Two level supply chain coordination with delay in payments for xed

lifetime products
q
Yongrui Duan

, Jiazhen Huo, Yanxia Zhang, Jianjun Zhang

School of Economics and Management, Tongji University, Shanghai 200092, PR China
a r t i c l e i n f o
Article history:
Received 4 July 2010
Received in revised form 25 September
2011
Accepted 17 April 2012
Available online 27 April 2012
Keywords:
Supply chain management
Delay in payments
Fixed lifetime products
Coordination
a b s t r a c t
In this paper, a single-vendor, single-buyer supply chain system for xed lifetime products is considered
in the settings of both decentralized and centralized models. In the decentralized model, the vendor is the
decision-maker of the supply chain. In particular, we study the coordination between the vendor and the
buyer that allows the buyer to delay his payment in compensation for altering his order size. This policy
has been studied in the literature for the products with unlimited lifetime. In this paper, we focus on the
products with xed and limited lifetime which is common in practice. To evaluate the efciency of the
proposed delay in payments policy, a centralized decision-making problem is modeled, where there is
a common decision-maker for both the vendor and the buyer. We derive analytically tractable solutions
to the proposed models. Furthermore, we prove that the decentralized model can achieve the same min-
imal cost as the centralized model when the vendor and the buyers costs of capital are equal. A detailed
numerical example is presented to illustrate the benet of the proposed delay in payments policy.
2012 Elsevier Ltd. All rights reserved.
1. Introduction and literature review
Most researches on inventory and supply chain management
models assume that stock items can be stored indenitely to meet
future demands. However, certain types of items undergo change
in storage so that they may become partially or entirely unt for
consumption. For example, lysis of red blood cells renders blood
unacceptable for transfusion 21 days after it is drawn. Fresh prod-
ucts, meats and other foodstuffs become unusable after a certain
time. Photographic lms and drugs are further examples of items
which have nite useful lifetime. Due to the nite product lifetime,
an ineffective inventory management at each stage in the supply
chain from manufacturers to customers can lead to high system
cost such as ordering cost and inventory holding cost. Moreover,
there is a risk of product expiration, which will further increase
the cost and decrease customer satisfaction. Kanchana and Anulark
(2006) found that the product lifetime is one of the main factors
that signicantly degrade the system performance.
In the past several decades, there have been many researches on
xed lifetime products. Nahmias (1975) dealt with the optimal
ordering policies for the product with an exact lifetime and devel-
oped convexity and uniqueness results for the nite horizon FLPP
(Fixed-life Perishability Problem). Fries (1975) studied the optimal
ordering policy for a perishable commodity with lifetime l in a
nite-horizon problem with continuous or discrete demands. The
form and properties of the exact optimal policy were presented.
Nandarkumar and Morton (1993) detailed the application of a class
of heuristics to the FLPP formulated by Nahmias (1975) and Fries
(1975), and derived efcient near myopic bounds on the order
quantities for FLPP by casting any periodic inventory problem in
the framework of a newsboy problem. Fujiwara, Soewandi, and Sed-
arage (1997) studied the problemof ordering and issuing policies in
a two-stage distribution systemin controlling nite-life-time fresh-
meat-carcass inventories in the supermarket, where the product is
stored and partially processed into sub-products in the cool-room
(stage I), before being issued to the display shelves (stage II). The
ordering quantity from the outside vendor, and the order-up-to
issuing quantities for each sub-product i were obtained. Liu and
Lian (1999) studied the replenishment problem of an (s, S) continu-
ous review inventory system for product with xed shelf lifetime.
They considered a general renewal demand process and developed
the closed-formresults for the case with back ordering. Hwang and
Hahn (2000) investigated an optimal procurement policy for a
retailer who deals with the xed lifetime items with inventory level
dependent demand rate. Berk and Grler (2008) considered a
continuous-review (Q, r) policy in a perishable inventory system
with Poisson demands, xed shelf lives, constant lead times, and
lost sales. An embedded Markov process approach was introduced
in the model formulation.
However, the above researches mainly addressed single-level
inventory systems. Kanchana and Anulark (2006) investigated a
two-level supply chain system where it is assumed that there is
0360-8352/$ - see front matter 2012 Elsevier Ltd. All rights reserved.
http://dx.doi.org/10.1016/j.cie.2012.04.007
q
This manuscript was processed by Area Editor Alexandre Dolgui.

Corresponding author. Tel.: +86 21 65982807; fax: +86 21 65986304.

