We present an analysis of setup cost reduction using the economic production quantity model. The objectives of the paper are to draw conclusions by investigating several classes of setup reduction functions and to provide a general solution procedure. We examine the trade-offs between reduced inventories and increased capital investment and show that given any hypothetical setup cost reduction function, we can determine whether the total relevant cost can be reduced and how the reduction is achieved.Subject Area: Inventory and Production/Operations Management.

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Previous work on setup reduction to dynamic lot-sizing with process improvement is extended. In this dynamic lot-sizing model, a new calculation of lot size is made at every setup, but the decision to invest jointly in setup reduction and process improvement is made at the initial setup. In the analysis, it is assumed that setup reduction and process quality are functions of capital expenditure. Such setup cost reductions and process quality improvements can arise from investing in new technology. A procedure is developed to find the optimal lot size, total cost, and required investments, and the solution is illustrated using declining exponential functions and power functions to model both setup cost reduction and process quality improvement. The implications of the analysis and the tradeoffs involved are discussed and illustrated numerically and graphically.