Business
Introduction
Smitheford pharmaceutical is a pharmaceutical company that was founded in 1878 by Robert Smitheford, who was a general during the civil war. The company expanded to become a large firm and even opened branches in cities such as Colorado, Durango among others. However, as time went by, the technological dynamics and change in pharmaceuticals industry rules have impacted the company negatively and, therefore, needs to review how it conducts its business.
In addition, though, the company utilizes employee incentives to ensure and enhance employee satisfaction, the lack of proper implementation of the quality management philosophies have not helped the company solve its current problems of inefficiencies. Therefore, to solve this problem, there is a need for the company to evaluate several quantitative and qualitative methods such as economic order quantity method as outlined below.
The economic order quantity is the quantity that minimizes the total holding and ordering costs thus minimizing the total stock costs. It is a simple model that assists the manager to determine the optimal quantity of stock to order so as to keep the total costs at a minimum. It is based on several assumptions that include: it assumes that the annual demand is certain, constant, and continuous over time (Hansen, & Mowen, 2009). Holding costs, ordering costs, supply lead time, price, and cost per unit are also known and constant over time. In addition, the model assumes that the same quantity is ordered every time an order is placed, and no stock outs are allowed and therefore instantaneous delivery.
The various costs under economic order quantity are determined as follows:
Total costs = Total ordering costs +Total holding costs
Total ordering costs = Cost per order X Number of orders in a period
The number of orders in a period = Annual demand/ quantity per order
Total holding cost =Average stock quantity* holding cost per unit
Where Average stock quantity = (beginning + ending inventory)/2
Mathematically the EOQ can be determined as follows:
Where A= Annual demand Cp= Ordering costs Ch= Holding cost per unit
Derivation:
In addition to obtaining 1763.8 as the optimal order quantity, it is also advisable for the management to have a proper and effective material control cost control in order to minimize the inventory costs. As such, the material cost control system should be put in place and should have adequate perpetual inventory records that will include records for each item held in store. This will include a stock record card that will aid in identifying all the items of stock in store and hence minimize cases of loss of inventories through improper accountability.
The system should also aid in checking of perpetual inventory records such as through periodic or continuous stock taking. Stock taking will assist the management in tracking issuance and purchasing of inventories and hence reduce costs associated with loss of inventory. In addition, the system should assist the management in the maintenance of target stock levels through stock management practices.
As such, the management should identify then minimum stock levels, maximum stock levels, and the reorder quantity levels and hence minimize the costs of ordering, holding stocks and the total inventory stocks. Moreover, delegation of responsibility and authority to the materials is key as it will meet and control access to materials for the company. In the case of any losses such as theft, the management will know where to refer to and enhance accountability and effective issuance of materials. This will reduce costs associated with inventory loss and hence reduce the total costs of the company.
Reporting of the inventory stocks is essential to ensuring that items are held at the right quantities and available when required. As such, continuous reporting will give the management a broad picture of where it stands in terms of available materials for production therefore adequate time to plan for material purchases to avoid stock-outs and loss of customers due to stock outs. Lastly, control will be critical to the management where the management compares the budgeted and actual stock levels. After comparison, the management will have to take appropriate steps on a regular basis to investigate the deviation before issues get out of hand.
The management may also consider the use of just in time system of material control. This is a system that advocates zero inventories and stocks production through just in time purchasing and production. It is different to EOQ in that there are no inventory costs and therefore removal or elimination of the inefficiencies that EOQ creates. However, using such a system calls for a greater and harmonized relationship with the suppliers where a company receives continuous but small quantities of inventory. As a result, holding costs are reduced by a significant margin and may only arise due to waste and inefficiencies (DuBrin, 2009).
Because supplies arrive immediately before production starts, supplies are provided continuously around the clock keeping the workers occupied and the business focused on the turnover. As a consequence, the management is focused on meeting deadlines and motivating employees to work hard to realize the company goals. This leads to a reduction of idle time and lead time as workers do not have to wait for the materials to arrive, and no stock outs are experienced.
There is more emphasis for quality under the just in time system since the company has to single source stocks from a few trusted suppliers. The suppliers have to guarantee the quality of stocks to enhance long-term relationships with the company (DuBrin, 2009). The setup time in the factory will also be greatly reduced. When the setup time is reduced, the company becomes efficient and concentrates efforts to the other areas that may need improvement. Reduced setup time ultimately leads to reduction or removal of inventory held to allow for ‘changeover' time.
Conclusion
Therefore, as seen above, the economic order quantity for the company stands at 1764. This is the quantity that the company should utilize in order to minimize its total costs that comprise of ordering, holding and the purchase costs. If the company orders a quantity below this amount, such as 1000, the ordering costs will reduce but the holding costs will reduce.
However, the increase in the holding costs is greater than the ordering costs, thus increasing the total costs. The company will, therefore, have not solved its current problems and should therefore lay emphasis on the EOQ. In addition, the company should utilize other inventory methods such as just in time methodology and an effective material control unit. The just in time system will ensure that materials are delivered on time while an effective stores system will enhance control of materials.
References
Anderson, D. (2008). Quantitative methods for business (11th ed.). Mason, OH: Thomson/SouthWestern.
DuBrin, A. (2009). Essentials of management (8th ed.). Mason, OH: Thomson Business & Economics.
Hansen, D., & Mowen, M. (2009). Cost management: Accounting and control (6th ed.). Mason, Ohio: South-Western.