E-mail address: yrduan@163.com (Y. Duan).
Computers & Industrial Engineering 63 (2012) 456463
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a common decision-maker for both the vendor and the buyer. They
have a common goal to maximize the benet of the supply chain.
In fact, members of a supply chain are different entities with their
own interests, each decision-maker tends to optimize his/her own
performance, which may lead to an inefcient system. To solve this
problem, a proper mechanism is necessary to enforce the coordina-
tion among parties in the supply chain. Examples of such mecha-
nisms include quantity discount mechanism (Goyal & Gupta,
1989), the payback policy (Emmons & Gilbert, 1998), revenue shar-
ing contract (Giannoccaro & Pontrandolfo, 2004) and delay in pay-
ments policy (Jaber & Osman, 2006).
Among the coordination mechanisms, delay in payments is one
of the commonly used methods in practice. The vendor often offers
the buyer a delay period, known as trade credit period, as a mar-
keting policy to increase sales and reduce on hand stock level. Once
a trade credit is offered, the amount of time that the buyers capital
tied up in stock is reduced, which leads to a reduction in the
buyers holding cost of nance. In addition, during the trade credit
period, the buyer can accumulate revenues by selling items and
earning interests. As a matter of fact, buyers, especially small busi-
nesses which tend to have a limited number of nancing opportu-
nities, rely on trade credit as a source of short-term funds (Liang &
Zhou, 2011). Jaber and Osman (2006) proposed a centralized model
where players in a two-level (supplier-retailer) supply chain coor-
dinate their orders through delay in payments to minimize their
local costs and that of the chain. Chen and Kang (2007) developed
the integrated models for determining the coefcient of negotia-
tion and the maximum delay payment period. Sarmah, Acharya,
and Goyal (2007) studied a coordination mechanism through cred-
it option such that both parties can divide the surplus equitably
after satisfying their own prot targets, and explored two situa-
tions: in the rst situation, both parties have no individual prot
target from the business and there are individual prot targets
for both parties in the second situation.
The present researches on delay in payments have a common
assumption that the lifetime is innite, and are insufcient for
addressing the mostly encountered setting where items have the
xed and limited shelf lives, although the problems associated
with xed lifetime products arise in many areas of the economic
sector. To the best of our knowledge, the research on the supply
chain coordination for xed lifetime products through delay in
payments has not been addressed yet.
In this paper, we deal with the supply chain coordination prob-
lem for items with xed lifetime. The contributions of this paper
are as follows. We propose and analyze the coordination models
for xed lifetime products through delay in payments. The condi-
tions under which the delay in payments policy is applicable for
xed lifetime products are derived. The exact optimal delay in pay-
ments policy including the buyer and the vendors optimal order-
ing quantities as well as the delay period the vendor presenting
to the buyer are obtained. Moreover, we prove that the buyers
ordering quantity with coordination is larger than that without
coordination. The vendors annual cost as well as that of the system
can be reduced no matter how much the parameters change under
the proposed policy. By comparing the optimal policies in the
decentralized and centralized scenarios, we proved that the delay
in payments can achieve the system optimization if both parties
costs of capital are equal.
The rest of this paper is organized as follows. In Section 2, the
decentralized model that minimizes the vendors cost and the cen-
tralized model that minimizes the system cost are formulated. The
analytically tractable solutions to the proposed models are ob-
tained. In addition, the comparison between the centralized and
decentralized models are conducted. In Section 3, the process to
determine the optimal policy is proposed. A numerical example
is presented in Section 4 to illustrate the effectiveness of the pro-
posed policy. The summary and concluding remarks are presented
in the last section.
2. Model formulation
In this section, the decentralized and centralized decision-mak-
ing models for a two-level supply chain of the xed lifetime prod-
ucts are formulated and analyzed. In the decentralized model, the
vendor is the decision-maker of the supply chain, and delay in pay-
ments is adopted as the coordination policy. In this policy, the
buyer is requested to alter his current order size so that the vendor
can benet from lower ordering and inventory holding costs. To
entice the buyer to accept it, a delay period is offered by the vendor
to compensate the buyer for his increased inventory cost, and pos-
sibly provides an additional saving. The objective of the decentral-
ized model is to minimize the vendors cost. In the centralized
model whose objective is to minimize the annual system cost,
there is a common decision-maker for both the vendor and the
buyer. Moreover, the conditions for the decentralized decision-
making to achieve the supply chain optimization are obtained.
Some of the common assumptions are made in our analysis
which had been used in some researches (see, for example, Mona-
han, 1984; Lee & Rosenblatt, 1986; Goyal & Gupta, 1989; Lu, 1995;
Wang & Wang, 2005).
(i) The annual number of items demanded by the nal consum-
ers is assumed to be constant, and the demand has to be ful-
lled without backlogging. For xed lifetime products, such
as bread, milk and beverages, the customers would not pur-
chase until the products are to be used up. If stock-out hap-
pens, most of themare not willing to wait for the backlogged
items, but buy the substitute products or go to other retail-
ers. Meanwhile, the difculty in estimating costs caused by
shortage is well recognized in the inventory literature (Abad,
2003). In fact, these costs include not only the loss of prot
but also other opportunity costs such as the costs induced by
the declined demand in the following periods and the loss of
goodwill, which are both difcult to evaluate in practice. In
addition, because the demand is assumed to be constant in
this paper, shortage can be eliminated by increasing the
ordering quantity.
(ii) We assume that replenishment is instantaneous and lead
time is negligible for the vendor and the buyer. As stated
in Lee and Rosenblatt (1986), if the lead time is constant,
such an assumption is equivalent to the vendor or buyers
placing an order in advance by a period exactly equal to
the lead time.
(iii) We adopt the assumption in Hwang and Hahn (2000) that all
items ordered by the vendor arrive new and fresh, that is,
their age equals zero. Moving to the more realistic case that
the arrived items have positive age denoted by l, only
involves replacing the product lifetime L by L = L l in the
following analysis. Since l is exogenous, the general case
leads to the same conclusions. The notations used in this
paper are as follows:
D denotes the constant demand rate;
p
1
and p
2
denote the delivered unit price paid by the vendor
and the buyer;
A
1
and A
2
denote the vendor and the buyers set up costs;
i
1
and i
2
denote the vendor and the buyers costs of capital;
h
1
and h
2
denote the vendor and the buyers unit holding
costs;
Q
0
is the buyers EOQ;
t
0
is the order cycle of the buyer in the absence of any coor-
dination and t
0
= Q
0
/D;
Y. Duan et al. / Computers & Industrial Engineering 63 (2012) 456463 457
m denotes the vendors order multiple in the absence of any
coordination;
K denotes the buyers order multiple in the presence of coor-
dination, KQ
0
is the buyers new order quantity;
T(K) denotes the delay period to the buyer if he orders KQ
0
every time;
n denotes the vendors order multiple in the presence of
coordination;
L denotes the lifetime of the product.
2.1. Model formulation for decentralized decision-making system
In this subsection, the decentralized supply chain decision-
making problem is addressed. Models with and without coordina-
tion are proposed and analyzed.
2.1.1. Decentralized model without coordination
In the absence of any coordination, the buyers ordering quan-
tity is simply the EOQ, i.e. Q
0

