IIE Transactions (1997) 29, 373381

Analysis of supply contracts with total minimum commitment

YEHUDA BASSOK1 and RAVI ANUPINDI2
1
2

Department of Industrial Engineering and Management Sciences, Northwestern University, Evanston, I1 60207
J.L. Kellogg Graduate School, School of Management, Northwestern University, Evanston, I1 60207

Received December 1993 and accepted November 1994

In this paper we analyze a supply contract for a single product that species that the cumulative orders placed by a buyer, over a
nite horizon, be at least as large as a (contracted upon) given quantity. We assume that the demand for the product is uncertain,
and the buyer places orders periodically. We derive the optimal purchase policy for the buyer for a given total minimum quantity
commitment and a discounted price. We show that the policy is characterized by the order-up-to levels of the corresponding nite
horizon and a single-period standard newsboy problem with no commitment but with discounted price. We show that this policy
can be computed easily. We can use this to evaluate any discount schedule characterized by a set of (price discount, minimum
commitment) pairs.

1. Introduction
Traditional (periodic review) stochastic inventory models
analyze what can be viewed as, a class of supply contracts
that species a per-unit purchase cost and the buyer
places orders periodically. In all these models, there are
no restrictions placed on the buyer regarding quantities to
be purchased. In that sense, these contracts are probably
the most exible for the buyer. However, in practice,
many contracts impose some restriction on the buyer.
Usually, this takes the form of commitments by the buyer
to purchase certain minimum quantities.
Commitments could take various forms. In this paper
we analyze, in a stochastic demand setting, the most
`exible' commitment for the buyer, which requires him
to specify a total minimum quantity to be purchased over
the planning horizon. In other words, the buyer guarantees that his cumulative orders across all periods in the
planning horizon will exceed a certain, previously negotiated, minimum quantity; the buyer has the exibility to
place any order in any period. In return for the buyer's
commitment, the supplier provides a price discount. In
practice, a supplier provides a menu of (per unit price,
total minimum commitment) pairs from which the buyer
chooses a commitment at the corresponding price; it is
reasonable to expect that as the total minimum commitment increases, the per unit price would decline; in that
sense, this menu is a price discount scheme for commitments.
Minimum commitment contracts are a common
practice in the electronics industry. Usually the buyer
makes a commitment to purchase a minimum quantity
during the coming year, and the supplier agrees to sell
0740-817X

1997 ``IIE''

the product (integrated circuits) for a discounted price.

In a more general contract, also common in this industry,
the minimum quantity is specied for a family of products as opposed to a single product. In this case the
commitment is expressed in terms of a minimum amount
of money that must be spent to purchase products of the
specic family.
Other forms of commitment contracts, perhaps more
stringent, also exist and have been analyzed recently. For
example, for a stochastic environment, Anupindi and
Akella [1] study a class of contracts that require the buyer
to commit, at the beginning of the planning horizon, to
purchase a certain minimum quantity in every period of
the horizon. Orders for each period are permitted to be
adjusted upwards at a price premium. Furthermore, the
delivery responsiveness of the supplier (for example,
supply lead time) on these adjustments is also a parameter
of the contract. Such commitments reduce the variance in
the order process to the supplier.
Other work also exists. Recently there has been evidence from industry practices that suppliers oer discount schemes for a priori commitments; see Katz et al.
[2] and Sadrian and Yoon [3]. The focus of Katz et al. [2]
and Sadrian and Yoon [3], however, is to evaluate such
contracts in a deterministic environment where commitments by the buyer take the form of total dollar volume
of purchases, i.e., the buyer makes, at the beginning of the
horizon, a commitment to purchase a family of products
for a minimum dollar volume. In return for this commitment the supplier provides a price discount. R. Srinivasan (personal communication) provides evidence that
supply contracts with minimum commitments are common in the electronics industry, where the demands are

