CASE 6
Western Pharmaceuticals (A)
George Castro had a lot to be proud of. His company, Western Pharmaceuticals, had just merged with the largest producer of over-the-counter (OTC) cold remedies on the East Coast. The merger with Atlantic Medical should guarantee coast-to-coast market penetration for both Western’s upset stomach products and Atlantic’s cough syrups. George had been selected to serve as CEO of the newly formed United Pharmaceuticals, and was rapidly becoming recognized as being one of the top Mexican-American business leaders in the country.
History
Western Pharmaceuticals had been founded by George’s grandfather in post-war Los Angeles. Tony Romero’s reputation for hard work combined with his strong pharmaceutical background made the introduction of his first antacid tablet an unqualified success
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in the booming downtown area. The company grew quickly, and soon became the largest producer of antacid tablets in Central and Southern California.
George’s father, Rudy, married in to the Romero family in 1961. Although not a pharmacist, Rudy received a degree in urban planning from Pepperdine University. After many heated discussions with his new son-in-law, Tony acted on Rudy’s advice to expand the company outside of the now congested Los Angeles city limits. Tablet production would now take place in tiny Ontario, some distance to the east of L.A. The urban site, conveniently located in proximity to several major freeways and a railhead, would now serve only as a distribution center.
Rudy’s suggestion to separate production and distribution worked. Ontario offered markedly lower rent and labor costs than Los Angeles, but was close enough to the city to prevent any significant inconveniences. Additionally, allowing the Los Angeles site to focus only on distribution led to significant economies. Western Pharmaceutical flourished.
Upon his father-in-law’s recommendation, Rudy enrolled in business school and received his MBA from Cal-State Los Angeles in 1968. Rudy was subsequently appointed executive vice-president of Western and quickly focused on expanding and diversifying the company. Aside from seeking new products, Rudy recognized the importance of a viable distribution system to market penetration. A second distribution center was constructed in Indianapolis, and Western Pharmaceuticals became the market leader of Nevada and Arizona by mid-1971. By 1972, Western had a dominant position in the Northwest, Utah, Idaho, and New Mexico, and was making significant inroads in Colorado. Upon Rudy’s recommendation, Tony pursued the acquisition of Central Solutions, a small Midwestern outfit that manufactured liquid antacids. Although Central was a struggling company, its acquisition allowed Western Pharmaceutical to diversify into the liquid market. More importantly, Western obtained distribution centers in Nebraska and Sparks. Midwestern market share and profits followed.
George started working part-time as a warehouseman in the Los Angeles distribution center in 1978. After graduating from UCLA in 1982, George worked as a production manager at the Ontario site. By the time George earned his MBA in 1986, Western Pharmaceuticals had conquered the majority of the West and Midwest and was now eyeing the South. In 1988, Western opened its newest distribution center near Atlanta’s inner beltway. Construction of the Atlanta site made access to the South and Southeast significantly more efficient, and market share increased accordingly.
By 1996, Western Pharmaceuticals was recognized as a “cash-cow” in the stomach upset industry. No longer an innovator, Western had well-recognized products that retained their market share through creative and aggressive advertising campaigns. Rudy, now president of the company, was content to leave the company in its current state. This led to some amount of disagreement between him and his son. George, always the “go-getter,” had developed an aggressive reputation within the company and frequently encouraged his father to tackle the East Coast.
George became the president of Western Pharmaceuticals after his father’s retirement in mid-1997, and immediately began his pursuit of the East Coast. Atlantic Medical offered everything that he felt Western needed in order to guarantee its continued success. First, the company offered cold remedies, something that Western had considered but never pursued. Second, the company had key East Coast distribution centers in Mechanicsburg, PA., and Atlanta, GA. George was convinced that the successful merger of the companies would guarantee nationwide success in the OTC market for antacids and cough syrups.
Present
The newly formed United Pharmaceuticals was comprised of six factories and seven distribution centers. The newly formed company produced six products (A–F) with nationwide market penetration. Now that the company had achieved a coast-to-coast presence, George
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looked internally for further efficiencies. Namely, based on production and handling costs, inbound, outbound and service costs, were all of the distribution centers necessary?
