveniently be
written:
0 0 ... 0
1 0 ... 0
+ 0,0,..., P ,
Q j = Pj , Pj +1 ,..., Pj 1
j
 
#
....  

columns
Q j 1

0 1 0

 

(6.16)

square matrix ( )

where the post-multiplication by the ( )-the columns in Q j 1 one

step to the left, discarding the left-most column and emptying the rightmost column to be filled with Pj in the summation.
In the current continuous time case, the description of a state transition
will be more involved, since there is not necessarily the same number of
earlier decisions to account for during the given lead time for different
transitions. Some decisions, on occasion, might be closer in time than at
other times. However, a list of the cumulative production vectors
representing decisions during the interval will always suffice. Due to
the fixed set-up cost K, there can never be an infinite number of optimum
production decisions within any finite time interval. Therefore, by
choosing a sufficiently large but finite number n of earlier cumulative
production vectors as the state description, this will suffice for our
purposes, and the transition between states may be written:

82

 0 0 ... 0
1 0 ... 0
+ 0,0,..., P .
Q j = Pj n , Pj n +1 ,..., Pj 1
j
 
#
....  

Q j 1
n columns

0 1 0

 

(6.17)

square matrix ( n n )

The information about the timing of each Pk , i. e. tk , may also be

included in Q j . A simple method for this purpose would be to add an
extra component tk to each Pk in Q j .
The possible variable costs of capacity utilisation, with the interpretation
that capacity is used during the lead time , are considered to incur a
w (e 1)
t
Pj e j . The
contribution to the NPV at stage j by

contribution to the NPV from decisions at stage j will then be

t
NPV j (Q j 1 , t j , Pj ) = ( (c + w (e 1) / ) Pj + K ) e j +

( (

))

) )

t
t
P
+ r min Pj , max 0, Dt
e j + D e j1 e t / ,
j
j 1

(6.18)

and the recursive optimisation problem

W j (Q j 1 ) = max ( NPVj (Q j 1 , t j , Pj ) + W j +1 (Q j ) ) .

(6.19)

t j , Pj

Furthermore, without loss of generality, we may choose cumulative

production Pj , including timing t j , rather than Pj (and t j ), as decision
variables, since Pj and the state Pj 1 would then define the decision.
This shortens our argument notation somewhat:
NPV j (Q j 1 , Pj ) = ( (c + w (e 1) / )( Pj Pj 1 ) + K ) e

( (

))

t j

) )

t
t
P
+ r min Pj Pj 1 , max 0, Dt
e j + D e j 1 e t / ,
j
j 1

83

W j (Q j 1 ) = max ( NPVj (Q j 1 , Pj ) + W j +1 (Q j ) ) ,

(6.20)

Pj

where the maximisation is subject to the capacity constraint for t in the

interval t j < t t j , i.e. 1 h ( e s 1) Pj Pj 1 / s C (t ) . Finally,

we introduce internal (dependent) demand into this introductory

example.

Let there be requirements of a second item, which is a sub-component,

amounting to hPj , when Pj is the end item planned to be completed at
t j . The timing of this requirement is at t j . Available inventory of
this second item must be non-negative throughout. This requires
knowledge about available inventory of this second item immediately
prior to t j . Thus available inventory, which is given by cumulative
production of the component and cumulative earlier production of the
end item generating internal demand (and also possibly initial available
inventory), will need to be added to the state description. However, we
are now leaving the one-item example and proceeding into the general
multi-item case of the next section.

6.4 Multi-Item Case with Deterministic

Demand and Given Capacity Limits

External

Turning to the general deterministic continuous-time case, the objective

function is written

) (

 sB ( c + wH (  I ) / s ) P + K ,
NPV = r D
s=

(6.21)

where r, c, w and K are row vectors capturing economic consequences in

the form of external item sales prices, unit production costs, unit variable
capacity costs per time unit and set-up costs for batches of each item. D,
B, P and are column vectors for external demand, backlogs,
production and set-ups and H is the input matrix for capacity
requirements and  the lead time matrix, the latter having e s i as its
84

diagonal elements and zeros elsewhere. The production and cumulative

production vectors may be written
n

j =1

j =1

st
st
P = P j e j , P = P j e j / s ,

(6.22)

and the set-up vector

n

st
 = j e j .

(6.23)

j =1

The timing t j is interpreted to cover any production completion at t j

and items that are not relevant at that time will have zero components in
their position in P j . Similarly, the set-up vector j will contain a unit
value for an item completed at time t j and zeros elsewhere. The
available inventory and capacity constraints for the whole process are

R (0) + (I H )P
1
0,
s

(6.24)

where R(0) is the vector of initial available inventory and H the input
matrix for component requirements, and


H(  ( s) I )P ( s )
1 C
(s)
0,
s

(6.25)

 ( s) is the resource vector of available capacity.

where C
In order to apply dynamic programming, at stage j we need to determine
the contribution to the NPV from the current decision P j (or,
equivalently, P j ) when given the state Q j 1 just prior to t j ,
NPVj (Q j 1 , Pj ) , where Q j 1 is a matrix of n previous cumulative

85

production vectors P j 1 , P j 2 , ... , P j n , and where n is sufficiently

large to capture all production decisions that could have taken place
during the longest lead time = max i . The revenue (and backlog)
i

consequences need to be split up into their respective contributions to the

NPV at the particular stage, whereas the contributions from production
costs, capacity costs and set-up costs are obtained in an immediate
straightforward way.
As in our introductory example, the recursive optimisation for each stage
will be given by
W j (Q j 1 ) = max ( NPV j (Q j 1 , Pj ) + W j +1 (Q j ) ) ,

(6.26)

Pj

where the decision P j must satisfy conditions (6.24)-(6.25).

