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A Robust Optimization Approach to Inventory Theory

Sloan School of Management and Operations Research Center, Massachusetts Institute of Technology, E53-363, Cambridge, Massachusetts 02139
Department of Industrial and Systems Engineering, Lehigh University, Mohler Building, Bethlehem, Pennsylvania 18015
dbertsim{at}mit.edu
aurelie.thiele{at}lehigh.edu

We propose a general methodology based on robust optimization to address the problem of optimally controlling a supply chain subject to stochastic demand in discrete time. This problem has been studied in the past using dynamic programming, which suffers from dimensionality problems and assumes full knowledge of the demand distribution. The proposed approach takes into account the uncertainty of the demand in the supply chain without assuming a specific distribution, while remaining highly tractable and providing insight into the corresponding optimal policy. It also allows adjustment of the level of robustness of the solution to trade off performance and protection against uncertainty. An attractive feature of the proposed approach is its numerical tractability, especially when compared to multidimensional dynamic programming problems in complex supply chains, as the robust problem is of the same difficulty as the nominal problem, that is, a linear programming problem when there are no fixed costs, and a mixed-integer programming problem when fixed costs are present. Furthermore, we show that the optimal policy obtained in the robust approach is identical to the optimal policy obtained in the nominal case for a modified and explicitly computable demand sequence. In this way, we show that the structure of the optimal robust policy is of the same base-stock character as the optimal stochastic policy for a wide range of inventory problems in single installations, series systems, and general supply chains. Preliminary computational results are very promising.

Subject classifications: programming; linear; integer; stochastic; inventory; production; uncertainty.
History: Received April 2003; revision received December 2003; revision received May 2004; revision received July 2004; accepted November 2004.

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