CASES IN SUPPLY CHAIN ANALYTICS

(BMGT44530)
MEMO 1: GLOBAL PHARMA,
MANAGING UNCERTAINITY
STUDENT NAME: SHAILESH
PANIGRAHY
STUDENT NUMBER: 14200021
SUBMITTED ON 01 MARCH 2015

INTRODUCTION
Global Pharma, manufacturer of Active Pharmaceutical Ingredients (APIs),
generics and pharmaceutical services is headquartered in Hyderabad the
pharmaceutical hub of India (Felker, Greg; Chaudhuri, Shekhar; Gyrgy, Katalin
(1997))1. The $2 million company exports its products manufactured in 20

different plants located throughout India to 40 different countries. Global

Pharma is a very small player in the $11 billion Indian pharma industry.
INDUSTRY BACKGROUND
The Indian Pharmaceutical Industry has seen tremendous growth since the
late 2000s , it the third largest pharmaceutical industry in the world in terms
of volume (Ramsurya,MV) 2. Earlier on the Indian government had imposed a
16% tax on the selling price of the medicines instead of the ex-factory price.
This resulted in the pharma companies shifting their production to tax-free
states of India. The tax free states lacked strong transport and industrial
facilities. Later on the government reduced taxes to 8% and subsequently
4%, this propelled growth and pharma companies moved to sites with
excellent transport and manufacturing facilities. Hyderabad turned out to be
the pharmaceutical hub of the country. The top 10 pharma manufacturers
have their head office and manufacturing facility located at Hyderabad.
Further, compliance with World Trade Organization (WTO)'s Agreement on
Trade Related Aspects of Intellectual Property Rights (TRIPS) has precipitated
the growth of the pharma industry in India.

1 Felker, Greg; Chaudhuri, Shekhar; Gyrgy, Katalin (1997). The pharmaceutical

industry in India and Hungary. World Bank Publications. pp. 910. ISSN 0253-7494.
2 Ramsurya,MV. (2010). Pharma, engineering to topple IT as big paymaster.
Available: http://articles.economictimes.indiatimes.com/2010-0608/news/28423319_1_salary-hikes-manufacturing-sector-survey. Last accessed 1st
March 2015

The number of domestic pharma companies is lower when compared to the

large multinational companies. These companies started investing in India to
benefit on cheap and skilled labor. Hence, as a result the exports involved in
this sector have seen a drastic growth. The increase in volume from the nonurban markets has also helped in the growth of the small and medium
enterprises (SMEs) in the pharma industry. Development in public health
sector and the higher demand for low cost quality drugs could be achieved
mainly by the growth of the smaller industries.
GLOBAL VALUE CHAIN
The Global value chain of the Indian pharmaceutical industry are broadly
classified into two categories:
API manufacturers who produce the basic ingredients used in medicine and
supply the same to the larger or end manufacturers and finished form
manufacturers who carry out the major research and development and
combine the APIs involved to produce the final product to be sold to the end
consumer. Logistics of pharmaceuticals items also plays an important role in
the price determination, as the products are time bound. Further, several
products require additional handling and storage, which automatically affects
the price.
Determinants of manufacturer price
In concern with the Indian Pharmaceutical industry the government of India
has several regulations over the pricing of the medicine, these policies are
unique for every medicine and are aimed at benefitting the end customer.
Lack of the free market concept such as in Europe restricts the profit making
capability of these companies. Hence, the only way that a company can
generate profit is by utilizing their resources in the most efficient manner
possible. The first phase involves research and development of new drugs, it
is necessary to understand the market and find API manufacturers for the
new drug being researched and their supply capability.

On top of this, there are several uncertainties involved throughout. The

forecast for the Indian Pharma Industry over the next few years is close to 5
times the current growth rate, in such situations every company is in a
dilemma over their daily demand procurement structure. The aim of every
company is to get the best costs with the shortest of lead times, but they do
not want to lose out on excess holding cost. Other uncertainties included
change in government regulatory norms over the period, change in quality,
stock outs and delayed material availability.

Distribution
Similar to other markets the distribution of medicines in the Indian
Pharmaceutical Industry is carried out by importers, clearing and forwarding
agents(CFAs) who are responsible for packing, storage, customs clearance
and transportation of the medicines. The wholesalers also play a role in
distribution and form a bridge between the manufacturers and the end
customers. They share vital information required for the continuous supply of
medicine. With the current data available there are close to 1,500 CFAs and
60,000 wholesales present in the Indian Pharma supply chain.
Determinants of distributor margin
Distributors/CFAs are traditionally paid on the basis of the stock they carry
throughout the year, the margin is fixed and regulated as a percentage on
the basis of the price of the medicine. To lower the costs the companies use
regressive margin, wherein a lower percentage is applied for the more
expensive drugs. The distributors receive incentives on the basis of the
amount of medicines they sell to the wholesalers. To increase stock rotation
and sales, they often tend to give out discounts. In cases where the
wholesaler cam influence the manufacturers product the percentage of
discount provided is higher.