2DA
2
h
2
_
, with the annual cost
TC
b

2DA
2
h
2
_
. Since the buyers ordering quantity is xed at
Q
0
, the vendor is faced with a stream of demands, each with order
size Q
0
, and at xed intervals of t
0

2A
2
Dh
2
_
. Given such a stream of
demands, the vendors economic ordering quantity should be some
integer multiple of Q
0
(Lee & Rosenblatt, 1986). Let mQ
0
denote the
vendors ordering quantity where m is a positive integer.
The vendors average inventory held up per year is:
m 1Q
0
m 2Q
0
Q
0
0Q
0
=m m 1Q
0
=2:
Hence, the annual cost for the vendor is given by
TC
v
m
A
1
D
mQ
0
h
1
m 1Q
0
2
:
The vendors problem without coordination can be formulated
as follows:
min TC
v
m
A
1
D
mQ
0
h
1
m1Q
0
2
s:t:
mQ
0
D
6 L
m P1 is an integer;
_
1
where the rst constraint of (1) is to ensure that the products will
not overdue before they are sold out.
Substituting Q
0
into (1), we have
min TC
v
m
A
1
m

Dh
2
2A
2
_
m1h
1

DA
2
2h
2
_
s:t:
m

2A
2
Dh
2
_
6 L
m P1 is an integer:
_
Theorem 1. Let m

be the optimum of (1). If L P

2A
2
Dh2
_
, then
m

minfm

1
; m

2
g; 2
where m

1
min
mP1
TC
v
m

1
4

A
1
h
2
A
2
h
1
_

1
2
_ _
; m

2
L

Dh
2
2A
2
_ _ _
; dxe de-
notes the least integer greater than or equal to x, [x] denotes the integer
part of x.
Proof. It is easy to verify that TC
v
(m) is strictly convex in m, hence
m

1
maxfminfmjTC
v
m1 PTC
v
mg; 1g: 3
By (3),
A
1
m 1

Dh
2
2A
2

mh
1

DA
2
2h
2

P
A
1
m

Dh
2
2A
2

m 1h
1

DA
2
2h
2

;
i.e.,
h
1

DA
2
2h
2

P
A
1
mm 1

Dh
2
2A
2

:
By a simple calculation, we have
m P

1
4

A
1
h
2
A
2
h
1

1
2
> 0:
Hence

1
4

A
1
h
2
A
2
h
1
_

1
2
_ _
P1; m

1
4

A
1
h
2
A
2
h
1
_

1
2
_ _
. By L
2
P
2A
2
Dh
2
, we
have m

2
L

Dh
2
2A
2
_ _ _
P1. Since TC
v
(m) is convex in m, if m

1
6 m

2
,
then m

1
; else if m

1
> m

2
, then m

2
. Hence,
m

minfm

1
; m

2
g. The proof of Theorem 1 is complete. h
Theorem 1 demonstrates that in the absence of any coordina-
tion, the vendor places orders with an interval of m

2A
2
Dh
2
_
, and
the order size every time is m

2DA
2
h
2
_
. The annual optimal cost is
TC
v
(m

).
In Theorem 1, L P

2A
2
Dh
2
_
is to guarantee the EOQ model is appli-
cable and efcient to the buyer, and the items are not overdue be-
fore sold out. In fact, if L <

2A
2
Dh
2
_
, then by the convexity of TC
b
, the
buyers optimal ordering period should be L. In this case, the delay
in payments policy is not applicable any more. In addition, if L = 1,
then L P

2A
2
Dh
2
_
holds no matter how much other parameters
change. In this case, m

1
, the problem is reduced to that for
products with innite lifetime.
2.1.2. Decentralized model with coordination
In this subsection, we will investigate the decentralized deci-
sion-making model where delay in payments policy is introduced.
In this policy, the vendor requests the buyer to alter his current
EOQ by a factor K(K > 0), and the vendors order size (nKQ
0
) is an-
other integer multiple of the buyers new ordering quantity KQ
0
such that the vendor can benet from lower ordering and inven-
tory holding costs. To entice the buyer to accept this policy, the
vendor offers a delay period to the buyer to compensate him for
his increased inventory cost, and possibly provides an additional
saving, where the delay period T(K) is dependent on the buyers or-
der size. Here, n, K and T(K) are all variables to be determined.
The vendors annual cost TC
v
n; K is composed of three parts:
(i) the ordering cost which is equal to
A
1
D
nKQ
0
;
(ii) the inventory cost which is equal to
n1KQ
0
h
1
2
;
(iii) the lost opportunity returns which is equal to p
2
DT(K)i
1
.
By (i)(iii),
TC
v
n; K
A
1
D
nKQ
0

n 1KQ
0
h
1
2
p
2
DTKi
1
The buyers increasedcost due to the increased ordering quantity
is
DA
2
KQ
0