374
assumed to be random. Dobler et al. [4] describe various
forms of contracts observed in practice.
The deterministic inventory models (e.g., EOQ models)
can be also be seen as representing a specic form of
contract. Here the buyer species a schedule (quantity,
timing of purchase) for a given per unit price quoted by
the supplier. Thus the quantity discounts literature in this
deterministic environment [5, 6] are analyses of contracts
that specify a menu of triples (price, quantity, timing of
purchases). However, literature on similar quantity discount schemes for the stochastic demand situations is
sparse. Jucker and Rosenblatt [7] present a single-period
model with random demands, and dierent schemes of
price discounts but with no commitments.
In contrast, in this paper we study a single-product
periodic review inventory problem in which, at the beginning of the horizon, the buyer makes a commitment to
purchase at least a minimum quantity by the end of the
horizon. We assume that in return for this commitment,
the unit purchase price is discounted by the supplier and
this discount applies to all units purchased. The buyer, by
making such commitments a priori is taking a risk of
committing too high a quantity and having, at the end of
the horizon, excess inventory. In return for the commitment the supplier oers a lower price for the goods. The
supplier is willing to reduce the price because he ensures
that a minimum quantity is purchased. In addition, by
specifying ahead of time that a minimum quantity will be
purchased, the uncertainty in the production process of
the supplier can be reduced, and a better production plan
can be obtained leading to reduced costs.
We assume that the demands are random, deliveries
are instantaneous, and unsatised demand is backlogged.
We also assume that the setup costs are negligible. Typically, in the electronics industry the cost of the products
(integrated circuits) is high and their volume (size) is very
small, which means that the transportation and handling
costs are negligible with respect to the value of the products, and as a result we assume that the setup cost can be
ignored. Clearly, there are industries in which the setup
cost is substantial and must be considered. The analysis in
that case is more complex. We conjecture that the intuition and structural results obtained in this study can be
generalized to that case.
We derive optimal order policies that minimize costs
purchase, holding, and shortage for the buyer. The
optimal policy structure is characterized in terms of (a)
the order-up-to levels of the nite horizon version of the
standard `newsboy' problem (i.e., without any commitment) with the discounted purchase price, and (b) the
order-up-to level of a single-period standard newsboy
problem with zero purchase cost. This structure makes
the problem computationally tractable. We recognize that
a buyer may in reality have to choose from a discount
schedule oered by supplier(s). For example, a discount
schedule might specify a nite set (choices) of discounted

Bassok and Anupindi

purchase price and the corresponding total minimum
commitment. The basic model presented here allows us to
evaluate any (price discount, total minimum commitment) pair. Since the computation of any one such pair is
easy, the entire discount schedule can be easily evaluated
by enumeration.
Our paper diers from most of the existing literature in
the following two ways: (1) we assume a stochastic environment, whereas most of the quantity discount literature [5, 6] and the total quantity commitment
literature [2, 3] assumes a deterministic environment; (2)
we assume that the buyer makes a commitment a priori to
purchase a minimum quantity, in contrast with the work
of Jucker and Rosenblatt [7].
The main contributions of this paper are: (1) we introduce the notion of a minimum commitment over the
horizon in a stochastic environment; (2) we identify the
structure of the optimal purchasing policy given the
commitment and show that this structure is simple and
easy to calculate; and (3) the simplicity of the optimal
policy structure enables us to evaluate and compare different contracts and to choose the best one.
The rest of the paper is organized as follows. In
Section 2 we present a model for evaluating the costs of
such a commitment contract and derive the optimal
policy structure. We describe a computational study in
Section 3 to illustrate the benets to the buyer of signing
such contracts. We also study the eect of various system
parameters on the expected savings that result from such
contracts. We conclude with Section 4.

2. Model and analysis

A total minimum quantity commitment contract for a
single product can be characterized by a (price, minimum
total quantity) pair that species the price per unit (applied to all quantities purchased) if the buyer commits to
purchase the minimum total quantity. We show that the
optimal policy is characterized by N 1 critical numbers consisting of the N order-up-to levels, S1 ; . . . ; SN
corresponding to the nite-horizon version of the standard newsboy problem (we refer to the inventory problem
without commitment as the standard newsboy problem)
with discounted price, and S M , which is the order-up-to
level in a single-period standard newsboy problem with
zero purchase cost. (We refer to this problem as the
myopic problem.) The optimal policy has the following
basic structure: until the cumulative purchases exceed the
total commitment quantity (say this happens in period t),
follow a base stock policy with order-up-to level S M
until period t 1; after the commitment has been met,
follow a base stock policy for the rest of horizon as in a
standard newsboy problem with order-up-to levels of
St1 ; . . . ; S1 ; in period t, the policy is a little more involved
and will be described later.

