Minimizing Inventory Costs for Capacity-constrained Production Using a Hybrid Simulation Model

A hybrid simulation model is developed to determine the cost-minimizing target level for a single-item, single-stage production-inventory system. The model is based on a single discrete-event simulation of the unconstrained production system, from which an analytical approximation of the inventory shortfall is derived. Using this analytical expression it is then possible to evaluate inventory performance, and associated costs, at any target level. From these calculations, the cost-minimizing target level can then be found efficiently using a local search. Computational experiments show that model accuracy is preserved at high levels of demand variation, where existing analytical methods are known to be unreliable. By deriving an expression for the shortfall distribution via simulation, no user modelling of the demand distribution or estimation of demand parameters is required. Thus this model can be applied to situations when the demand distribution does not have an identifiable analytical form