Quality control for products supplied with warranty

A batch of products is to be supplied to customers with warranty. The units in the batch are either defective or nondefective, with different lifetime distributions. The defect rate – the proportion of defects in the batch – is itself a random variable, known only in terms of its distribution. We develop a sequential quality control procedure that exploits the knowledge of the defect distribution gained through inspection, and strikes an optimal balance between the inspection repair cost and the warranty cost. We identify a simple threshold policy, and we prove its optimality for a very general class of warranty cost functions without imposing any restrictions on the type of distributions involved. The key to optimality is that the warranty cost, as a function of the number of inspected units and the conditional defect index, satisfies a so-called K-submodularity property, which is a strengthening of the usual notion of submodularity.