Supply contracts with total minimum commitment

We rst present the basic model formulation. We then
analyze the single (last)-period problem and the twoperiod problem. Finally, we present the optimal policy for
the general N-period problem.
2.1. The basic model
We study a single-product problem in which at the beginning of the horizon the buyer commits to buying a
minimum quantity KN over the entire horizon. We assume that the purchasing, holding, and shortage costs
incurred by the buyer are proportional in their respective
quantities and are stationary over time; and the salvage
value is zero (this assumption can be relaxed easily). We
also assume that the supply lead time is zero. This,
however, is not a major restriction because it is well
known that an inventory model with non-zero leadtimes
and backlogging of demand can be reduced to a model
with zero lead time.
At the beginning of the horizon (period N), the buyer
does not know the actual demands in every period.
However, we assume that he knows their distributions.
We also assume that the demands are independent and
identically distributed. During the horizon the buyer
does not have the opportunity to renegotiate the contract. Thus, cumulative purchases through the horizon
must equal at least KN units. This is equivalent to imposing a high enough penalty for not keeping the commitment.
The sequence of events and actions taken by the buyer
are as follows: (1) at the beginning of each period the
inventory and the remaining commitment quantity are
observed; (2) orders are placed, which are delivered instantaneously; (3) demand is observed and is satised as
much as possible; (4) excess demand (inventory) is
backlogged (carried) to the next period. Note that periods
are numbered backwards, i.e., the rst period is period N
and the last period is period 1.
We use the following notation:
initial inventory at period t
order quantity at period t
optimal order quantity at period t
minimum remaining quantity that the buyer
must purchase through periods
t; t 1; . . . ; 1 : Kt fKN QN . . .
Qt1 g
c
marginal purchasing cost
h
marginal holding cost
p
marginal shortage cost
Ct It ; Kt ; Qt total expected cost from period t through
period 1
optimal cost from period t through period 1
Ct It ; Kt
L

one-period expected holding and shortage
cost

It
Qt
Qt
Kt

375
Dt
nt
f

F

demand at period t r: v
realization of the demand at period t
PDF of the random demand per period
CDF of the random demand per period

We formulate the problem as a stochastic dynamic

program with two state variables: the on-hand inventory
It and the remaining commitment Kt . The periodic
purchase quantity Qt is the only decision variable.
We formulate the dynamic recursion as follows:

It1 ; Kt1 g
Ct It ; Kt ; Qt cQt LIt Qt EDt fCt1

and
Ct It ; Kt minQt Ct It ; Kt ; Qt ;
C0 I0 ; 0  0 ;

where
It1 It Qt nt ;
Kt1 Kt Qt
and
Z1

Zx
x nf ndn p

Lx h
n 0

n xf ndn
n x

The optimization problem is dened as follows:

min CN IN ; KN ; QN
subject to

N
X

Q i  KN

i1

Qi  0

i 1; . . . ; N

2.2. The single-period problem

We rst solve the last-period problem. We assume that
K1 > 0; otherwise we get the standard newsboy problem.
The last-period problem is:
min C1 I1 ; K1 ; Q1 cQ1 LI1 Q1
subject to Q1  K1 .
The constraint ensures that the committed quantity is
indeed purchased.
It is well known that cost function is convex with respect to Q1 . Thus the above problem is a convex problem.
Taking the derivative with respect to Q1 and equating to
zero we get that the optimal purchasing policy is

S1 I1 if S1 I1  K1 ;
Q1
K1
otherwise ;
where S1 is the order-up-to level obtained when solving
the last period of the standard newsboy problem (the
unconstrained problem).

