A dynamic ordering policy for a stochastic inventory problem with cash constraints

Abstract

This paper investigates a stochastic inventory management problem in which a cash-constrained small retailer periodically purchases a product from suppliers and sells it to a market while facing non-stationary demands. In each period, the retailer's available cash restricts the maximum quantity that can be ordered. There exists a fixed ordering cost for the retailer when purchasing. We partially characterize the optimal ordering policy by showing it has an $\bf s-C$ structure: for each period, when initial inventory is above the $\bf$s threshold, no product should be ordered no matter how much initial cash it has; when initial inventory is not large enough to be a $\bf s$ threshold, it is also better to not order when initial cash is below the threshold $C$. The values of $C$ may be state-dependent and related to each period's initial inventory. A heuristic policy $(s, C(x), S)$ is proposed: when initial inventory $x$ is less than $s$ and initial cash is greater than $C(x)$, order a quantity that brings inventory as close to $S$ as possible; otherwise, do not order. We first determine the values of the controlling parameters $s$, $C(x)$ and $S$ based on the results of stochastic dynamic programming and test their performance via an extensive computational study. The results show that the $(s, C(x), S)$ policy performs well with a maximum optimality gap of less than 1\% and an average gap of approximately 0.01\%. We then develop a simple and time-efficient heuristic method for computing policy $(s, C(x), S)$ by solving a mixed-integer linear programming problem and approximate newsvendor models: the average gap for this heuristic is approximately 2\% on our test bed.