KQ
0
h
2
2

2DA
2
h
2
_
, and his total interest savings on the money
payable during the delay period is p
2
DT(K)i
2
. Thus the problem can
be formulated as the following mathematical programming:
min TC
v
n; K
s:t:
nK
Q
0
D
6 L
DA
2
KQ
0
KQ
0
h
2
=2

2DA
2
h
2
_
6 p
2
DTKi
2
n P1:
_

_
4
458 Y. Duan et al. / Computers & Industrial Engineering 63 (2012) 456463
The rst constraint is to ensure the items are not overdue before
they are used up (sold up). The second constraint is the buyers
participation constraint, i.e. the buyers cost in the presence of
coordination cannot exceed that in the absence of any
coordination.
Theorem 2. Let m

, K

and n

be the optimum of (2) and (4)

respectively, then
TC
v
n

; K

6 TC
v
m

: 5
Proof. Since TC
v
n; K is increasing in T(K), it is obvious that
TC
v
n; K is minimized only if the second constraint is an equation,
i.e.,
DA
2
KQ
0

KQ
0
h
2
2

2DA
2
h
2
_
p
2
DTKi
2
;
so
TK
K
1
K
2

DA
2
h
2
2
_
p
2
Di
2
: 6
Furthermore, it is easy to verify that T(1) = 0, and (4) is reduced
to (2) if K = 1, so (5) holds. The proof of Theorem 2 is complete. h
By the proof of Theorem 2, the buyers cost with cooperation is
the same as that without cooperation, the vendors annual cost as
well as that of the system can be reduced no matter how much the
parameters change under the proposed policy. In this case, the
vendor will usually provide the buyer an additional saving (in %)
of 100a over the vendors increased prot TC
v
m

TC
v
n

; K

.
Note that a is determined through the negotiation between the
vendor and the buyer, which is generally dependent upon the
existing balance of power between them.
For items with innite lifetime, the second constraint of (4)
holds obviously for large T. It is possible that TC
v
n; K is minimized
when both T(K) and K are very large, which is meaningless in prac-
tice. Hence, for items with innite lifetime, an upper bound T
needs to be set on delay period T. But for items with nite lifetime,
the rst constraint of (4) ensures that K will not be very large. By
(6), T will not be very large, either. The upper bound on T is not
necessary any more.
Next, we will determine the vendor and the buyers optimal
ordering quantities.
Substituting (6) and Q
0

2DA
2
=h
2
_
into (4), yields
TC
v
n; K
A
1
nK

Dh
2
2A
2

n1Kh
1

DA
2
2h
2

i
1
i
2
K
1
K
2

DA
2
h
2
2
_
: 7
It is easy to verify that TC
v
n; K is convex in K, so the optimal K

is determined by
@TC
v
n; K
@K

A
1
n

Dh
2
2A
2

1
K
2
n 1h
1

DA
2
2h
2

i
1
i
2

DA
2
h
2
2
_
1
1
K
2

0:
Hence,
K

A
1
nA
2

i
1
i
2
n 1
h
1
h
2

i
1
i
2

_
: 8
Because the credit period T(K) is sufcient to entice the buyer to
boost his order by a factor K, Eq. (8) indicates that the cost mini-
mizing vendor should inform his buyer that the only credit period
available is to order K

times as large as his current order. The cor-

responding credit period is that value found by substituting K

into
(6).
By (8), it is straightforward that K

is decreasing in n for n P1.

In particular, if the vendor adopts the lot-for-lot policy, i.e. n = 1,
then the buyers order multiple is K

n 1

A
1
i
2
A
2
i1
1
_
. The
buyers ordering quantity will increase, except in the unusual case
where the vendors ordering cost or the buyers capital cost is zero.
In fact, if the vendors ordering cost is zero, then the vendor will
not stimulate the buyer to boost his order quantity. If the buyers
capital cost is zero, the credit period is not useful for the buyer
any more. In this case, the buyer is not willing to change his order-
ing quantity or accept delay payment incentive.
Clearly, when A
1
is much greater than A
2
or i
2
is much greater
than i
1
, the buyers order multiple will be very large. This is most
likely to occur in circumstances where the vendor produces the
items internally, and hence must include manufacturing set-up
costs, as well as order processing costs in his determination of size
of A
1
(Monahan, 1984), or when the buyer has much more invest-
ment information and channel than the vendor.
In the next, we will determine the vendors optimal order multi-
ple. Substituting (8) and Q
0

