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CHAPTER TWO: LITERATURE REVIEW
2.1 Introduction
This chapter represents theoretical literature review, analytical literature review, the summary and gaps to be filled in this study.
2.2 Past Studies
2.2.1 Effects of Ordering Cost on the Pricing of Medicines in Pharmacies in Nyeri County
According to Marshall (1999) , ordering costs are costs of ordering a new batch of inventory. These include the cost of placing a new order, cost of inspection or receiving batches, documentation cost, handling cost, etc. Ordering cost vary inversely with carring costs. It means that the more orders a business places with its suppliers, the higher will be the ordering cost. It is important for a business to minimize the sum of these costs which it does by applying the EOQ model.
According to Henry (1999) , order cost is simply the total expense incurred in placing an order. In the EOQ model, this is the cost of preparing a purchase order and the cost of receiving the goods ordered and used in calculating order quantities, the cost that increases as the number of orders placed increases. It includes costs related to the clerical work of preparing, releasing, monitoring and receiving orders, the physical handling of the goods, inspection and setup costs as applicable. Holding costs, on the other hand, is the cost associated with holding one unit of an item in stock for one period of time incorporating elements to cover: capital cost of stock; taxes; insurance; storage; handling; administration; shrinkage; obsolescence snd deterioration. In warehouse management, holding cost is money spent to keep and maintain a stock of goods in storage. There are a number of costs that make up the total inventory cost for a company. One of these costs is the carrying cost that a business expends while the material is in the warehouse but, there are other costs such as the order and setup cost. Order cost include the expenses involved in placing an order for a quantity of material but, this does not include the actual cost of the material itself.
According to Anderson (1998), when a company orders materials, there is a cost associated with the process. The cost is made up of two components; the fixed cost and the variable cost. The fixed cost remains the same for any order that is placed by a business to a vendor. This type of fixed cost will include the cost of a company's facilities and the maintenance cost of the computer system used to process purchase orders. These costs will remain the same; if one or a thousand orders are made. The other component of order cost includes the variable cost. These variable costs will vary depending on the number of purchase orders that are processed. The variable cost can be significant and includes the cost of preparing a purchase requisition, the cost of creating the purchase order, the cost reviewing the inventory level, the cost involved in preparing and processing the payments made to the vendor when the invoice is received and the cost involved in receiving and checking items as they are received from the vendor.
Marshall (1999) asserts that order costs are often overlooked by companies as they perceive the actions of employees, such as checking inventory or testing the quality of incoming materials, as a part of an employees' normal function. However, when calculating the cost of ordering items, it is often a surprise to companies when they find out how much it actually costs to have an item of materials purchased and available at their warehouse. Companies often forget that it costs far more to create ten orders for five items each from a vendor than one order of fifty. It is easier for businesses to understand and appreciate the costs involved in production setups than the cost of ordering materials from a vendor. Manufacturing companies are often too aware of the cost of changing the manufacturing line for creating one item to creating another. There is often much discussion and analysis of the best way to minimize the time and cost of changing production on the shop floor. With setup costs, there are still two component costs; fixed and variable.
According to Anderson (1998), in a production setup, the fixed costs will include the cost of the capital equipment used in tearing down the production line used for the old items and setting up machines for the new items. The variable cost in production setup include the personnel cost in changing over production, as well as the consumable materials used in the tear down and setup. When a business is looking at their overall costs, they should examine the carrying cost of holding inventory against the cost of ordering matarials from the vendor. It is clear that order costs are very high if a small number of items are ordered, whilst carrying costs are much lower when the inventory in the warehouse is very low. The total cost of inventory is made up of the two costs, carrying cost and order cost and, at a certain point there is an optimum size of order where the total cost is at its very minimum. After that point, usually when there's no more benefits gained in large orders due to the fixed costs of purchasing, the carrying costs of additional inventory continues to rise, forcing the total cost of inventory to go even higher.
