Deterministic hierarchical substitution inventory models

In this paper, we consider a deterministic nested substitution problem where there are multiple products which can be substituted one for the other, if necessary, at a certain cost. We consider the case when there are n products, and product j can substitute products j + 1, ..., n at certain costs. The trade‐off is the cost of storing products (for example, customised products) at a higher inventory holding stage versus the cost of transferring downwards from a lower inventory holding cost (generic product) stage. The standard approach to solving the problem yields an intractable formulation, but by reformulating the problem to determine the optimal run‐out times, we are able to determine the optimal order and substitution quantities. Numerical examples showing the effect of various system parameters on the optimal order and substitution policy are also presented.