2DA
2
h
2
_
into nK
Q
0
D
6 L, we have
n

A
1
n

Dh
2
2A
2
_

i
1
i
2

DA
2
h
2
2
_
n 1h
1

DA
2
2h
2
_

i
1
i
2

DA
2
h
2
2
_

2A
2
Dh
2

6 L; 9
i.e.,
n
2 A
1
A
2
n

i
1
i
2
_ _
2A
2
n 1
h
1
h
2

i
1
i
2
Dh
2
6 L
2
: 10
Setting
gn
2A
2
i
1
i
2
n
2
L
2
Dh
1
2A
1
n L
2
D
h
2
i
1
i
2
h
1
_ _
; 11
(10) is equivalent to g(n) P0. Substituting (8) into TC
v
n; K, we
obtain
TC
v
n 2

n1h
1

DA
2
2h
2
_

i
1
i
2

DA
2
h
2
2
_
_ _
A
1
n

Dh
2
2A
2
_

i
1
i
2

DA
2
h
2
2
_
_ _

i
1
i
2

2DA
2
h
2
_
:
12
By (11) and (12), (4) is equivalent to
min TC
v
n 2

n1h
1

DA
2
2h
2
_

i
1
i
2

DA
2
h
2
2
_
_ _
A
1
n

Dh
2
2A
2
_

i
1
i
2

DA
2
h
2
2
_
_ _

i
1
i
2

2DA
2
h
2
_
s:t:
gn P0
nP1:
_
13
Since

x
p
is a strictly increasing function for x P0, (13) is equiv-
alent to the following problem:
min

TC
v
n n 1h
1

DA
2
2h
2
_

i
1
i
2

DA
2
h
2
2
_
_ _
A
1
n

Dh
2
2A
2
_

i
1
i
2

DA
2
h
2
2
_
_ _
s:t:
gn P0
n P1
_
14
In the following, the properties of

TC
v
n and g(n) will be
discussed.
Y. Duan et al. / Computers & Industrial Engineering 63 (2012) 456463 459
Proposition 1. Let n

1
be the minimum of

TC
v
n for n P1, then
n

A
1
A
2
h
2
h
1

i
2
i
1
_ _

1
4
_

1
2
_ _
;
A
1
A
2
h
2
h
1

i
2
i
1
_ _

1
4
> 0
1; otherwise
_
_
_
15
Proof. Since n

1
is the minimum of

TC
v
n for n P1, the following
inequality holds:

TC
v
n

1
_ _
6 minf

TC
v
n

1
1
_ _
;

TC
v
n

1
1
_ _
g:
By

TC
v
n

1
_ _

TC
v
n

1
1
_ _
A
1
h
1

i
1
h
2
A
1
i
2
_ _
1
n

1
n

1
1

h
1
A
2
i
1
i
2
6 0,
we have
n

1

1
2
_ _
2
6
A
1
A
2
h
2
h
1

i
2
i
1
_ _

1
4
: 16
Similarly, by

TC
v
n

1
_ _

TC
v
n

1
1
_ _
6 0, we have
n

1

1
2
_ _
2
P
A
1
A
2
h
2
h
1

i
2
i
1
_ _

1
4
: 17
If
A
1
A
2
h
2
h
1

i
2
i
1
_ _

1
4
6 0, then by (17),

TC
v
n 6

TC
v
n 1 for every
n, so n

1
1. If
A
1
h
2
h
1

A
2
h
1

1
4
> 0, from (16) and (17), we obtain

A
1
A
2
h
2
h
1

i
2
i
1
_ _

1
4

1
2
6 n 6

A
1
A
2
h
2
h
1

i
2
i
1
_ _

1
4

1
2
;
n

A
1
A
2
h
2
h
1

i
2
i
1
_ _

1
4
_

1
2
_ _
P1. Hence, (15) holds. The proof of
Proposition 1 is complete. h
Proposition 2. Let n

21
and n

22
be solutions of quadratic equation
g(n) = 0. If L
2
P
2A
2
Dh
2

2A
1
Dh
1
and
h
2
h
1
P
i
2
i
1
, then n

21
_
P1 and g(n) P0
for 1 6 n 6 n

21
_
.
Proof. By a simple computation, we have
n

21

L
2
Dh
1
2A
1

L
2
Dh
1
2A
1

8A
2
i
1
i
2
L
2
D
h
2
i
1
i
2
h
1
_ _
_
4A
2
i
1
i
2
n

22

L
2
Dh
1
2A
1

L
2
Dh
1
2A
1

8A
2
i
1
i
2
L
2
D
h
2
i
1
i
2
h
1
_ _
_
4A
2
i
1
i
2
and g(n) P0 for n

22
_ _
6 n 6 n

21
_
. Since n P1 and g(n) P0 in (14),
it makes sense only if n

21
P1, i.e.

L
2
Dh
1
2A
1

8A
2
i
1
i
2
L
2
D
h
2
i
1
i
2
h
1
_ _

P
4A
2
i
1
i
2
L
2
Dh
1
2A
1
:
By simplication, we have
L
2
Dh
2
i
1
i
2
P
2A
2
i
1
i
2
2A
1
: 18
So if
h
2
h
1
P
i
2
i
1
and L
2
P
2A
2
Dh
2

2A
1
Dh
1
, (18) holds obviously. As a result,
n

21
_
P1, and g(n) P0 for 1 6 n 6 n

21
_
. h
In Proposition 2, L
2
P
2A
2
Dh
2

2A
1
Dh
1
and
h
2
h
1
P
i
2
i
1
are to ensure that (14)
has the feasible solutions. Otherwise, (14) is meaningless. In this
case, the vendors optimal order multiple does not exists, and delay
in payments policy is not applicable any more. By the proof of
Proposition 2, if the lifetime of products is not considered in the
model formulation, i.e. L = 1, then (18) holds in any case, and
(14) is meaningful no matter how much the parameters change.
The delay in payments is applicable in any case.
Theorem 3. If
h
2
h
1
P
i
2
i
1
and L
2
P
2A
2
Dh
2