According to Lucy (2002) , ordering is the process of determining what a company will receive in exchange for its products. Pricing factor is manufacturing cost, market price, competition, market conditions and quality of product. It is the manual or automatic process of applying prices to purchase and order sales based on factors for example amount, quantity break, promotions and sales campaigns. It is important in marketing since the need of the consumer can be converted into demand only if the consumer has willingness and capasity to buy the product. A well chosen price should achieve the financial goal of the company, that is, profitability, fit the realities of the market price and be consistent with other variables such as the type of distribution channel used, the type of promotion used and the quantity of the product. It needs to be relatively high if the manufacturing is expensive, distribution is exclucive and the product is supported by extensive advertising and promotional campaigns. From a marketer's point of view, an efficient price is one close to the maximum that customers are ready to pay. A good pricing strategy would be the one which could balance the floor and the ceiling. Pricing is the most effective profit lever.
Anderson (1998), states that the appropriate way to establish the cost of every stock or cost of production, is to establish various cost centers in the production process. The various cost centers include; cost of raw material, transportation cost, premium and allowable losses, material handling charges and the conversion process. An organization will fix the price of its product only after valuing the inventory of raw materials and after considering the above stock cost valuation. Some of the stock valuation techniques increase the possibilities of clerical errors if the consignments were released at a frequency of fluctuating prices at every time an issue of material was made. The store ledger clerk would have to go through his records to ascertain prices to be charged.
Henry (1998), asserts that ordering may result in overstating or understating the market price. Any rise in the price does not reflect the market price as the material were issued according to their time in store. Therefore, charge to production becomes low resulting in reduced costs in the organization. The objective of profitability relates to a company's ability to earn satisfactory income so that investors and shareholders will continue to provide capital to it. Evaluating profits is very important to determine which method is going to be used. The management of stock for profit is one of the most challenging tasks in terms of shillings. The inventory of goods held for sale is one of the largest assets of merchandizing business and inventory is important to a manufacturing firm. A company's investor valuation method affects not only the reported profitability but also the reported liquidity.
Anderson (1998), stated that some of the stock evaluation techniques value stock in hand at a price which does not reflect current market prices, resulting to closing stock being understated in the balance sheet. Also the technique selected by a company may reflect the ratio and financial statement and subtotals evaluating the company's financial statements. The prices and profits of goods sold for life valuation method versus FIFO depends on cost in each value layer relative to current cost inventory. If FIFO is used, generally costs increase over time and the prices are higher. On the other hand, the reduction of life layer results into lower cost of goods sold, better prices and hence, higher profits than FIFO . Rapidly rising costs results in inventory profits or profits when FIFO assumption is used, because the release of older, lower cost goods. The income statement results higher profits. The current costs of replacing merchandise to sell is considerably higher than old cost thus, users of financial statements can be misinformed about the firms' real economic profitability. To avoid this situation, many firms use life to price and value stock at least for a part of the inventory during the years of high inflation.
According to Lucy (2002), this change from FIFO to life results to higher cost of goods sold and lower profits, lower taxes and more realistic financial reporting of net income.
According to Marshall (1998), changes in quantities of stock will have an impact on profits that is dependent on the cost flow assumption used in the context of cost changes during the year under FIFO method which the price rise and issue price do not reflect the market price as materials were issued from the price of the earliest consignment. The comparison between one job and another can be done through this method although it becomes difficult because if a job starts in a few minutes after another, they may bear different changes in materials consumed merely because the earlier job exhausted the supply of the lower priced or higher priced materials in the stock.
2.2.2 Effects of Purchasing Policy on the Pricing of Medicines in Pharmacies in Nyeri County
According to Jian (1996), policies are broad guidelines that show how objectives of an organization will be achieved. It defines the management and the values the organization should adopt when dealing with customers and also personnel. Policies can be implied or explicit, however, explicit are preferable. Businesses should establish policies and procedures and commit them to the company, before commencement of trading activities. They show how to handle specific scenarios and procedures and direct them on how to accomplish certain tasks that are critical to every business purchasing operation regardless of the size. The company is able to operate with greater consistency both in its internal and external workings. If stock policies are not well stated, they affect pricing. Take for instance, the dividend policy; stock price is ultimately driven by investor demand. If an investor likes a companys' dividend policy, there will be more share demand driving the prices higher.
