An optimal critical level policy for inventory systems with two demand classes

Traditional inventory systems treat all demands of a given item equally. This approach is optimal if the penalty costs of all customers are the same, but it is not optimal if the penalty costs are different for different customer classes. Then, demands of customers with high penalty costs must be filled before demands of customers with low penalty costs. A commonly used inventory policy for dealing with demands with different penalty costs is the critical level inventory policy. Under this policy demands with low penalty costs are filled as long as inventory is above a certain critical level. If the inventory reaches the critical level, only demands with high penalty costs are filled and demands with low penalty costs are backordered. In this article, we consider a critical level policy for a periodic review inventory system with two demand classes. Because traditional approaches cannot be used to find the optimal parameters of the policy, we use a multidimensional Markov chain to model the inventory system. We use a sample path approach to prove several properties of this inventory system. Although the cost function is not convex, we can build on these properties to develop an optimization approach that finds the optimal solution. We also present some numerical results. © 2008 Wiley Periodicals, Inc. Naval Research Logistics, 2008