6.5 Numerical Examples

To calculate these examples we have made use of the Swedish National
Super Computer. A program was written in C++.

6.5.1 Two-level Serial Product Structure.

In our first example, the product structure is given by Figure 6.1
A

2* X
Figure 6.1 Two-level serial product structure.

The parameters are assumed to have values according to Table 6.1.

86

Planning horizon (time periods) T

Lead time of A A .
Interest continuous rate
Demand rate D

10
2
0.05

Sales revenue rA
Set-up costs K A
Unit production costs cA
Variable capacity cost wX per time unit
Variable product capacity costs w A per time unit

500
70

100
20
40

Table 6.1. Parameter values for one product case.

Cumulative production
Production time

4 5 9 10 14 15 19 20
2.1 3.1 4.1 5.1 6.1 7.1 8.1 9.1

Table 6.2. Results from example with constant demand D A =3 and

constant capacity CX = 10. Optimum number of batches= 8. Resulting
NPV= 3799.03.

Cumulative production
Production time

5
2.1

7
3.1

12
4.1

14
5.1

15
6.1

21
7.1

22
8.1

26
9.1

Table 6.3. Results from example with constant demand D A =3 and

constant capacity CX = 15. Optimum number of batches= 8. Resulting
NPV= 4845.18.

87

Cumulative production
Production time

7 10 17 20 27 30
2.1 3.3 5.3 6.6 9 10

Table 6.4. Results from example with constant demand D A =3 and

constant capacity CX = 20. Optimum number of batches = 6. Resulting
NPV=5573.40.

Demand
Constant
DA=3

Available capacity CX NPV

Ratio = NPV/ CX
10
3799.03
379.90
15
4845.18
323.01
20
5573.40
278.67

Table 6.5. Ratio of NPV and available capacity of two-level serial product
structure. .

6.5.2 Three-level Product Structure

The lead time of A and B are assumed to be A = 1, B = 2 , and the
product structure given as in Figure 6.2.

1*

1*

2*

Figure 6.2. Three-level product structure

88

Planning horizon (time periods) T

Initial available inventory RA0 , RB0
Interest rate per time period
Sales revenue rA
Set-up costs K A , K B
Unit production costs cA , cB
Variable capacity cost per time unit wX
Variable capacity cost produced per time Unit w A , w B

10
0, 6
0.05
1000
80, 50
100, 70
20
40, 20

Table 6.6. Parameter values for the three-level product structure.

Item
A Cumulative production
Production time
B Cumulative production
Production time

4
6
8 11 14 16 18 22 24
1.1 2.1 3.1 4.1 5.1 6.1 7.1 8.1 9.1
2
6
8 10 12 16 18
2.1 3.1 4.1 5.1 6.1 7.1 8.1

Table 6.7. Results from example with constant demand D A =3 and

constant capacity CX = 10. Optimum number of batches of A = 9, and of
B = 7. Resulting NPV=12449.94.

Item
A Cumulative production
Production time
B Cumulative production
Production time

6
8 12 15 18 22 27
1.5 3.1 4.1 5.1 6.3 8.0 9.0
3
7 10 16 19 21 24
2.1 3.1 4.1 5.3 7.0 8.0 9.0

30
10

Table 6.8. Results from example with constant demand D A =3 and

constant capacity CX = 15. Optimum number of batches of A = 8 and of
B = 7. Resulting NPV=14718.63.

89

Item
A Cumulative production
Production time
B Cumulative production
Production time

6 10
1.5 3.3
7 10
2.3
4

16
5
15
5

21
6
18
7

24
8
24
9

30
10

Table 6.9. Results from example with constant demand D A =3 and

constant capacity CX = 20. Optimum number of batches of A = 6 and of
B = 5. Resulting NPV=14903.58.

Demand
Constant
DA=3

Available capacity CX NPV

Ratio = NPV/ CX
10
12449.94
1244.99
15
14718.63
981.24
20
14903.58
745.18

Table 6.10. Ratio of NPV and available capacity of three-level product

structure.

6.6 Summary
When applying dynamic programming to the non-zero lead time
capacitated lot-sizing problem in continuous time, the complexity of the
states increase enormously. In Section 6.3 and Section 6.4, the
theoretical analysis is introduced when choosing an appropriate
definition of the state space.
In the continuous time case, there is not necessarily the same number of
earlier decisions to account for during the given lead time for different
transitions. Due to the fixed set-up cost K, there also can never be an
infinite number of optimum production decisions within any finite time
interval. Therefore, by choosing a sufficiently large but finite number n
of earlier cumulative production vectors as the state description, this will
suffice for our purposes, and the transition between states may be written
as matrix Q j 1 in a similar way as in Chapter 5.