2A
1
Dh
1
, then
n

minfn

1
; n

21
_
g: 19
Proof. It is easy to verify that

TC
v
n is convex if
h
2
h
1
P
i
2
i
1
. Further-
more,

TC
v
n is increasing in n for n Pn

1
and decreasing in n for
n < n

1
. Hence, if n

1
6 n

21
_
; n

1
; else n

21
_
. The proof of
Theorem 3 is complete. h
It is straight forward that n

21
is strictly increasing in L, so n

is
non-decreasing in L. The longer the lifetime is, the larger the ven-
dors order multiple is. Furthermore, if L is large enough, then
n

1
6 n

21
_
and n

1
. In fact, if L is very large, the second con-
straint of (4) is not useful any more, and (4) is reduced to the delay
in payments model for the innite lifetime items.
Theorem 4. If
h2
h
1
P
i2
i
1
, and L
2
P
2A2
Dh
2

2A1
Dh
1
, then K(n

) > 1.
Proof. By (8), to prove K(n

) > 1, we only need to prove

A
1
n

Dh
2
2A
2

i
1
i
2

DA
2
h
2
2
_
> n 1h
1

DA
2
2h
2

i
1
i
2

DA
2
h
2
2
_
;
which is equivalent to
n
1
2
_ _
2
<
A
1
h
2
A
2
h
1

1
4
:
Since n P1, it is reduced to n <

A
1
h
2
A
2
h
1

1
4
_

1
2
. Hence, if
n <

A
1
h
2
A
2
h
1

1
4
_

1
2
, then K > 1. In fact, by (15) and (19), if
h
2
h
1
P
i
2
i
1
, and
L
2
P
2A
2
Dh
2

2A
1
Dh
1
; n

<

A
1
h
2
A
2
h
1

1
4
_

1
2
, so K(n

) > 1. The proof of Theorem

4 is complete. h
In Theorem 4,
h
2
h
1
P
i
2
i
1
and L
2
P
2A
2
Dh
2

2A
1
Dh
1
are to ensure that there
exists n

21
P1 satisfying the rst constraint of (4). Furthermore,
from Theorem 4, if the delay in payments is applicable, then the
buyers order size in the presence of coordination is larger than
that in the absence of any coordination.
2.2. Model formulation for centralized decision-making system
In Subsection 2.1, the coordination policy in a decentralized
decision-making scenario is considered. Under the proposed pol-
icy, the vendors inventory cost can be reduced while the buyers
cost remains the same. In this section, the centralized decision-
making model with the common decision-maker is proposed. Fur-
thermore, we will examine whether the decentralized contract
proposed in last section can optimize the supply chain and achieve
a winwin outcome.
If there is a common decision-maker for both the buyer and the
vendor, the objective is to minimize the annual cost of the system.
Let Q be the buyers ordering quantity, then the vendor orders
nQ every time, where Q and n are both decision variables. The mod-
el for centralized decision-making can be formulated as follows:
min TC
s
n; Q
DA
1
nQ

n1Qh
1
2

DA
2
Q

Qh
2
2
s:t:
n
Q
D
6 L
n P1:
_
20
460 Y. Duan et al. / Computers & Industrial Engineering 63 (2012) 456463
Theorem 5. If i
1
= i
2
, the proposed delay in payments policy can
achieve the system optimization.
Proof. It is obvious that TC
s
(n, Q) is convex in Q. Let Q

be the
buyers optimal ordering quantity, then Q

satises
@TC
s
n; Q
@Q
j
QQ

DA
1
n
DA
2
_ _
1
Q
2

n 1h
1
h
2
2
0; 21
and
Q

2
DA
1
n
DA
2

n 1h
1
h
2

: 22
Substituting (22) into (20), yields
min TC
s
n

2DA
1
h
1

DA
1
h
2
h
1

n
DA
2
h
1
n DA
2
h
2
h
1

_
s:t:
A
2
n
2

L
2
Dh
1
2
A
1
_ _
n
L
2
D
2
h
2
h
1
P0
n P1:
_
23
Since

x
p
is strictly increasing for x P0, (23) is equivalent to the fol-
lowing problem:
min

TC
s
n DA
1
h
1

DA
1
h
2
h
1

n
DA
2
h
1
n DA
2
h
2
h
1

s:t:
A
2
n
2

L
2
Dh
1
2
A
1
_ _
n
L
2
D
2
h
2
h
1
P0
n P1:
_
24
It is obvious that (14) is exactly equivalent to (24) if i
1
= i
2
, so
the optimal solution of (14) and (24) are the same. By (13) and
(23),
TC
s
n

TC
v
n

2DA
2
h
2
_
; 25
where

2DA
2
h
2
_
is the buyers annual cost without any coordina-
tion. Furthermore, by (8) and (24), if i
1
= i
2
, the buyers optimal
ordering quantity of the decentralized coordination system is equal
to that of the centralized system, i.e.,
K

Q
0
Q

: 26
The vendors optimal ordering quantity is also the same in these
two scenarios, i.e.,
n

Q
0
n

: 27
By (25)(27), delay in payments policy can achieve the system opti-
mization if i
1
= i
2
.
Table 1
Sample computing results for D = 150,000, L = 0.2, a = 0.5, p
2
= 5.
h
1
h
2
i
1
i
2
n

