CHAPTER TWO

Literature Review

introduction
This Chapter covers the overview of the types on inventory kept, inventory control techniques, cost of
keeping inventory and impact of inventory management on pharmaceutical firms as well as significance for
holding inventory in organizations.

Definition of Inventory

Inventory management refers to the management of investment in inventory in the form of raw material, work
in progress or even finished goods. High investment in inventory is considered to be poor management as it
leads to idle funds in inventory. Shortage of inventory or lack of sufficient investment in inventory is also
dangerous as it might lead to stoppage of production, loss of good will etc. So there has to be an optimal
investment in inventory leading to efficiency.
Inventory is the array of finished goods or goods used in production held by a company. Inventory is
classified as a current asset on a company's balance sheet, and it serves as a buffer

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between manufacturing and order fulfillment. When an inventory item is sold, its carrying cost transfers to the
cost of goods sold (COGS)category on the income statement.
Pharmaceutical companies

Pharmacy is the science and technique of preparing, dispensing, and reviewing drugs and providing
additional clinical services. It’s a health profession that links health sciences with pharmaceutical sciences
and aims to ensure the safe, effective, and affordable use of drug. The professional practice is becoming more
clinically oriented as most of the drugs are now manufactured by pharmaceutical industries. Based on the
setting, the pharmacy is classified ads a community or institutional pharmacy.
Pharmaceutical is one of the most sensitive and major industry that deals with human and animal life. Purity
is highly deserved in this industry and there is no option of second chance. Quality, security, identities are the
most important to maintain. So inventory management of the industry is a difficult job. A pharmaceutical
company handled 500-600 types of products that includes huge amount of raw materials movement,
packaging and secondary packaging of the finished products. Planning and scheduling in the pharmaceutical
companies is a critical activity. Demand management under constraints of life- limited inventory buffers and
non-discrete nature of products is challenging.

Theoretical Framework

Inventory is generally categorized as raw materials, work-in-progress, and finished goods. Raw materials are
unprocessed materials used to produce a good. Examples of raw materials include aluminum and steel for the
manufacture of cars, flour for bakeries production of bread, and crude oil held by refineries.

Work-in-progress inventory is the partially finished goods waiting for completion and resale; work-in-
progress inventory is otherwise known as inventory on the production floor. For example, a half-assembled
airliner or a partially completed yacht would be work-in-process.

Finished goods are products that have completed production and are ready for sale. Retailers typically refer to
this inventory as "merchandise". Common examples of merchandise include electronics, clothes, and cars
held by retailers.

inventory management
Inventory Management plays a decisive role in the enhancement of efficiency and competitiveness of
business enterprises. Therefore, there is increased need for business enterprises to embrace effective inventory
management practices as a strategy to improve their competitiveness (Rajeev, 2008). Inventory management
is the function responsible for all decisions about inventory in an organization. It makes decisions for policies,
activities and procedures to make sure the right amount of each item is held in stock at any time (Donald,
2003).

Inventory Management according to Stevenson (2010) is a terminology adopted by a firm to take charge of
her investment in inventory. Thus, inventories characterize items which are kept for sale or are yet to be used
in the productive process, while an inventory system is a function of the particular level to be sustained, when
to replenish stock and how the order size will look like.

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Every inventory policy aimed at having in place enough and sustained quantities of excellent quality items
accessible to furnish customer needs and at the same time reducing inventory carrying costs (Brigham and
Ehrhad, 2005). Inventory management refers to the process of ordering, storing, and using a company's
inventory. These include the management of raw materials, components, and finished products, as well as
warehousing and processing such items.

Axsäter (2006) describes, inventories make high cost, both in the sense of tied up capital and also operating
and administrating the inventory itself. It is argued that time from ordering to delivery of replenishing the
inventory, referred to as the lead time, is often long and the demand from customers is almost never
completely known (Axsäter, 2006). Therefore, managers should consider how to achieve the balance between
good customer service and reasonable cost, which is the purpose of inventory management, involving the
time and volume of replenishment.

To this end, inventory in many small business owners is one of the most visible and tangible aspects of doing
business. Raw materials, goods in process, and finished goods all represent various forms of inventory. Each
type represents money tied up until the inventory leaves the company as purchased products. Likewise,
merchandise stocks in a retail store contribute to profits

only when their sale puts money into the cash register. In a literal sense, inventory refers to stocks of anything
necessary to do business. These stocks represent a large portion of the business investment and must be well
managed in order to maximize profits. In fact, many small businesses cannot absorb the types of losses arising
from poor inventory management. Unless

inventories are controlled, they are unreliable, inefficient, and costly. Inventory is an idle stock of physical
goods that contain economic value, and are held in various forms by an organization in its custody awaiting
packing, processing, transformation, use or sale in a future point of time.