90

But from a numerical perspective, the volume of computations and

associated memory requirements has increased substantially. Therefore,
we have been forced to examine only very limited structures as in
Section 6.4.1 (two-level) and Section 6.4.2 (three-level).
In both structures, the three cases chosen have all given solutions the
relation between NPV and capacity is close to linear, but with a small
degressive element showing "diminishing returns to scale" (Table 6.5,
Table 6.10 and Figure 6.3).
Ratio of NPV and Capacity
1300
1200
1100

Three-level product structure

1000
900
800
700
600
500

Two-level product structure

400
300
200
100
10

12

14

16

18

20

Capacity

Figure 6.3. NPV over Capacity as Functions of Capacity.

91

92

CAPACITY-CONSTRAINED
PRODUCTION-INVENTORY SYSTEMS
WITH NON-ZERO LEAD TIMES IN
CONTINUOUS TIME AND WITH
STOCHASTIC DEMAND

We now finalise our attempt to find amounts to produce of each item in

a multi-level/multi-stage capacity-constrained production-inventory
system in the most general of the cases considered. Below we introduce
stochastic external demand to the continuous time case. This is an
extension of Chapter 6 by adding stochastic properties to external
demand and it represents the thick-line triangle of Table 1.1. We are
now turning to the most general, but also most complicated case, and our
treatment will therefore be limited to an outline of the procedures
involved, and no numerical examples will be provided.
The model is based on the assumption that external demand is
stochastic. An example treated in Grubbstrm (1996) concerned demand
being a renewal process made up of stochastic events separated by
independent stochastic time intervals with a common given probability
density function.
In this chapter we need to modify our dynamic programming procedure
in order to propose a solution to the non-zero lead time problem. The
objective is to choose the best production plan maximising the expected
net present value of the total cash flow associated with production and
demand. However, since the problem now is stochastic, the plan chosen
will be an optimal plan as seen from the initial point of time. The
decisions computed, are based on maximising the expected NPV from
the events taking place later on, not yet known, before the horizon T is
reached. Therefore, in a practical case, only the first decision in the plan
would be realised, the remaining decisions being part of the strategy
determined by the calculations. Which future decisions that will be taken
will depend on the realisation of the demand process and the
consequences this and previous decisions have on the state at each point
in time.

93

Here, we continue applying the combination of Laplace transforms and

Input-Output Analysis.

7.1 Objective Function and Constraints

In the model developed here, stochastic demand events are assumed to
take place as known processes in continuous time. We state the
following expression for the expectation of the Net Present Value of the
payments concerned. This follows the deterministic model in Chapter 6.
N

NPV =
i =1

i =1

t =0

+ ri

ni

c P
j =1

i ij

+ K i ij + wk hki
k =1

e i 1

t
Pij e ij

E Di (t ) Bi (t ) e t dt ri E [ Bi (T ) ] e T =

) (

 sB ,
= ( c + wH(  I) / s ) P + K + r E D
s=

(7.1)

where E[ ] is the expectation operator. The decision variables are the

production vectors P which need be determined as a function of the
state, and the setup vectors  which are given, when the P are given
(roughly speaking,  = sgn(P ) ). Equation (7.1) can be looked upon as
the net present value consequence of a realisation of the process. The
sequence of vectors P , in general, will not have unique values at
different points in time, since their realisation will depend on the prior
stochastic development of the state. Instead, the optimal sequence will be
proposed decisions to take as functions of what the state happens to be at
a particular point in time.
As before, there are two types of constraints involved in this problem.
On the one hand, available inventory must be non-negative in order for
the production plan P to be feasible. For any realisation, this can be
written
(R (0) + (I H )P ( s ))
1
(7.2)
0,
s

94

  always is satisfied.
meaning that at least internal demand HP

Secondly, there is the set of capacity constraints. The demand for

capacity is always internal

H(  ( s ) I)P ( s)
1 
1 C
( s)
( s ) H ( s )P ( s) 0 ,
= C
s

(7.3)

where  ( s ) is the original diagonal lead time matrix having e i in its ith
diagonal position, and where we have introduced the short notation
( s ) = (  ( s ) I ) / s

(7.4)

for a modified diagonal lead time matrix ( s ) when assuming

capacities to be used constantly throughout the lead time, rather
than as impulses at the point of completion (as previously
explained in Section 6.2).
 including
Our basic problem is to choose values of the components of P
their timing properties tij , as functions of the state, such that the
expectation of the future contribution to the objective function NPV in
(7.1) is maximised subject to these two sets of constraints.