(n

) T(K

) MTC VS (%) RS (%)

6 8 0.06 0.07 1 2.962731 0.105077 1516.912 4.802772 8.938492
6 8 0.07 0.07 2 1.573592 0.016896 910.6899 2.883381 5.366292
6 8 0.08 0.07 2 1.537784 0.015198 790.5115 2.502878 4.658134
6 8 0.09 0.07 2 1.506322 0.013753 682.0831 2.159577 4.019213
6 8 0.10 0.07 2 1.478443 0.012512 583.7013 1.848086 3.439493
6 8 0.11 0.07 2 1.453554 0.011437 493.9865 1.564035 2.910844
6 8 0.12 0.07 2 1.431192 0.010498 411.8077 1.303845 2.4266
6 8 0.13 0.07 2 1.410981 0.009674 336.2272 1.064546 1.981238
6 8 0.14 0.07 2 1.392621 0.008945 266.4606 0.843654 1.570134
6 8 0.15 0.07 2 1.375865 0.008298 201.8459 0.639074 1.189388
6 8 0.1 0.04 3 1.086534 0.000975 127.0771 0.402345 0.748809
6 8 0.1 0.05 2 1.392621 0.012523 266.4606 0.843654 1.570134
6 8 0.1 0.06 2 1.43839 0.012597 438.4247 1.388118 2.583442
6 8 0.1 0.07 2 1.478443 0.012512 583.7013 1.848086 3.439493
6 8 0.1 0.08 2 1.5313825 0.012332 708.188 2.242229 4.173038
6 8 0.1 0.09 2 1.545335 0.012096 816.1349 2.584005 4.809121
6 8 0.1 0.10 2 1.573592 0.011827 910.6899 2.883381 5.366292
6 8 0.1 0.11 1 2.886751 0.063416 1237.855 3.919234 7.294131
6 8 0.1 0.12 1 3 0.062854 1649.916 5.223881 9.722222
6 8 0.1 0.13 1 3.109126 0.062258 2025.489 6.413003 11.93531
5 8 0.1 0.07 3 1.16746 0.001941 318.6852 1.081653 1.877871
6 8 0.1 0.07 2 1.478443 0.012512 583.7013 1.848086 3.439493
6.5 8 0.1 0.07 2 1.457681 0.011613 724.7722 2.220179 4.270761
7 8 0.1 0.07 2 1.43777 0.010772 871.2342 2.584849 5.133797
7.5 8 0.1 0.07 2 1.418654 0.009984 1022.869 2.942147 6.027315
8 8 0.1 0.07 2 1.40028 0.009247 1179.474 3.292161 6.950117
8.5 8 0.1 0.07 1 2.380476 0.064695 1709.804 4.635197 10.07512
9 8 0.1 0.07 1 2.380476 0.064695 2181.209 5.765784 12.85289
9.5 8 0.1 0.07 1 2.380476 0.064695 2446.374 6.377317 14.41539
10 8 0.1 0.07 1 2.380476 0.064695 2711.539 6.972172 15.97789
6 6 0.1 0.07 2 1.40028 0.008008 1021.454 3.292161 6.950117
6 6.5 0.1 0.07 2 1.422998 0.009159 890.0559 2.860344 5.818477
6 7 0.1 0.07 2 1.443376 0.010295 775.3189 2.481413 4.88405
6 7.5 0.1 0.07 2 1.461763 0.011414 674.0148 2.146355 4.101923
6 8 0.1 0.07 2 1.478443 0.012512 583.7013 1.848086 3.439493
6 8.5 0.1 0.07 2 1.493644 0.01359 502.4973 1.580955 2.872586
6 9 0.1 0.07 2 1.507557 0.014647 428.9304 1.340407 2.382946
6 9.5 0.1 0.07 2 1.520341 0.015683 361.8317 1.122725 1.956562
6 10 0.1 0.07 3 1.178511 0.002443 397.3219 1.1223807 2.09407
6 11 0.1 0.07 3 1.203755 0.003268 470.1221 1.430476 2.362453
6 12 0.1 0.07 3 1.226078 0.004126 356.3112 1.082718 1.714303
6 13 0.1 0.07 3 1.24597 0.005002 261.0064 0.790817 1.206503
6 14 0.1 0.07 3 1.263813 0.005887 180.1322 0.543543 0.802372
Y. Duan et al. / Computers & Industrial Engineering 63 (2012) 456463 461
By Theorem 5, the decentralized delay in payment model
proposed in this paper can achieve the same minimal cost as the
centralized model when the vendor and the buyers costs of capital
are equal. h
3. Algorithm
By the results derived in Section 2, the process for solving the
optimization problem is summarized as follows:
Step 1: Input the initial value D, A
1
, A
2
, h
1
, h
2
, a, i
1
, i
2
.
Step 2: If L
2
D P
A
2
h
2
, set m

as in (2), and compute TC

v
(m

) as in (1),
TC
b

2DA
2
h
2
_
, then goto Step 3, else stop.
Step 3: If
h
2
h
1
P
i
2
i
1
and
L
2
D
2
P
A
2
h
2