376

Bassok and Anupindi

2.3. The two-period problem

We assume that K2 > 0; otherwise we get the standard
newsboy problem whose analysis is well known in the
literature. The cost function for the two-period problem
is as follows.
(P)
C2 I2 ; K2 ; Q2 cQ2 LI2 Q2 EfC1 I1 ; K1 g ;
where C1 I1 ; K1 is dened as

cS1 I1 LS1 if S1 I1  K1 ;

C1 I1 ; K1
cK1 LI1 K1 if S1 I1 < K1 :
We rst show the convexity of the last-period value
function and the two-period cost function.
Proposition 1.
1. The function C1 I1 ; K1 is convex with respect to I1 ; K1 .
2. The function C2 I2 ; K2 ; Q2 is convex in I2 ; K2 ; Q2 .
Proof : See Appendix A.
Observe that either Q2 < K2 (i.e., K1 > 0) or Q2  K2 (i.e.,
K1 0). When K1 0 we need to solve, in the last period,
the standard newsboy problem. However, if K1 > 0 we
need to solve a constrained problem in the last period.
Later, in Proposition 3, we show that to solve Problem
(P) it is sucient to solve the unconstrained version of
problems (P1) and (P2) (dened below) corresponding to
the two cases just described.

Proof : See Appendix A.

It is interesting to observe that the optimal period twopurchase quantity in Problem (P1) is not a function of the
purchase cost. Because the commitment quantity in the
next period is still positive it is clear that some quantity
must be purchased in the last period, and thus the purchasing cost can be considered as a sunk cost as far as the
second period is concerned; the only relevant costs at this
point of time are the holding (which might depend on the
purchasing cost) and shortage cost. It is also important to
note that S M is the optimal order-up-to level in a singleperiod problem when the purchasing cost is zero (or
salvage value is equal to the purchasing cost).
The next proposition states that the solution of Problem (P) can be characterized by solutions to Problems
(P1) and (P2) described earlier in Proposition 2.
Proposition 3.
1. Assuming that I2  S M , one and only one of the following conditions holds:
1.1. Problem (P1) has an unconstrained optimal solution that is feasible. In this case, this solution is also the
optimal solution of Problem (P).
1.2. Problem (P2) has an unconstrained optimal solution that is feasible. In this case, this solution is also the
optimal solution of Problem (P).
1.3. Neither Problem (P1) nor Problem (P2) has an
optimal unconstrained solution that is feasible. In this
case the optimal solution of Problem (P) is Q2 K2 .
2. If I2  S M then Q2 0.
Proof : See Appendix A.

(P1)
MaxQ2 fcQ2 LI2 Q2 EfC1 I1 ; K1 g
subject to Q2 < K2 ;
Q2  0:
(P2)
MaxQ2 fcQ2 LI2 Q2 EfC1 I1 ; 0g

From propositions (1)(3) the structure of the optimal

solution to Problem (P) can be stated as
8
>
0
if I2  S M ;
>
< M
S I2 if S M I2 < K2 and S M > I2 ;
Q2
>
K
if S M I2  K2 and S2 I2 < K2 ;
>
: 2
if S2 I2  K2 :
S2 I2

subject to Q2  K2 .

This is illustrated graphically in Fig. 1.

The following proposition describes the solution structure

for the unconstrained versions of problems (P1) and (P2).

2.4. The N-period problem

Proposition 2.
1. The unconstrained solution of P 1 is order-up-to S M ,
that is, Q2 S M I2 , where S M F 1 p = p h :
2. The unconstrained solution of (P2) is order-up-to S2
where S2 is the optimal order-up-to level of the two period
standard newsboy problem.
3. S2  S M .

The main objective of this section is to show that the

optimal purchasing policy at any period t  2 is identical,
in structure, with the solution obtained for the two-period
problem.
Proposition 4.
1. The function Ct It ; Kt is convex with respect to It ; Kt for
t 1; . . . ; N 1.