7.2 Dynamic Programming Solution Procedure

As our point of departure, we introduce the state Q(t) as a time
dependent set of variables defining the current situation at each point in
time. As yet, we have not specified what, or how much information that
is contained in Q(t). In the deterministic case, earlier treated
(Sections 5.2 and 6.3), we defined Q(t) to be a sequence of past
cumulative production vectors, but this definition will not suffice in this
stochastic setting. For the moment, we simply assume the existence of a
Q(t) containing a sufficient amount of information, so that an optimal
production decision P(t) (and (t ) ) can be taken when Q(t) is known.
95

The state Q(t) will develop stochastically based on stochastic external

demand D(t).
The NPV function in (7.1) is an integral over time. It is therefore the sum
of a set of contributions from intervals of the time scale. Consider a
small interval [t, t + dt]. If the state, just prior to the decision at t, is Q(t),
the contribution to the NPV may be written

NPV(Q(t ), P(t , Q(t ))) ,

(7.5)

since it will depend on the state Q(t) and on the current decision P(t),
which at t is to be chosen optimally as a function of t and Q(t), hence the
notation P(t, Q(t)) for the second argument of NPV .
As a result of the decision P(t, Q(t)), Q(t) will change to Q(t+dt), but this
new state also depends on how stochastic demand develops. We
therefore need to have probabilities available for the state transition from
Q(t) to Q(t+dt). Let these probabilities be written
pQ ( t ), q ( Q(t ), P(t , Q(t )) )

(7.6)

where q is one of the opportunities that the new state will take,
when given the old state Q(t). These opportunities we collect in
the set Q (t + dt ) . If we now introduce E [ NPVt + dt | q ] for the
expected contribution to the NPV from time (t + dt) onwards, if the
new state is q and if the remaining sequence of decisions are taken
optimally (knowing how they should be when given each future
state), then the expected contribution to the NPV from t and
onwards will be
NPV(Q(t ), P (t , Q(t ))) +

pQ ( t ), q ( Q(t ), P (t , Q (t )) ) E [ NPVt + dt | q ] dq ,

qQ ( t + dt )

96

(7.7)

where the triple integral symbolically represents taking the expectation

of the maximum future NPV over all possible developments of the state
during the interval [t, t + dt].
Finally, let us introduce the notation P (Q(t )) for the set of available
decisions P(t) when the state at t, i.e. Q(t), is known, and when available
inventory and capacity constraints are taken into account appropriately.
The problem at t is thus to choose an optimal P(t) from the set P (Q(t )) .

Hence, the recursive equation governing this optimisation, may be

written
E [ NPVt | Q(t )] =

=
+

max

P ( t ,Q ( t ))P ( Q ( t ))

( t + dt )

NPV(Q(t ), P(t , Q(t ))) +

pQ (t ), q ( Q(t ), P(t , Q(t )) ) E [ NPVt + dt | q ] dq .

(7.8)

This is a differential equation determining the development of

E [ NPVt | Q(t ) ] . If, for instance, the value of E [ NPVT | Q(T ) ] is known
to be zero (since the process has ended there), in principle, the whole
development of E [ NPVt | Q(t ) ] going backwards from T to t = 0 is given
by the equation.

7.3 Interpretation of the State and Other Entities

The immediate consequences from taking a decision P(t) at t as regards
production, are easily found to be
N
M

e i 1
NPVproduction = K i i (t ) + ci + wk hki
Pi (t ) e dt , (7.9)

i =1
k =1

97

where Pi (t ) (and i (t ) ) includes a Dirac function at t, if a batch of the

ith item is completed in this interval.
Furthermore, we have the consequences from sales and backlogs which
are generated by the influence of the state Q(t)

NPVsales = ri ( Di (t ) Bi (t ) ) e t dt .
N

(7.10)

i =1

At the very end t = T, there might also be the additional lost sales term
ri E [ Bi (T )] e T (t T )dt .
The term NPV ( Q(t ), P ( t , Q(t ) ) ) in (7.8) will thus be
NPV ( Q(t ), P ( t , Q(t ) ) ) = NPVproduction + NPVsales .

(7.11)

Let us now examine the set of possible production decisions P ( Q(t ) ) .

Production is limited by the availability of components, as expressed by
the available inventory constraint (7.2). It is also limited by the need for
capacity usage (7.3). The amount of information needed therefore goes
back at most to the longest lead time prior to the point of decision, i.e. to
t , where , as previously, is defined by

= max i .

(7.12)

Therefore, Q(t) needs to contain available inventory information of the

interval [t , t ] . This requires information on cumulative production P
and cumulative demand D during the interval. If Q(t) contains this
information, it will suffice to determine all opportunities for the current
production decision as expressed by P ( Q(t ) ) .
We finally have the state transition probabilities pQ ( t ), q ( Q(t ), P ( t , Q(t ) ) ) .
As regards production, it is obvious how the future cumulative
production depends on the earlier sequence and on the current decision
98

(in the same way as in Chapters 5 and 6). Only specific combinations
will provide an opportunity for a positive probability. However, as
regards demand, the transition is dependent on what new demand that
appears at t. The transition probabilities must therefore be computed
from properties of the demand process. The opportunities for Q(t) to take
on new values q in Q (t + dt ) , are also expressed by these

considerations.

