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The average-cost formulation of lot sizing models and inventory carrying charges: a technical note

Author

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  • Davide Castellano

    (Università degli Studi di Napoli “Federico II”)

  • Christoph H. Glock

    (Technical University of Darmstadt)

Abstract

It is generally recognised that the present-value criterion should be preferred to the average-cost formulation in developing lot sizing models. Despite the advantages of the present-value measure, average-cost lot sizing models are far more widely applied. Because of the nature of the average-cost formulation, inventory carrying costs are evaluated according to a look-back approach, relying on historical values. In this regard, a general misconception in the inventory management literature concerned with average-cost models is that the unit stockholding cost rate should be established considering fixed warehouse costs, which are costs that are, in the short term, independent of the inventory level. This paper develops arguments supporting our belief that inventory carrying charges used in lot sizing models should take into account only those costs varying with the inventory level in the warehouse, and that considering fixed warehouse costs leads to pitfalls when making inventory replenishment decisions. To this aim, we first present an analytical treatment based on the classical Economic Order Quantity (EOQ) model, as its full analytical tractability permits us to better discuss the problem we are interested in. Finally, we present numerical experiments to assess the effect of the correct procedure to establish the unit stockholding cost rate on inventory management decisions. These experiments are performed considering warehouse costs taken from some industrial case studies presented in the literature.

Suggested Citation

  • Davide Castellano & Christoph H. Glock, 2021. "The average-cost formulation of lot sizing models and inventory carrying charges: a technical note," Operations Management Research, Springer, vol. 14(1), pages 194-201, June.
  • Handle: RePEc:spr:opmare:v:14:y:2021:i:1:d:10.1007_s12063-021-00191-2
    DOI: 10.1007/s12063-021-00191-2
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    References listed on IDEAS

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    1. Andriolo, Alessandro & Battini, Daria & Grubbström, Robert W. & Persona, Alessandro & Sgarbossa, Fabio, 2014. "A century of evolution from Harris׳s basic lot size model: Survey and research agenda," International Journal of Production Economics, Elsevier, vol. 155(C), pages 16-38.
    2. Glock, C. H., 2014. "Produktion und Supply Chain Management. Eine Einführung," Publications of Darmstadt Technical University, Institute for Business Studies (BWL) 66208, Darmstadt Technical University, Department of Business Administration, Economics and Law, Institute for Business Studies (BWL).
    3. Glock, Christoph H. & Grosse, Eric H. & Ries, Jörg M., 2014. "The lot sizing problem: A tertiary study," International Journal of Production Economics, Elsevier, vol. 155(C), pages 39-51.
    4. Grubbstrom, Robert W. & Thorstenson, Anders, 1986. "Evaluation of capital costs in a multi-level inventory system by means of the annuity stream principle," European Journal of Operational Research, Elsevier, vol. 24(1), pages 136-145, January.
    5. Glock, C. H. & Grosse, E. H. & Ries, J. M., 2014. "The Lot Sizing Problem: A Tertiary Study," Publications of Darmstadt Technical University, Institute for Business Studies (BWL) 63361, Darmstadt Technical University, Department of Business Administration, Economics and Law, Institute for Business Studies (BWL).
    6. Teunter, Ruud H. & van der Laan, Erwin & Inderfurth, Karl, 2000. "How to set the holding cost rates in average cost inventory models with reverse logistics?," Omega, Elsevier, vol. 28(4), pages 409-415, August.
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    Cited by:

    1. Debabrata Das & Sameer Kumar & Nirmal Baran Hui & Vipul Jain & Charu Chandra, 2023. "Pricing and revenue-based outsourcing strategies in a multi-echelon lot-sizing model under insufficient production capacity," Journal of Revenue and Pricing Management, Palgrave Macmillan, vol. 22(6), pages 514-530, December.
    2. Parisa Rafigh & Ali Akbar Akbari & Hadi Mohammadi Bidhandi & Ali Husseinzadeh Kashan, 2022. "A sustainable supply chain network considering lot sizing with quantity discounts under disruption risks: centralized and decentralized models," Journal of Combinatorial Optimization, Springer, vol. 44(3), pages 1387-1432, October.

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