Production-Inventory Systems with Lost Sales and Compound Poisson Demands

This paper considers a continuous-review, single-product production-inventory system with a constant replenishment rate, compound Poisson demands and lost-sales. Two objective functions that represent metrics of operational costs are considered: (1) the sum of the expected discounted inventory holding costs and lost-sales penalties, both over an infinite time horizon, given an initial inventory level; and (2) the long-run time average of the same costs. The goal is to minimize these cost metrics with respect to the replenishment rate. It is, however, not possible to obtain closed form expressions for the aforementioned cost functions directly in terms of positive replenishment rate (PRR). To overcome this difficulty, we construct a bijection from the PRR space to the space of positive roots of Lundberg’s fundamental equation, to be referred to as the Lundberg Positive Root (LPR) space. This transformation allows us to derive closed form expressions for the aforementioned cost metrics with respect to the LPR variable, in lieu of the PRR variable. We then proceed to solve the optimization problem in the LPR space, and finally recover the optimal replenishment rate from the optimal LPR variable via the inverse bijection. For the special cases of constant or loss-proportional penalty and exponentially distributed demand sizes, we obtain simpler explicit formulas for the optimal replenishment rate.