7.4 Summary
In this chapter we have attempted to extend our previous theory to the
case of stochastic demand, when the processes take place within a
continuous time framework and lead times are non zero. Our treatment
has resulted in an outline for such a development, but it is clear that the
theory has become so very complex and that the investigation is far from
complete. In particular, the concept of the state Q in this stochastic
situation needs a substantial amount of additional careful attention.

99

100

CAPACITY CONSTRAINTS IN A PAPER

MILL (BILLERUD SKRBLACKA AB)

8.1 Introduction
Skrblacka AB is one of four paper mills of the Billerud company. It is
located in Skrblacka, Norrkping, Sweden. The mill was originally
built in 1872, but the foundations for the modern mill were laid in the
early 1960s. Today the mill comprises three pulp lines, four paper
machines and a drying machine for market pulp. Production is focused
on brown sack paper, white MG paper, and fluting.
Having a large production capacity, the mill consumes huge resources of
Wood: 3900 m3/24h
Oil: 68 m3/24h
Electricity 1200 MWh/24h
Water 75000 m3/24h
Truck loads 104/24h
In Table 8.1 is shown the production capacity of the mill in 2004.

Product
Sack Kraft paper
MG Kraft paper
Fluting
Market pulp
Number of employees

Quantity (tons)
150 000
88 000
90 000
80 000
720

Table 8.1. The production capacity of Billerud Skrblacka AB (2004)

The company buys materials from the suppliers of wood. When the logs
reach the mill they enter into the wood room. The bark is removed in a
rotating drum. Then the logs are cut into chips and the chips are stored in

101

large silos or piles. The bark is used as fuel. The chips are then sent to a
digester.
In the pulp cooking process, the cellulose fibres in the wood chips must
be parted from each other carefully. This takes place by cooking the
chips under pressure together with chemicals. The cooking liquid, or
white liquor, becomes black during this process. Around half of the
wood becomes pulp. The remainder is dissolved in the black liquor and
is used as biofuel in a recovery boiler.
During subsequent washing and screening stages, the black liquor and
chips that have not dissolved in the pulp are washed and screened in
several stages to ensure that no impurities remain. The pulp then
continues either to a bleaching station or straight to a paper machine if
the product is unbleached.
Bleaching is a process that produces a cleaner, whiter and more durable
pulp. The process takes place in several stages and the chemicals used
are oxygen, chlorine dioxide, hydrogen peroxide and caustic soda. The
bleached cellulose fibres are now ready to become white paper.
The cooking liquid, or black liquor, is first dried, and then burnt in the
recovery boiler. This produces heat for creating steam and electricity,
during which the chemicals form a solution at the bottom of the boiler.
This solution is dissolved in water to produce green liquor. The green
liquor is treated with lime and converted into new cooking liquor (white
liquor), which can be returned to the pulp digester. This circulation of
chemicals in different eco cycles is a key element in the environmental
impact as well as for the economy of the mill as a whole.
During paper production stages, cellulose fibres are mixed with water
and chemicals, and ground together. This mixture (stock), is poured
onto the wire of the paper machine where it forms a paper web. The web
is then led through the paper machine through a system of filters and
rollers, where the paper is dewatered, pressed and dried. At the end of the
machine, the paper is wound onto massive reels.

102

Sawmill chips, Softwood, Hardwood

Wood Room
Sulphate
cooking 1
Washing
Screening

Reject
from
Screening

Reject
Handling

Oxygen
Bleaching

Sulphate
cooking 2

Semi-chemical
Pulp Cooking

Washing

Defibration

Screening

Washing

Washing

Washing

Bought
Fibre

Final
Bleaching

PM 8
MG Kraft

PM 7
MG Kraft

TM 1
Bleached Pulp

PM 9
Sack Paper

PM 4
Fluting

Figure 8.1. The production flowchart of Billerud Skrblacka AB.

PM 8, PM 7, PM 9, PM 4 are paper machines, and TM 1 is a drying
machine for market pulp.
Depending on customer demand, some of the paper is coated in special
coating machines. By adding a thin coat of white colouring, the paper
becomes smoother and better sealed and thus easier to print on.

103

Winding and packaging are the finishing stages. In the winding stage, the
large paper reels (popes) are cut into smaller sizes, and in the packaging
stage they are packed to protect the products during storage and transport
to the customers.
In addition to measures carried out inside the mill to reduce emissions
from the various production stages, waste water is also treated externally.
The wastewater first enters sedimentation ponds, where particles (mainly
wood fibres) are separated from the water. Then the water is treated in a
biological process, in which micro organisms break down pollutants.

8.2 Production Planning and Capacity Constraint

Problems.
At the mill, production takes place 24 hours a day, every day of the year.
Machinery and environmental protection equipment are fine-tuned
continuously to meet requirements concerning product quality and the
environment. There are several constraints in the mill. Here, we shall
focus mainly on production capacity constraints.
The pulp cooking equipment always runs at 100% capacity. With a wide
range of paper products, the production planner copes with several set-up
selections at the bleaching stage and at paper machines. Depending on
customers demand, there are several different kinds of products
according to bleaching grade and extensible (cf Table 8.2) grades. The
product must be designed to fulfil the requirements of a multitude of
industries, materials, filling machines, climatic conditions and market
exposure. The sack paper, for instance, is classified according to some
special indices such as Table 8.2 indicates.
The fact that capacities are fully utilised corresponds to strict equalities
in the relevant rows of the capacity constraint inequalities (such as in
(6.3)):

 ( s ) H ( s )P ( s ) 0 .
1 C

(8.1)

104

White and Brown

grades

Stretch
MD

TEA
index
geom.