For companies with complex supply chains and manufacturing processes, balancing the risks of inventory
gluts and shortages is especially difficult. To achieve these balances, firms have developed two major
methods for inventory management: just-in-time and materials requirement planning: just-in-time (JIT) and
materials requirement planning (MRP).

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Inventory Management techniques

According to Saxena (2003), in a production unit, regular inventories are divided into categories for effective
operations and control. Lonergan (2001) classifies inventory as raw materials, components, assemblies, sub-
assemblies, work in progress and finished goods. However, Morrison and Jessop (2000) agree with above
authors. They classify inventory as stock in trade, raw materials, equipment, spares, tools, gauges, fixtures,
work in progress, packing materials, scrap and residues.

Materials Requirements Planning

According to Fuller (2000), in situations where fixed order Quantity is not suitable, Materials Requirements
Planning approach has been developed as a means of managing inventory. The system is used for controlling
inventories of raw materials, work in progress, component parts and sub-assemblies. Material Requirement
Planning Inventory has been proven to be a very powerful tool in the planning and control of manufacturing
firm.
Gerald Hobson (2004) explains that material requirement planning is basically an information system in
which sales are converted directly into loads on the facility by sub unit and time period. Material are
scheduled more closely there by reducing inventories and delivery times become shorter and more
predictable. And only fervors smaller firms and the computer system is only one part of the total project
which is long term.
According to Salem (2004), Inventory control refers to a planned method of purchasing and storing materials
at the lowest possible costs without affecting the production and distribution schedule. Inventory Control
therefore is a scientific method of determining what, when and how to have in stock for a given period of
time.

Just In Time

The JIT technique is a Japanese philosophy, rationality associated with assembling which comprises having
the right things in the right quality and amount in the correct place and at the

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opportune time. Utilization of JIT technique brings about the increment in quality, profitability, and
effectiveness, enhanced correspondence, and abatements in expenses and squanders.
Hutchins (1999) characterizes JIT as a process that is prepared for moment response to the request without
the necessity for any overstocking, either in the desire of the application being approaching or as a concern of
improvident characteristics all the while. Hutchins (1999) additionally concentrated on that the prime
objective of JIT technique is the accomplishment of zero stock, not simply inside the bounds of a single
association at the end of the day all through the whole production network. It can be connected to the
assembling procedure inside any organization as it is additionally being adjusted inside administration
associations.
The components of JIT technique incorporate consistent change, taking out the seven sorts of squanders
among others. The fundamental reason of JIT is to have as of late the proper measure of stock, whether rough
materials or finished stock, open to meet the solicitations of your creation
strategy and the solicitations of the enterprise’s end customers. The less a firm spends to store and pass on the
stock, the less obsolete quality it has to markdown. Finally, this all culminates into saving the company’s
honest to goodness money.
Lysons and Gillingham (2003), defines Just in Time as an inventory control philosophy whose goal is to
maintain supply just enough, at the right place at the right time to make just the right amount of the products.
The aim is that by limiting production and assembly to what is actually needed, both materials and work in
progress inventories can be limited or significantly reduced.
Just in Time

implies a low or zero inventories and at times it is referred to as stockless buying. However, Saleem (2004)
points out that just in time inventory is only an approach which works to eliminate inventories rather than
optimize them. The inventory of raw materials and work in progress fall to that needed in a single day. This is
accomplished by reducing set up times and lead times so that small lots may be ordered.
Stock Control is an operational process where inventory management is a management process. Inventory
control therefore forms the basis of materials control without which the entire

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functioning of store-keeping may be rendered either ineffective or aimless to a certain extent. The inventory
control hence gives birth to materials control. Inventory control precedes stock- keeping which predetermines
the scope of inventories and investment therein.

Inventory Control Techniques

Inventory is essential in an organization for production activities, maintenance of plant and machinery and for
other operational requirements (Jessop 2003). The normal tendency is to have more inventories so that most
of the items are available when needed this results in blocking of money which otherwise could have been
used more productively. Inventory is part of the company’s assets in its balance sheet and is therefore always
under close scrutiny of management. The management is very concerned
about any shortage of items required for production. This is so because any increase in the down time of the
down time of the machines due to shortage of raw materials lead to production loss. The two aspects therefore
call for inventory control not only looking at the physical balance of various materials but also looking into
aspects of minimizing the inventory cost.
In other hand, Saxena (2003) advises that avoiding shortages, excessive stocking and increasing inventory
turnover, are some of the main issues concerning inventory control. Further, methods of reducing the
component of materials cost in the product cost, is an important consideration in cost reduction.

The Economic Order Quantity Concept

Economic Order Quantity (EDQ) attempts to reconcile the problem of storage costs and ordering costs. Ford
Harris is the one who discovered and derived Economic Order Quantity Model 1915. Its function is to
determine the optimal order that minimizes quantity that will minimize carrying costs and ordering costs.
Economic Order Quantity is therefore the Order Quantity that will minimize both carrying costs and ordering
costs (Fuller 2000).