A
1
h
1
, then set n

as in (19), goto Step 4;

else stop.
Step 4: Compute K

= K

(n

), T(K

) and TC
v
n

, as in (8), (6) and

(12).
4. Numerical example
In this section, we present the following example to illustrate
the benet of the proposed policy and examine the implications
of the change in the value of the parameters. Let a be the percent-
age of the vendors decreased cost which the vendor shares with
the buyer. The value of a generally reects the negotiation power
between the vendor and the buyer and is usually determined in
a negotiation process.
GivenD= 150,000units per year, a = 0.5, p
2
= 5$ per unit, L = 0.2 year,
A
1
= 200$ per order, A
2
= 30 per order. The different values of i
1
, i
2
, h
1
and
h
2
are as speciedinthe rst 4rows inTable 1. Byapplying the algorithm
giveninSection3, n

, K

(n

), T

(K

), the buyers savings inpercentage (BS)

and the vendors savings in percentage (VS) are as shown in Table 1,
where BS
aTCv m

TCv n

TC
b
; VS
1aTCv m

TCv n

TCv m

.
(1) Set h
1
= 6$ per unit per year, h
2
= 8$ per unit per year,
i
2
= 0.07 per $. As shown in Fig. 1, both the vendor and the
buyers savings in percentage are decreasing in i
1
. Further-
more, by taking different i
2
, both BS and VS are increasing
in
i
2
i
1
. In fact, when
i
2
i
1
is larger, the vendor and the buyer will
have greater incentive to cooperate. As shown in Fig. 2, the
similar results are obtained when i
1
= 0.1 and i
2
changes
from 0.04 to 0.13.
(2) Set i
1
= 0.1 per $, i
2
= 0.07 per $, h
2
= 8$ per unite per year. As
shown in Fig. 3, when h
1
changes from 5 to 10, BS and VS are
both increasing. In fact, if h
1
increases, the vendor will prefer
to provide a longer credit period to inspire the buyer to order
more, so that his holding cost can be reduced. Meanwhile,
Fig. 1. The vendor and retailers savings when i
1
changing.
Fig. 2. The vendor and retailers savings when i
2
changing.
Fig. 3. The vendor and retailers savings when h
1
changing.
1
Fig. 4. The vendor and retailers savings when h
2
changing.
462 Y. Duan et al. / Computers & Industrial Engineering 63 (2012) 456463
the buyer can gain more interest savings to compensate his
increased holding cost. Furthermore, as h
1
increasing, the
vendor will order less to reduce the holding cost. The com-
puting results in Table 1 also indicate that K

and T

(K

)
are both increasing in h
1
, but the vendors optimal ordering
quantity multiple n

is decreasing in h
1
. By Fig. 4, as h
2
increasing, BS and VS both decrease. In fact, when h
2
is lar-
ger, the buyer will order fewer to reduce his holding cost.
The results in Table 1 also indicate that K

and T

(K

) both
decrease as h
2
increasing, but the vendors optimal ordering
quantity n

Q is increasing in h
2
.
From Figs. 14, the following conclusions can be drawn:
(i) Both the vendor and the buyers savings in percentage are
increasing in h
1
, and decreasing in h
2
. Hence, if the vendors
holding cost is relatively high, the vendor and the buyer can
both gain much by coordination. If the buyers holding cost
is high, both parties cannot gain much by coordination.
(ii) Both the vendor and the buyers savings in percentage are
decreasing in i
1
, and increasing in i
2
. Hence, if the buyers cost
of capital is relatively high, the system can gain much by
coordination. However, if the vendors cost of capital is rela-
tively high, the system cannot gain much by coordination.
5. Conclusions
In this paper, the supply chain coordination policy by delay in
payments for the products with xed lifetime is modeled, and ana-
lytically tractable solutions are obtained. The condition under
which the delay in payments policy is applicable is presented,
which is to ensure that the items are not overdue before sold
out. By comparing the models with and without coordination, we
prove that the buyers order size is larger at cooperation against
non-cooperation (K > 1) whenever the delay in payments policy
is applicable (the model is meaningful if h
2
Ph
1
and
L
2
P
2A
2
Dh
2

2A
1
Dh
1
). The vendors annual cost as well as that of the total
system can be reduced no matter how much the parameters
change. Thus, the vendor can not only compensate the buyer for
his increased inventory cost by offering an order size dependent
delay period, but also provide the buyer with an additional saving
of aTC
v
n

TC
v
m

, where a is determined through the nego-

tiation between the vendor and the buyer, and is generally depen-
dent on the existing balance of the power between them. To
validate the efciency of the proposed delay in payments policy,
the system optimization problem under the centralized decision-
making scenario is modeled. We prove that delay in payments
incentive can achieve the system optimization and a winwin out-
come if the vendor and the buyers costs of capital are equal, that
is, i
1
= i
2
. As a result, both the vendor and the buyer will benet
in the long run. A numerical example is conducted to illustrate
the performance of the policy and examine the implications of
the change in the value of parameters. Moreover, the sensitive
analysis on the parameters indicates that the cost can be reduced
signicantly if the vendors holding cost or the buyers cost of cap-
ital is relatively high; the reduction in the cost is insignicant if the
buyers holding cost or the vendors cost of capital is relatively
high.
Acknowledgements
This work is supported by the National Natural Science Founda-
tion of China (71002020, 70832005), the Fundamental Research
Funds for the Central Universities and the Innovation Program of
Shanghai Municipal Education Commission (09ZS39). The authors
will give great appreciation to the Area Editor and anonymous
referees for their valuable recommendations and comments.
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