Supply contracts with total minimum commitment

377
against a base case in which no contract is signed; that is,
in the base case, the buyer purchases quantities at a
market price with no restriction on total quantities purchased. We will call the price per unit for the base case the
market price. Any discounted contracted price is specied
as a percentage discount over the market price. We then
dene percentage savings as the savings in total costs of
the contract on that of the base case. We are primarily
interested in studying the eect of the size of the commitment, the coecient of variation in demand, magnitude of discount oered, and the penalty costs of not
meeting demand in the period on the savings to the buyer.
The following parameters were used for the computational study:

Fig. 1. The optimal order quantity as a function of initial inventory.

2. The cost function Ct It ; Kt ; Qt is convex in It ; Kt ; Qt for

t 1; . . . ; N .
Proof : The proof is omitted because this proposition can
be proved by induction, using the same arguments that
were used in Proposition 1 and the arguments used to
prove convexity of the cost function in the standard
newsboy problem.
j
Proposition 5. At every period t, t 2; . . . ; N , if Kt > 0
then there are two critical levels S M and St such that
8
>
0
if It  S M ;
>
< M
S It if S M It < Kt and It < S M ;
Qt
>
if S M It  Kt and St It < Kt ;
K
>
: t
St It
if St It  Kt :
where St is the solution of the t-period standard newsboy
problem without commitment. When Kt 0 we simply
solve the standard newsboy problem.
Proof : See Appendix A.

(1)mean demand 100.0;

(2)coecient of variation of demand 0.125, 0.25, 0.5,
1.0;
(3)percentage discount 5%, 10%, 15%;
(4)market price per unit $1.00;
(5)penalty cost per unit $25.0, $40.0, $50.0;
(6)holding cost per unit 25% of purchase price;
(7)number of periods 10.
Demand distributions were assumed to be normal,
truncated at three standard deviations. Negative realizations of the demand were not considered. The program
was written in C programming language running on an
HP workstation.
3.1. Eect of coecient of variation of demand
In Fig. 2 we demonstrate the eects of the coecient of
variation of demand on the savings due to a minimum
commitment contract. The rest of the parameters were as
follows: price discount 10%; penalty cost $25.0. We
observe that as the committed quantity increases the
percentage savings decreases. When the commitment is
`large enough' it results in losses. This conrms our intuition that by making large commitments the buyer
takes the risk of purchasing more than is actually needed.

The importance of Proposition 5 is that it provides the

structure of the optimal purchasing policy that is very
simple and easy to implement. Observe that in order to
implement the optimal purchasing policy it is necessary
only to calculate the base stock levels S1 ; . . . ; SN and S M .
Computation of S1 ; . . . ; SN by stochastic dynamic programming takes about 2 CPU seconds on an HP workstation for N 10 periods.

3. Computational study
We now describe some numerical studies to evaluate the
benets, to the buyer, of signing a contract for total
minimum commitments. We evaluate such contracts

Fig. 2. Eect of coecient of variation of demand.

378

Bassok and Anupindi

Fig. 4. Eect of shortage (penalty) cost.

Fig. 3. Eect of price discount.

3.3. Eect of shortage cost

Note that in the region in which the commitment is small
the savings are at; this is due to the fact that for small
commitments there is high likelihood that all of the
committed quantity will indeed be used. Thus in this region, changes in the committed quantity do not aect the
total cost and hence savings. Next we observe that the
savings decrease as the coecient of variation of the demand increases for the same level of commitment. This
implies the higher risk of commitment with higher demand variances.
3.2. Eect of price discount
Fig. 3 demonstrates the eect of the discount on the
percentage savings. The rest of the parameters were as
follows: coecient of variation of demand 0.25; penalty
cost $25.0. Clearly the higher the percentage discount
the higher the percentage savings. The graphs of Fig. 3
can be used to determine the acceptance or rejection of a
specic contract. For example, if a 5% discount is oered,
the buyer should never commit to purchase more than
(approximately) 900 units. Any commitment below 900
units results in expected savings, and commitments above
900 units result in expected loss. Again, as expected, the
buyer can commit to higher quantities if larger discounts
are oered. For example, at a commitment of 900 units, a
10% or 15% discount is favorable. Finally observe that
the total savings cannot exceed the percentage discount
oered.
Observe that Fig. 3 can be used as a tool to compare
dierent contracts and to choose the best available contract. Recall that we dene a contract as a pair of commitment quantity and price discount. The buyer's
objective is to nd the pair that will generate the most
savings, or alternatively will result in smallest cost. For
example, if the buyer has to choose from the following
two commitments (950, 10%), and (600, 5%), in Fig. 3 we
see that the buyer should prefer the contract (600, 5%)
because it results in 5% savings, whereas the other contract results only in about 2.5% saving.