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According to Morrison and Jossep (2000), the Economic Order Quantity is the quantity, which minimizes the
sum of the acquisition cost and inventory carrying out cost. The Economic Order Quantity minimizes the total
annual cost.
According to Bowersox (2002), the inventory management needs to be organized in a logical way so that the
organization can be able to know when to order and how much to order. This must be attained through
calculating the Economic Order Quantity (EOQ). Monetary request amount engages correlation to arrange
their stock re-establishment on an ideal premise. For instance, the arrangement can be scheduled to happen
from month to month, quarterly, half yearly, or yearly. By so doing, it enables firms to have insignificant limit
costs or zero inside their circulation focuses. Along these lines, as associations attempt to enhance the stock
administration, the EOQ and Re-Order Point (ROP) are necessary instruments that associations can utilize.

The ABC Analysis

The ABC stock control technique relies on that the decision a little bundle of the things may usually address
the weight of money estimation of the total stock. It is used as a part of the era method, while a tremendous
number of things may happen from a little part of the money estimation of stores. Accordingly, to manage
stock control high regard things are more solidly controlled than low regard things.
ABC examination is an essential action method that follows the Pareto Principle concerning an organization’s
arrangement of stock. Most organization attempts and oversights are depleted on managing A things. C things
get the base thought, and B things are in the centers. The
ABC approach ranks using the following criteria: A things represent 70–80% of the firm’s annual
consumption approximation and just 10–20% of aggregate stocked items. B things represent 15–25% of
annual use esteem and 30% of aggregate the stock, and C things characterize 5% of the annual application of
esteem and half of total stocked items.
According to Fuller (2000), it is possible to utilize the concept of ABC in the formation of rational inventory
policy which should give the best possible service level to production while

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minimizing investment cost. Saxena (2003) stresses that various studies have shown that only 20% of the
items have 80% of the annual inventory consumption and 80% of the items have 20% of annual inventory
consumption, this is based on the findings of an Italian static Ian Vilfred Pareto (2004).
However Fuller (2000). argues that categories of inventories of items should be controlled differently. For
class A items, they should be controlled tightly, need accurate recording of receipts and issues, scheduled
should be constantly reviewed and minimum buffer stocks probably less than 2 weeks. Class B items require
moderate level of control, all receipts and issues should be recorded, schedules should be moderately
reviewed and later buffer stocks 6-8 weeks. Class C items need lower level of control, there should be
minimal recording of receipts and issues, need lower level of schedule and review and need large safety
stocks of 12 weeks.
But Morrison and Jessop (1999), argue that ABC analysis is based on 80:20 rule, as a rule of thumb, it will be
found in any store or stockyard that about 80% of the total value of issues in a year will be accounted for by
perhaps 20% of the items. Category „A‟ items, small in number, high in usage value. “The vital few” from
financial point of view. Category B items, medium in number, medium usage value. “The normal” items.
Category C items, high in number, low usage value. “The trivial many”. ABC analysis is an important tool to
control the inventory investment in an organization. It provides good guidelines for adopting appropriate
inventory management.

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Pharmaceutical firms

According to Dickinson (2008), small to medium-sized enterprises are considered as engines of growth in
both developed and developing countries. Jutla, et al (2002) point out that SMEs are contributing significantly
to the economy and the economic growth of a country, thus many countries recognize the need to study as
well as support small pharmaceutical companies.

Adeyemi and Salami (2010) claimed that the astute manager who understands the virtues of each of the
component of inventory could use them selectively to implement corporate strategy in the market place. An
organization can strategically build up inventory for market promotion and also to stabilize production
schedule. Inventory management is crucial to organization Almarsdóttir and Traulsen (2005) identified a
number of reasons why pharmaceutical deserve special consideration in the control of inventory. In the
current economic crisis, increasing attention is being focused on the rising costs of health care and
specifically inventory in many small business owners is one of the most visible and tangible aspects of doing
business. Raw materials, goods in process, and finished goods all represent various forms of inventory.

Each type represents money tied up until the inventory leaves the company as purchased products. Likewise,
merchandise stocks in a retail store contribute to profits only when their sale puts money into the cash
register. In a literal sense, inventory refers to stocks of anything necessary to do business. These stocks
represent a large portion of the business investment and must be well managed in order to maximize profits.
In fact, many small businesses cannot absorb the types of losses arising from poor inventory management.
Unless inventories are controlled, they are unreliable, inefficient, and costly. Inventory is an idle stock of
physical goods that contain economic value, and are held in various forms by an organization in its custody
awaiting packing, processing, transformation, use or sale in a future point of time.