Tear
index
geom.

Printability

Runability at Stiffness at
converting
filling

Natural grades
White Performance N

Brown Performance N

White NK

Duo white

Triple white

Print

GlossPrint

White Performance SE

Brown Performance SE

White SQ

White XZ

Semi-extensible grades

Table 8.2. Characteristics of sack paper for open mouth sacks.

Explanations to Terminology used in Table 8.2
Bendtsen ml/min: A measure of surface roughness. Roughness significantly affects the
printing quality, lamination and other demanding surface treatment
Porosity/air resistance, Gurley seconds: Air resistance is a measurement of the time taken
for 100ml of air, under constant pressure, to pass through a specified area of a paper
sheet. Short time signifies a highly porous paper.
TEA (Tensile Energy Absorption), J/m2: the most important sack paper strength property.
This is verified by the correlation between TEA and drop tests. When a sack is dropped,
the contents will move when hitting the floor. This movement causes strain on the sack
wall. To withstand this strain, the TEA should be high. The energy will then be absorbed
by a combination of the tensile strength and the stretch in the paper.
Tensile strength, kN/m: The tensile strength is the maximum force that the paper is able
to withstand without breaking. Tensile strength is one parameter in the measurement of
TEA.
Stretch, %: the elongation of the paper extended to rupture.

105

Production in these paper machines is planned depending on customer

orders every week (short-term planning) with the aim to minimise the
inventory of finish products.
In the production planning department, there are two main factors taken
into account, in order to hold production cost down.

Tons
350
300
250
PM 9

200

PM 8

150

PM 7

100

PM 4

50
0
Jan

Feb

Mar

Apr

May June July

Aug

Sep

Oct

Nov

Dec

Figure 8.2. Loss of paper quantity due to setup time.

Hours
30
25
20

PM 9
PM 8

15

PM 7
10

PM 4

5
0
Jan

Feb

Mar

Apr

May June July

Aug

Sep

Oct

Nov

Dec

Figure 8.3. Loss of machine time due to setup time.

106

On the one hand, there are setup costs due to setup times. When
changing from one kind of product to another kind, there is always some
loss at the setup stage. Therefore, to lower the production losses (shown
in Figures 8.2 and 8.3), the production planner aims at minimising the
frequency of setup changes.
Apart from these consequences, there are trimming losses. During the
packing stage, this type of loss is incurred, when the orders do not match
the popes dimension, for instance as illustrated in Figure 8.4. The
planner tries several different combinations until he is satisfied with the
resulting smaller loss.

loss

Order A

Order B

Figure 8.4. Pope Cutting.

The average total loss per annum because of setup and packing at
machines PM 7, PM 8, PM 9 is shown in Table 8.3.
Loss at
setup (tons)

Loss at
packing (tons)

Total

Loss percentage
(%)

PM 7

2842.2

3041.6

5883.8

11.2

PM 8

1813.2

2519.3

4332.5

9.0

PM9

1270.1

1506.9

2777.0

9.6

Table 8.3. Average total loss per annum in paper machines PM7, PM8,
PM9.
107

The company always attempts to satisfy all customer demand. In the

short term, sometimes the demand is higher than production capacity.
The sales department must discuss with customers before accepting an
order. The production planning department has to make sure that all
machines run as close to 100% capacity as possible.
Following the main production flow, various capacity limitations are
revealed:

The storage space for wood is limited. As a total, it is possible to

store 80,000 cubic metres of wood, which are distributed
according to round timber, purchased chips, and chips made
from round timber, which then are stored in chip silos. The
normal volume of wood is around 50 % of this maximum
limitation. As a whole, around 1,500,000 cubic metres of wood
is consumed per annum. Hence, the maximum storage
corresponds to approximately three weeks requirements and the
normal storage to some 1.5 weeks requirements. The main
limitations are due to the area of the wood yard and to the size of
the chip silos.

In the wood room, there are essentially no capacity limitations.

This stage is currently run according to a continuous two-shift
schedule. Occasionally, when running during a third night shift,
the noise level of this stage could limit capacity according to
environmental regulations. Currently, there is no need for a night
shift.

Externally purchased chemicals, energy, water and other factor

inputs are never envisaged as subject to limitations.

The sulphate cooking process is basically a chemical/energy

process, which affects the succeeding production stages. If this
process shows a lower performance, it will have an immediate
effect on the maximum capacity of the paper machines, since
both energy (steam) and the fibre raw materials are produced in
the sulphate process. Reasons for a lower performance would be
related to occasional technical problems, such as sedimentation,

108

breakdown, or similar disturbances. On occasion, the sulphate

cooking stage needs to be run at a reduced rate due to
environmental considerations, for instance if the threshold values
for emissions have been reached.