END OF CHAIN
The wholesalers/stockists purchase products from different CFAs. They have
the option of holding stocks from different companies (generally five to six).
The stockists then sell the drugs to the various retailers and from then to the
end customer. (IMS health, 2004)3

Source: Pharma SCM

CURRENT SCENARIO
Global Pharma has been reaping on the success of the Indian Pharma
Industry, sales in the previous year was so high that the one of the
companies drug faced a stock out situation. The stock out had a severe
impact on the sales of the drug resulting in loss of revenue. The newly
appointed director had taken up the responsibility to ensure that such a
situation does not take place this year. The major concern with the subject
drug was the availability of the API supplier, currently there was just one
3 IMS Health. (2004). Understanding the pharmaceutical value chain. Available:
http://www.imshealth.com/imshealth/Global/Content/Corporate/IMS%20Health
%20Institute/Insights/Understanding_Pharmaceutical_Value_Chain.pdf. Last
accessed 1st March 2015.

supplier who provided the integral API. The lead time for the API to reach
Global Pharma was quite high as well. The cost parameters affecting Global
Pharma currently was due to inadequate data availability to make proper
demand forecasts.
COMPANY PLANS
The new director after having analyzed the data available in the ERP system
realized that more time was required to come up with an accurate forecast.
He discussed with the API supplier on postponing his order, to be able to
provide him with a perfect order quantity. However, the lead time given to
the supplier was not supposed to change the desired service level had to be
maintained.
If we look at this decision from the perspective of Global Pharma, it gives
them more time to place more accurate orders. This eventually helps in
reducing the risk of running into a stock out and benefits them on reducing
the loss in revenue due to stock out and excess holding cost. Whereas, on
the supplier end postponement would result in increasing his production
temporarily to maintain desired service levels and to expedite the
distribution and logistics involved. Both of which would incur huge additional
cost, the supplier has to implement both these measures only on a
temporary basis hence the cost benefit achieved on a long term basis cannot
be availed here.
The increase in cost due to logistics and expedited production will be directly
passed on to Global Pharma, this will result in the cost of the final drug going
higher. Global Pharma is currently following the fixed time period model for
placing orders. Wherein, the inventory levels are measured with the sales
and demand data at a fixed time frame (weekly, quarterly, monthly, etc) and
so is the order placed in a particular/fixed time frame and the new director
wants to postpone the date of placing the next order.
POSSIBLE SOLUTIONS

In the presence of uncertain demand, the objective is to minimize the

expected cost or to maximize the expected profit. Two types of inventory
control models:
1.

2.

Fixed time period - Periodic review

One period (Newsvendor model)
Multiple periods
Fixed order quantity - Continuous review
(Q,R) models

In the Fixed order quantity policies. The order quantity is always the same
but the time between the orders will vary depending on demand and the
current inventory levels. Inventory levels are continuously monitored and an
order is placed whenever the inventory level drops below a pre specified
reorder point. This is regarded as the Continuous review policy of the
company.
In the Fixed time period policies the companies place orders at fixed time
periods, though there is no fixed quantity involved. The quantity ordered
each time changes with demand and the current inventories available with
the company. Inventory is reviewed periodically in fixed time intervals, such
as a week or month. Then on the basis of the inventory available an order
size is determined to increase the inventory level up-to the forecasted level.
(Gel, Esma Keskinocak,Pinar. (2007))4.

4 Gel, Esma Keskinocak,Pinar. (2007). Inventory Management Subject to Uncertain

Demand. Available: http://www2.isye.gatech.edu/~pinar/teaching/isye3104fall2012/inventory-StochasticDemand-PartI.pdf. Last accessed 1st March 2015

Source: (Gel,Esma Keskinocak,Pinar. (2007))

Global pharma currently follows the fixed time period order placing strategy.
With the data provided in the case, we have the following assumptions and
constraints
Assumptions:
1. There is only one product involved;
2. Demand is spread evenly throughout

the

year

so

that

the

demand rate is reasonably constant. Hence, no bullwhip effect can

be implied onto the case.
3. Daily demand and lead time are independent of each other.
4. Daily demand and lead time follow a normal distribution.

Constraints:
1. Each order is received in a single delivery. Hence, partial orders cannot
be obtained which might result in production being halted if there is
shortage of even 1 unit. The production can resume only after the
whole lot arrives.
2. There is no quantity discount. Generally, the holding cost is minimized
with a discount that suppliers provide on bulk discounts. Since no bulk

discounts are the provided the only option is to reach an optimal

solution
3. Back-ordering is not allowed. Once an order is placed there is no option
to increase more units.
4. Service level is equal to 98%. Hence, can be considered above the
threshold.
5. Minimum lead time: 7 days
Due to the above constraints involved, Global Pharma cannot re-order in the
middle to make up for any excess demand. Hence, the new director of global
pharma insists on postponing the fixed time period to make the order with
the most accurate data. Postponement provides the below advantages:
1.
2.
3.
4.