Pharmaceutical company generally possesses inventories like finished goods, work in process, packing
material, literature and promotional materials, physician sample, raw and packing material in transit, stock of
stationery, spare and accessories. Pharmaceuticals represent a significant part of health care costs, account for
approximately 10% of annual health care expenditure in the USA and about $600 billion globally in 2009.
Pharmaceutical is one of the most sensitive and major industry that deals with human and animal life. Purity
is highly deserved in this industry and there is no option of second chance. Quality, security, identities are the
most important to maintain. So inventory management of the industry is a difficult job. A pharmaceutical
company handled 500-600 types of products that includes huge amount of raw materials movement,
packaging and secondary packaging of the finished products. Planning and scheduling in the pharmaceutical
companies is a critical activity. Demand management under constraints of life-limited inventory buffers and
non-discrete nature of products are challenging.

Pharmaceutical products can be expensive to purchase and distribute, but shortages of essential medicines,
improper use of medicines, and spending on unnecessary or low-quality medicines also have a high cost in
terms of wasted resources and preventable illness and death.

pharmaceuticals. Careful management of pharmaceutical is directly related to a country’s ability to address

public health concerns. Aptel and Pour jalali(2001) stated that management of pharmaceutical supplies is one
of the most important managerial issues in health care industries . However, many health care industries
experience difficulty in managing their pharmaceutical products.

success since holding too little or too much stock has negative effect on the organization performance.
The problem of inventory has continued to receive much attention in most businesses. Inventory levels of raw
materials, semi-finished and finished goods need to be effectively managed to control the cost of inventory
(Kotler, 2002). t is common to find the balance sheet of an average company having inventory running to
60% of its current assets as capital tied down Pandey (2005). Apart from this, much has to be expended
additionally to keep it useful.
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To achieve the desired contribution of Pharmaceutical firms to the industrial growth of a nation, the
management of inventory in these organizations are of utmost importance. Inventories are goods that are kept
to meet future demand and to ensure production continuity. It is a very important asset in any business
organization. The management of this vital asset is very important for the efficiency, effectiveness and
profitability of the business (Forgionne 1986)

Empirical review

Inventory management of Pharmaceutical

Gill et al (2010) argue that excess inventory is an operational liability, because it uses valuable storage space
and increases inventory costs. Raw material ordering frequency is identified as an important factor
contributing to inventory cost. Frequent ordering in small quantity is considered as an important strategy. This
is very relevant in the context of Pharmaceutical firms. This is because Pharmaceutical generally do not get
the benefits of quantity discount. Their purchase requirement quantity of material is normally less to enable
them to get these benefits.

However, the study found that both factors have no direct impact on SCM-related organizational performance
and only indirect and significant positive effect. Whereas, studies by Teunter et al (2012) was that ABC
analysis is commonly used as an inventory management practice in SMEs worldwide. To exercise inventory
planning and control, the understanding of the factors influencing inventory management is necessary. This
will enable Pharmaceutical firms to select an appropriate inventory management practice in their enterprise.
Through the role of inventory management practices of a firm, their inventory cost on order quantity and
hence on inventory performance is well explained in theory; an empirical evaluation of the same is not done
so far in the context of SMEs, particularly in developing countries.

Jonsson and Mattsson (2008) studied the use of material planning methods to control material flow
inventories of purchased items. The study explored the perceived planning performance of material planning
methods used to control material flow in different types in manufacturing and distribution companies. They
also evaluated the difference in perceived planning performance depending on the way planning parameters
are determined and the methods used.

Koh et al (2007) probed a more prominent issue regarding the underlying dimensions of Supply Chain
Management (SCM) practices and to test a framework identifying the relationships among various SCM
practices, operational performance, and SCM-related organizational performance. The survey study was
conducted on SMEs in Turkey. The study brought out that both strategic collaboration and lean practices
(SCLP) and outsourcing and multi suppliers (OMS) factors have direct positive and significant impact on
Pharmaceutical firms.

Many researchers have analyzed different inventory management practices and performance and these studies
have amassed an enormous knowledge related to inventory management and organizational performance.
Maria and Jones (2003) argue that implementation of proper inventory management practice involves
providing high-quality products at relatively less cost. They further point out that it is essential to establish a
daily ordering and frequent calculation of inventory turns

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On the other, Ballon (2000) argues that inventory cost should be considered while taking inventory decisions.
He found that inventory carrying costs typically range from 20% to 40% of inventory value. Palmer, and
Dean (2000) are of the opinion that selection of right inventory management practice is a must for a
company’s inventory management performance.
The management of Pharmaceutical firm studies viewed the need for a more formal procedure to calculate its
inventory policy parameters. The growing investment in inventory combined with an increasing number of
backorders and lost sales lead to lower profitability. Therefore, it was decided to follow a more scientific
approach than the currently used rules of thumb to establish inventory policy parameters with the objective of
optimizing inventory cost.

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