Fig. 4 describes the eect of the shortage cost (penalty) on

the percentage savings. We observe that the eects are
negligible in the range of penalty costs considered.

4. Conclusion
In this paper we describe the structure of the optimal
purchasing policy when the buyer agrees to commit, at
the beginning of the horizon, that the cumulative orders
during the horizon will exceed a certain minimum quantity. We show that the structure of the policy is very
simple and easy to compute. The simplicity of the optimal
purchasing policy enables us to evaluate and compare
dierent contracts, determine whether a contract is
protable, and identify the best contract. Using a computational study, we show the eect of commitments,
coecient of variation of demand, percentage discount,
and penalty costs on savings due to such contracts. As
mentioned in the introduction, this is only one of the
many possible types of commitment that a buyer can
make; others could specify, in addition, an upper limit on
the total quantity purchased. The commitments (upper
and lower) could be on quantities purchased every period
instead of, or in addition to, the constraints on the total
quantities over the horizon. The basic idea of total
minimum quantity commitments for a single product can
also be extended to contracts with multiple products.
Usually, the commitments in a multi-product scenario
take the form of specication of minimum dollar volume
of business, that is, the total dollar volume of parts
purchased [2, 3]. Analysis of some of these (single and
multiproduct) contracts in a stochastic environment is in
progress.

References
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commitments. Submitted for publication.
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analyze price quotations with Bellcore PDSS software. Interfaces,
24, (JanuaryFebruary), pp. 5063.

Supply contracts with total minimum commitment

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Proof of Proposition 1: C1 I1 ; K1 minQ1 fC1 I1 ; K1 ; Q1 g:

It is clear that the function C1 I1 ; K1 ; Q1 is convex in
I1 ; K1 ; Q1 : The function C1 I1 ; K1 is convex in I1 ; K1 by
proposition B-4 of Heyman and Sobel [8]. To show that
C1 I1 ; K1 is convex in I2 ; K2 ; Q2 we observe that either
K1 > 0 Q2 < K2 or K1 0 Q2  K2 : We rewrite
C1 I1 ; K1 as follows:
 
~ I ; K if K1 > 0 ;
C
C1 I1 ; K1 ^ 1 1 1
C1 I1 ; K1 if K1 0 ;

~  I1 ; K1
C
1

^  I1 ; K1 ; C
~  I1 ; K1 g :
C1 I1 ; K1 maxfC
1
1
Theorem 4.13 in Avriel [10] ensures that a function that is
dened as the maximum (pointwise) of several convex
functions is convex. This proves that C1 I1 ; K1 is convex
in I2 ; K2 ; Q2 :
Lx2 Q2 is also convex and because the nonnegative
sum of convex functions is also convex we get that
j
C2 I2 ; K2 ; Q2 is convex in I2 ; K2 ; Q2 :
Proof of Proposition 2 : Problem (P1) can be written as
Z1
C1 I1 ; K1 f n2 dn2
minQ2 cQ2 LI2 Q2
n2 K2 I2 S1
K2 Z
I2 S1

C1 I1 ; K1 f n2 dn2

A1

n2 0

subject to Q2 < K2 ;
Q2  0 :
We now solve the unconstrained version of problem (P1).
Taking the derivative of the cost function with respect to
Q2 we get :

Appendix A

where

379

and
^  I1 ; 0
C
1

cS1 I1 LS1 if S1 I1  K1 ;
cK1 LI1 K1 if S1 I1 < K1 ;


cS1 I1 LS1
LI1

if S1 > I1 ;
if S1  I1 :