TABLE 1 Western Pharmaceuticals Current Plants and Distribution Centers
TABLE 2 Atlantic Medical Plants and Distribution Centers
TABLE 3 Plant Production Profile
Table 1 lists the pre-merger, Western Pharmaceuticals plants and distribution centers. Table 2 lists the pre-merger plants and distribution centers for Atlantic Medical.
Table 3 lists the production capability and percent of volume for each plant.
Even though both firms utilized contract warehouse facilities, there are fixed costs incurred for each facility due to management and technology. Each Distribution Center operates with fixed costs of $300,000. The handling cost at each distribution center is estimated at $1.00/cwt. The handling cost covers the labor and equipment required to receive shipments from plants, put-away, order picking, and truck loading.
For accounting and inventory carrying cost purposes, each pound of inventory is valued at $5/lbs. Finished goods inventory turns in the distribution centers have historically been 3.5 turns annually for Western Pharmaceuticals and 3.0 turns annually for Atlantic Medical. Each product at the distribution centers is typically replenished on a bi-weekly basis.
Table 4 lists the current service areas for each division and state. While there are numerous exception shipments, each state is generally served by its assigned distribution center.
At this time, the production capacity of the combined firm is 100 percent utilized. As a result, it is not possible to shut down any production capacity. It is possible, however, to shift capacity around to different plants for a one-time charge of $500,000. This covers the cost to prepare the new site, tear down the equipment, transfer it, set up, and recalibrate it at the alternative plant location.
Customer satisfaction requires that all products for a single customer must be shipped from a common distribution center. This implies that shipments cannot be made directly from any plants. The integrated firm has operationalized this policy by requiring that each state should be assigned to only one distribution center source. The firm also requires that 95 percent of the volume be within two days transit of the servicing distribution center. This effectively means that 95 percent of the volume must be within 750 miles of the servicing distribution center.
Western Pharmaceuticals (B)
Once George initiated the supply chain design project (see Western Pharmaceuticals A), his next task was to investigate the firm’s inventory management capability relative to the refined supply chain. The integration of the Western and Atlantic Medical distribution systems required a refinement of the firm’s inventory management system. [spreadsheet can be found at www.mhhe.com/bowersox4e <http://www.mhhe.com/bowersox4e>].
Although the firm wanted to have a comprehensive inventory analysis, the information available was limited due to the merger and a simultaneous move to an Enterprise Resource Planning system. In fact, in terms of quickly available data, there was only a limited sample from the Atlantic Medical sales and inventory records. For a sample of 100 stockkeeping units (SKUs), the data base includes the average and standard deviation of weekly sales, average order cycle time (OCT), replenishment order quantity (OQ), and the average inventory. Based on history, the current standard deviation in the replenishment cycle time is 1 week. The sales, order quantities, and inventory are recorded in cases. The historical information is provided for each of the three existing distribution centers.
Atlantic believes that the historical case fill rate is 95 percent but they are not really sure.
Questions
- What should the case fill rate be for each product given the current uncertainty levels and order quantities and how does the calculated aggregate case fill rate differ from the historically observed level?
- What are the safety stock and average inventory levels for each product and in aggregate necessary to achieve 95 percent case fill rate for each product? To what extent do the actual inventory levels deviate from the theoretical inventory levels? What conclusions can you draw from the differences?
- What is the inventory carrying cost impact for increasing the case fill rate from the current level of 95 percent to 99 percent? Assume an annual inventory carrying cost of 20 percent. Assuming that 5 percent is potentially lost due to stockouts (100 − 95 percent) and that there is a 25 percent margin on the average item (COGS = 75 percent), would you recommend that the service level be increased? Justify your answer.
- What would be the impact on inventory and service of consolidating all of Atlantic Medical stock into a single facility? Apply both the “square root of N” and item level approaches. The square root of N should be applied to aggregate inventory values for a total of all products. The item level approach uses the individual standard deviations. Discuss the differences between the two approaches. Why?