Reducing demand variability (Ernst and Kamrad, 2000)5

Reducing risk diversification (Grag and Tang, 1997)6
Reducing finished products inventory (Brown et al., 2000)7
Accurate demand forecasts

Mean Daily demand: 200

Annual average demand: 365 X 200= 73000
Ordering cost: Rs.100/order
Annual fixed cost of Inventory holding: Rs.1000/unit
Annual Percentage of Purchasing Cost for Variable cost of Inventory Holding:
50%
Variance in the daily demand: 100/Unit2
5 Ernst R. and Kamrad B. 2000. Evaluation of supply chain structures through
modularization and postponement. European Journal of Operational Research, 124
6
Grag, A. and Tang, C.S. (1997) On postponement structures for product families with multipl
e points of differentiation, IIE Transactions, Vol. 29, No. 8

7 Brown, B. A. T., Sellen, A. J., & O'Hara, K. P. (2000). A diary study of information
capture in working life. Proceedings of CHI 2000, 438-445. New York, NY: ACM.

Postponement of the order time with reduced lead time will lead to an
increase of Rs.0.15/day/unit. This would affect the total annual inventory cost
of Global Pharma. Following are the possible EOQ solutions depending on the
lead time.
Solution 1:
No. of days of postponement: 23 days
Increase in price per unit: Rs.3.45/unit
Hence, new purchasing cost of critical API: Rs.23.45
EOQ= SQRT ((2DS)/hC))
EOQ= SQRT ((2*73000*100)/(0.5*23.45))= 1115.86
Ordering cost= (D/Q) * S = (73000/1116)*100= Rs.6541
Carrying cost= (Q/2)*hC= (1116/2)*0.5*23.45= Rs.6543
Total cost= Purchase Cost+ Ordering Cost+ Carrying Cost= Rs.17,24,934
Solution 2:
No. of days of postponement: 18 days
Increase in price per unit: Rs.2.7/unit
Hence, new purchasing cost of critical API: Rs.22.70
EOQ: 1134
Ordering Cost: Rs.6437.69
Carrying Cost: Rs.6,435.45
Total Cost = Rs.16,69,972
Solution 3:
No. of days of postponement: 13 days

Increase in price per unit: Rs.1.95/unit

Hence, new purchasing cost of critical API: Rs.21.95
EOQ= 1153
Ordering Cost: Rs.6331.31
Carrying Cost: Rs.6,327.09
Total Cost = Rs.16,15,008.40
SAFETY STOCK
The goal is to reduce the number of inventories without disturbing sales,
maintaining a healthy safety stock is one of the possible solutions. Safety
stock is regarded as a function of cycle service level, demand uncertainty
and lead time uncertainty.
In the present case we are provided with a service level ( ) of 98%, we
can determine the safety stock on the basis of the following formula:
Desired Cycle service level: CSL =98%
Mean demand during lead time: DL
Standard deviation of demand during lead time:

Mean lead time of Supply (L) = 30 days

Variance in daily demand of Critical API d2=100; d=10
Mean daily demand of Critical API: 200 units
DL = D*L= 30*200= 6000
L= Ld= 30*10 = 54.77
Safety Stock (SS) = Fs-1(CSL)*L = NORMSIN(0.98)*14.14 =112.48 ~ 112
Hence, to maintain a service level of 98% a Safety stock of 112 is required

Safety stock can be calculated using normal approximation and exact value
methods, the normal approximation gives a better solution when service
levels are in the value of 50% to 70%. Exact vale method is used with higher
service levels like the way explained above. Further, the value of the service
level and fill rate can affect the reorder point of the commodity. With exact
demand available during the lead time instead of the normal approximation
we infer the following:
1. With cycle service levels above 50% but less than a threshold, reducing
lead time variability increases the reorder point and safety stock.
2. For cycle service levels above 50% but below a threshold, reducing the
lead time decreases the reorder point and safety stock. (Chopra,Sunil et
al.,2004)8
RECOMMENDATION AND CONCLUSION
On the basis of the EOQ model developed and the various possible solutions
tested, a postponement of 15 days is considered optimal, the total ordering
cost in this case would be close to Rs.16,15,008.40. Postponement by 13
days should give the director sufficient time to analyze the data from the ERP
system.

Further, it is essential to order an additional 112 units as safety

stock per order to avoid last minute stock out and maintain the 98% service
level.

8 Chopra, Sunil Reinhardt,Gilles Dada,Maqbool . (2004). The Effect of Lead Time

Uncertainty on Safety Stocks. The Effect of Lead Time Uncertainty on Safety Stocks.
35 (1), p1-p5.