In the paper machines, the number of different products

(according to different recipes and grammage (basis weight) are
around 50 per machine. On top of this, there are the dimensions
of width, diameter and reel, which make the diversification
extremely large. The latter kind of customisation takes place at
the packing stage where the popes are cut, and this only
indirectly affects the paper machines. The winding machine
might limit the overall capacity, when the frequency of changes
in paper variants becomes high. Then, this might also create a
storage limitation for the popes between the paper machine and
the winding machine. Such an occurrence, however, is extremely
rare.

In the vast majority of cases, a certain product variant will only

be manufactured in a predefined paper machine. There are rare
exceptions, when an order might be run in either of two paper
machines, but these cases are negligible.

The storage space of the end product inventory is limited. For

sack paper, the area is around 2,700 square metres and for white
MG paper around 3,500 square metres. The internal
transportation service within the end product inventory (using
fork trucks) also has a limited capacity. This service unit is
common for all types of products. If the storage area becomes
over full, there are options to rent additional storage space, for
instance in the harbour of Norrkping, or elsewhere.

A final capacity limitation concerns the delivery services from

the mill. These take place either by rail, or by truck.

109

8.3 Some Observations and Suggestions

When having investigated the types of capacity constraints occurring in
practice in a paper mill, they may be classified into essentially two
categories:

Limitations in the production process, constraining the flow of

products per time unit,
Limitations in storage facilities, constraining the volume of
available inventory.

In our theory developed in previous chapters, only the former type of

restriction has been applied when solving related problems. Therefore,
there appears to be a need for adding opportunities for additional
constraints in the form of upper bounds for inventory. This may
relatively easily be done by introducing supplementary inequalities of
the type:

{ }

 C (t ) ,
1 R
R

(8.2)

where CR (t) captures the upper limitations for available inventory over
time.
Furthermore, it appears essential to develop the theory in the direction of
including setup times. These times have been neglected earlier, and their
existence has only had an indirect effect through the economic
parameters by which a setup cost would be subtracted from the NPV at
the time of a setup, i.e. by K (t )e t , where K is the row vector of setup
costs and (t ) the setup vector at time t (a column vector). Hence, the
relation between (t ) and available capacity C(t) need be investigated
further.
In the practical choices made available to the production planning
department, little attention is given to the economic and monetary
consequences of which operational decisions that are taken. Behind the
110

vast majority of decisions, attention is directed mainly towards volume

consequences, rather than economic consequences. The quantity of
damaged and useless paper is in the forefront of awareness.
From our theoretical point of departure, one might wish to estimate the
value of losses more accurately. Due to the multiplicity of products
having different prices, the quantity measure alone would not reflect the
loss accurately.
Also, there are products that make a higher profit than others, such as
medical paper. Should priorities be given to the high-profit grades when
forming the product plan?
A similar observation might be made concerning the competition of
storage space among different products.
In general, it might be suggested that more attention might be given to
monetary consequences of operational decisions concerning capacity
utilisation.

111

112

CONCLUSIONS AND SUGGESTIONS

FOR FURTHER STUDIES

The aim of this dissertation has been to provide suggestions for stating
and solving the capacitated multi-level multi-period production planning
problem. In this final chapter, we summarise our results from Chapter 1
to Chapter 8. We also suggest some further research directions. All
through our developments, we have relied upon the scientific base of
MRP theory, involving the combination of Input-Output Analysis and
Laplace transforms.

9.1 Summary and Conclusions

Throughout the dissertation, we have employed the Laplace transform
(or z-transform) and Input-Output Analysis as tools for applying MRP
theory to the capacitated problems we have formulated. In essentially all
cases, the Net Present Value has been stated as the objective to
maximise. This choice has been based on the opinion argued in several
articles that such an approach must be superior to traditional average cost
considerations, the latter overwhelmingly appearing in earlier literature.
In Chapter 3, we analysed the previously developed fundamental
equations (available inventory, total inventory and backlogs) of MRP
Theory, when the basic ordering policies Lot-For-Lot (L4L), Fixed
Order Quantity (FOQ) and Fixed Period Requirements (FPR) were to be
applied.
Having presented a brief overview of the fundamental equations of MRP
theory, this was followed by deriving the basic properties of the
production plan for the three ordering policies in relation to this theory.
For the L4L policy, we found an explicit closed-form Laplace transform
expression for the time development of production, when given external
demand, whereas for the other two policies, the results were more
implicit. The optimal FOQ and optimal FPR were also determined for
the case that external demand was stochastic. When leaving the L4L
policy, it was shown that relevant expressions are possible to derive, but
they become considerably more complicated.
113