Note that when K1 > 0 Q2 < K2 then I1 ; K1 are both

linear in I2 ; K2 ; Q2 ; thus by Theorem 5.7 of Rockafellar [9]
~  I1 ; K1 is convex in I2 ; K2 ; Q2 : When
we get that C
1
K1 0 Q2  K2 then I1 ; K1 are both linear in I2 ; K2 ; Q2 ;
^  I1 ; K1 is
using again the same theorem we get that C
1
convex.
^  I1 ; K1
~  I1 ; K1 and C
Observe that if the functions C
1
1
are both dened for K1  0 then an alternative way to
dene C1 I1 ; K1 is

oC2 =oQ2 h pF I2 Q2 p :

A2

Q2

< K2 then the optimal solution

This means that if
satises F I2 Q2 p=h p:
Let S M F 1 p=p h, and we get that
Q2 S M I2 ;
which is part (1) of the proposition.
To show part (2), observe that problem (P2) can be rewritten as
Z1
C1 I1 ; 0f n2 dn2
minQ2 cQ2 LI2 Q2
n2 K2 I2 S1
K2 Z
I2 S1

C1 I1 ; 0f n2 dn2

A3

n2 0

subject to Q2  K2 :
Now we solve the unconstrained version of this problem.
Taking the derivative with respect to Q2 we get
Z1
@C2
c h pF I2 Q2 p
cf n2 dn2
@Q2
I2 Q2 S1

I2 Q
Z 2 S1

fh pF I2 Q2 n2 pgf n2 dn2 :
0

A4

380

Bassok and Anupindi

It is clear that the unconstrained solution of the above

equation is of the type order-up-to. Let S2 be the optimal
order-up-to level. Actually, observe that S2 is the optimal
order-up-to level of the two-period standard newsboy
problem.
Finally, part (3) of the proposition is a well known
result [11].
j

It K
Z t S M

(
cS M It1 LS M

n It Qt S M

Z1


Ct2
S M nt1 ; Kt Qt S M It1

nt1 0

Proof of Proposition 3 :

 f nt1 dnt1 f nt dnt

1. I2 < S M
From the convexity of the cost function it is clear that
at the most one problem has an unconstrained solution
that is feasible. Since

@C2 
@C2
< 0 and limQ2 !1
! a > 0;

@Q2 I2 Q2 <S 1
@Q2
the derivative has a root either at the point Q2 ; Q2 6 K2 or
at Q2 K2 : The rst case means that one and only one of
the problems has an unconstrained solution that is feasible. The second case means that solutions of both unconstrained problems are not feasible. In the rst case if
Q2 is the solution of (P1) then Q2 S M I2 : If Q2 is the
solution of (P2) then Q2 S2 I2 : In the second case
Q2 K2 :
2. When I2  S M ; @C2 =@Q2 > 0 for every Q2 ; thus
Q2 0; which proves part 2 of the proposition. j
Proof of Proposition 5 : Proof by induction. We assume
that the theorem is correct for periods 2; . . . ; t 1 and we
prove it for period t. As in the two-period problem we
solve the t period problem in two dierent regions:
Qt < Kt and Qt  Kt : We rst solve the problem PT1.
(PT1) minQt Ct It ; Kt ; Qt
subject to Qt < Kt ;
Qt  0 ;
where
Ct It ; Kt ; Qt cQt LIt Qt

A5

M
It Q
Z t S (

LIt Qt nt
nt 0

Z1

nt1 0

It K
Zt St1

cKt1 LIt1 Kt1

n It Kt S M

Z1

nt1 0


Ct2
It1 Kt1 nt1 ; 0 

)
f nt1 dnt1 f nt dnt

)
f nt1 dnt1 f nt dnt

A6

A8

Z1

cSt1 It1 LSt1

n It Kt St1

Z1

nt1 0


Ct2
St1 nt1 ; Kt Qt St1 It1

)
 f nt1 dnt1 f nt dnt

A9

where (A5) represents the expected cost at period t, (A6)

