Tactical inventory and backorder decisions for systems with predictable production yield

We consider a manufacturing system with stochastic demand and predictable production yield. The manufacturer has predetermined prices and limited production capacity in each period. The manufacturer also has the option to save some inventory for future periods even if there is demand in the current period. The demand that is not met is lost or may be backordered for only one period. Our objective is to maximize the expected profit by choosing optimal produce-up-to level (Yt¯⁎), save (St⁎) and backorder quantities (Bt⁎) in each period t. We formulate this problem as a Markov Decision Process where the state of the system is represented by the net inventory and the yield rate. We show that a modified order-up-to policy (Yt¯⁎,St⁎,Bt⁎) is optimal in each period t. We also perform computational analysis to examine the effects of production yield on the optimal decisions.