All through Chapter 4 until Chapter 7, we have been treating capacitated

multi-level, multi-stage production planning problems. In Chapter 4, a
four-procedure heuristic method was suggested for the non-zero lead
time problem in the discrete-time framework. Numerical examples
illustrated how the NPV increases, when available capacity was allowed
to increase. However, the increase took place with a small degressive
element showing "diminishing returns to scale". This phenomenon
repeated itself in the numerical examples treated in subsequent chapters.
Instead of using a heuristic, in the three chapters following, a dynamic
programming procedure was applied in order to find the optimal solution
of the capacitated multi-level multi-stage production planning problem.
This development followed the diagram depicted in Table 1.1.
In Chapter 5, the model treated concerned external demand being
deterministic in a discrete time setting. In order to apply dynamic
programming, we formulated the state confronting decisions in each
period to be a set of historical vectors of cumulative production, which
were collected in matrices Q , collecting the necessary information for
taking optimal future decisions. The array Q in period n, i.e. Q n , was
then defined as a sequence of previous cumulative production vectors
where was the maximum of all production lead times.
In the continuous-time model of Chapter 6 instead, there was not
necessarily the same number of earlier decisions to account for during
the given maximum lead time for different transitions. Some decisions,
on occasion, might be closer in time than at other times. However, a list
of the cumulative production vectors representing decisions during the
maximum interval would always suffice for providing the necessary
amount of information. By choosing a sufficiently large but finite
number n of earlier cumulative production vectors as the state
description, according to our findings, this would suffice for our
purposes.
In Chapter 7, we have made an attempt to extend our previous theory to
the case of stochastic demand, when the processes take place within a
continuous time framework and lead times are non-zero. There, we
presented an outline for such a development. It was shown that the
theory became increasingly complex. Our results from this investigation
114

cannot be considered other than far from complete. In particular, the

concept of the state Q in this stochastic situation still will need a
substantial amount of additional attention.
When computing results from numerical examples in Chapters 5 and 6,
the NPV was shown to behave as one might have expected intuitively,
namely that there is a close to linear relation between available capacity
and NPV. As mentioned above, this relation was perturbed by a small
degressive element showing diminishing returns to scale.
When introducing non-zero lead times into the capacitated lot-sizing
problem, the complexity of the model has been shown to grow
dramatically. The theoretical analysis was still manageable to cope with,
when choosing an appropriate definition of the state space. We might
therefore conclude that an embryo for the existence of a non-zero lead
time extension of MRP theory in both discrete time and in continuous
time has been established.
Results from a study of capacity constraints in a paper mill were
presented in Chapter 8. In the practical scenario, a great number of
restrictions, many of which were possible to interpret as capacity
constraints, proved to be present. The major capacity constraints could
be classified into two categories: (i) limitations in the production
process, constraining the flow of products per time unit, and (ii)
limitations in storage facilities, constraining the volumes of available
inventory, such as the limited area of the wood yard. We were also given
attention to the importance of capacity losses due to setup frequency and
trimming. These observations have also provided ideas for further
theoretical extensions of MRP theory.

9.2 Suggestions for Further Studies

Relaxing Assumptions
During our theoretical developments, we have been forced to make
assumptions of various kinds in order to keep complexity down for the
sake of managing the problems treated. When addressing extensions of
current theory, the first natural choice is to study consequences from

115

relaxing restrictions being based on assumptions. A few of these

limitations are listed as follows:
Non-Constant Lead Times
Lead times have been considered constant throughout our developments.
This is in line with Material Requirements Planning methodology from
its start. However, in practical situations the true lead time is dependent
on the current work load, i.e. on current capacity utilisation. Therefore,
lead times also may be considered as consequences of the production
plan, and not only the plan a consequence of the given lead times. The
way in which this type of interaction takes place is yet to be analysed.
Stochastic Elements in Lead Times
Lead times are also subject to stochastic influences because of machine
breakdowns etc. Extensions of the theory to possible variations in the
lead time matrix  , would be an interesting topic to develop.
Variations in Bill-Of-Materials
Also the given constant properties of the Bill-Of-Materials (the
technical coefficients), captured in the various appearances of the
matrix H, have been taken as a preset starting point, when stating the
capacitated problem. Due to technical development in the longer run, or
perturbations such as quality variation and scrap in the shorter run, the
elements of H are not necessarily constant. Consequences of the
uncertainty in H might be an item for further attention.
Remanufacturing and Feedback
An increasingly important feature in modern economies is the question
of the reuse of resources, including remanufacturing and reprocessing,
often called reverse logistics. When examining the physical flows
involved in remanufacturing, there is a natural element of feedback. This
corresponds to product structures with some ingredient disobeying the
strict assembly type of product structure usually assumed in MRP.
Consequences of non-triangular input matrices H constitute a further line
of investigation. Here, we also might study pure disassembly structures,
which come close to the arborescent type of product structure.

116

Setup Times
The case study in Chapter 8 revealed that the finite setup times were of
obvious significance, when taking operational decisions. Inclusion of
setup times, and not only setup costs, is an item of additional interest.
Storage Limitations
Also this study showed, that capacities not only limited flows, but also
stock. Developing consequences of upper limits for storage, etc., would
comprise a natural extension to current MRP theory.
Methodological Developments
Although we have presented an outline for the case of stochastic external
demand in Chapter 7, this treatment is evidently far from being
conclusive. In particular, more attention is needed to investigate the
properties of the state Q in this general case, as well as the description of
how one state leads to a succeeding state and the stochastic properties of
such transitions. Developing suitable numerical examples would be an
important piece of work within this line of research.

117

118

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