is the optimal expected cost from period t 1 through
period 1 when the optimal purchasing quantity at period
t 1 is equal to zero, (A7) is the optimal expected cost
from period t 1 through period 1 in the case that at
period t 1 it is optimal to raise the inventory level up to
S M ; (A8) is the optimal expected cost from period t 1
through period 1 in the case that at period t 1 it is
optimal to purchase exactly Kt1 units, and (A9) is the
optimal expected cost from period t 1 through period 1
in the case that at period t 1 it is optimal to raise the
inventory level up to St1 :
Taking the derivative of the cost function with respect
to Qt we get:
@Ct
c h pF It Qt p
@Qt


Ct2
I2 Qt nt nt1 ; Kt Qt 

A7

A10

Supply contracts with total minimum commitment

M
yZ
t S

nt 0

(
@
LIt Qt nt
@Qt
Z1


Ct2
It Qt nt nt1 ; Kt Qt

nt1 0

)
 f nt1 dnt1 f nt dnt

A11

Z1

cf nt dnt :
nt It Qt

A12

S M

The last part of the derivative (A12) is obtained by observing that in (A7) to (A-9) only the expected purchasing
cost at period t 1 is a function of Qt : To see this point
observe that It1 Kt1 It Kt Dt and Kt Qt
S M It1 Kt S M Dt are independent of Qt :
Because the problem is strictly convex it has at the
most one stationary point. We now prove that S M is the
unique solution of (A6) to (A8). We substitute, in (A6) to
(A8), S M for It Qt to get
@Ct
c h pF S M p
@Qt

Z1
cf nt dnt 0 :
nt 0

This and the fact that the cost function is convex proves
that:
1. if It  S M then it is optimal not to order;
2. if It < S M and S M It < Kt then it is optimal to raise
the inventory up to S M :
To complete the proof we dene, as in the two-period
problem, (PT2):
PT2

minQt Ct It ; Kt ; Qt

subject to Qt  Kt :

381
Repeating arguments that were used in solving the twoperiod problem, we get that the solution of problem
(PT2) is identical to the t-period problem without commitments (the standard newsboy problem). Using the
same arguments as for the two period problem we obtain:
3. if It < S M and S M It > Kt and St It > Kt then the
optimal order quantity is Qt St It ; but if It < S M and
S M It > Kt and St It  Kt then the optimal order
quantity is Qt Kt : This completes the proof of the
theorem.
j

Biographics
Yehuda Bassok is an Assistant Professor of Operations Management
at the McCormick School of Engineering, Northwestern University,
Evanston, IL. His research interests are mainly in the area of Logistics,
Supply Chain Management, Production Planning, Production and
Inventory Control, Supply Contract, and Multi-Stage Distribution
Systems. Professor Bassok teaches undergraduate, graduate and executive courses in the McCormick School of Engineering and Kellogg
Graduate School of Management in the areas of Inventory Control,
Supply Chain Management and Distribution. He has worked as a
consultant in the electronic, aerospace and textile industries. His research has appeared in journals such as Management Science, Transportation Science and Operations Research. Professor Bassok received
his Ph.D. in Engineering and Public Policy from Carnegie Mellon
University in 1990, and his B.Sc. in Mathematics and Economic from
the Hebrew University in 1973.
Ravi Anupindi is an Assistant Professor of Operations Management at
the J.L. Kellogg Graduate School of Management, Northwestern
University, Evanston, IL. His research interests are in Supply Chain
Management, Production and Inventory Management, Supply Contracts, and MarketingManufacturing Interfaces. He teaches courses in
Operations Management and Logistics at Kellogg. Some of his research work has appeared in journals such as Management Science and
IEEE Transactions in Semiconductor Manufacturing. Professor Anupindi received a Ph.D. in Management of Manufacturing and Automation from Carnegie Mellon University in 1993; an M.E. in
Automation from the Indian Institute of Science, Bangalore, India in
1984; and a B.E. (Hons.) in Electrical and Electronics Engineering
from the Birla Institute of Technology and Science, Pilani, India, in
1982.