According to Henry (1998), a procurement policy is simply the rules and regulations that are set in place to govern the process of acquiring goods and services needed by an organization to function efficiently. The exact process will seek to minimize expenses associated with the purchase of goods and services by using such strategies as volume purchasing, the establishment of a set roaster of vendors and establishing reorder protocals that help to keep inventories low without jeopardizing the function of the operation. Both small and large companies as well as non-profit organizations routinely make use of some sort of procurement policy. There is no right way to establish a procurement policy. Factors such as the size of the business, the availability of vendors to supply the necessary goods and services and the cash flow and credit of the company will often influence the purchasing procurement approach. The size of the company is also likely to make a difference in the formation of procurement policy, in that a small company may not be able to command the volume purchase discount that a large corporation can manage with relative ease.
In like manner, Lucy (2002), notes that circumstances and financial goals of the business or entity influence the selection of procurement systems. Some systems are simple manual processes that make use of older methods such as flip card system to track purchases, issuance of items to various departments and a running tally of inventory that is used to plan future purchases. Today's electronic systems make it possible to automatically track all these functions. This includes automatically generating acquisitions and purchase orders when a certain level of a given inventory item is reached.
According to Dryer (2011), e-procurement is a common way of placing and tracking orders today. Vendors establish network connections with clients that make it possible to interact with any procurement program used by the client and automatically place orders using the internet to establish the connection. Programs of this type also make it possible to quickly track order fulfillment, delivery dates and even review any procurement contract that is currently in place. Whether the procurement policy involves the establishment of construction procurement procedure or govern purchases made by a manufacturer or a charity, a solid policy will benefit the organization by keeping costs in line and clearly defining how purchases will be made. As the need of the entity changes, there is a good chance that the procurememt policy will be adjusted to meet those new circumstances. This is necessary to make sure the policy continues to function in the best interest of the company or non-profit organization and keep the acquisition process simple and orderly.
According to Lucy (2002), policies are vital to have in place in an organization so that employees know what is expected of them, what they can do and what they cannot do. Having prior policies in place can help to make sure all organizations' information is secured effectively. Implemented policies ensures every employee understands the behavior that constitutes acceptable use within the organization. Although formal policies and rules are easily accessible to factor, policies that are embedded in the everyday work of the organization are less visible.
According to R. Anderson (1998), policies of an enterprice resource planning require a substantial capital investment to implement it. Considerable time and money must be set aside to evaluate FIFO and information software applications and their accessories, in order to purchase the necessary hardware and software and then to train employees on how to operate the new system. However, the policy of stock valuation option, the pricing of materials, comparing one job to another becomes difficult because in the use of techniques like FIFO it's a job start nature. The issue price will be different because the earlier job exhausted the supply of the lowered price material in stock. The price rises as materials are issued from the earliest consignment. Therefore, the change to production will be low because the charge of replacing the materials consumed will be higher than the price of issue.
Dryer (2011) states that stock valuation policy is a physiology of manufacturing based on eliminating possible errors i.e. clerical errors, if consignments are reduced frequently at fluctuating prices as every issue made, the store ledger clerk will have to go through his records to ascertain the price changed or price to be changed. This is not the only way of improving efficiency and hence increasing organization profitability. Materials issued from the store are debated to the sober works.
2.2.3 Effects of Lead Time on the Pricing of Medicines in Pharmacies in Nyeri County
According to Frank (2007), lead time of material requisitioned by the various production centres and other departments must be ascertained and its flow and continuity of supply must be maintained by the materials management department. Insufficient or zero inventories, many times, create the situation of stock-outs and leads to stoppage of production. Failure of material handling devices is also responsible for disruption of materials supply. Alternative or emergency supply systems can be used for assuring production lines continue.
Saleemi (2010), states that lead time is the period between a customers' order and the delivery of the final products. A small order if pre-existing items may only have a few hours lead time but a large order of custom made items, may have a lead time of weeks, months or even longer. It all depends on the number of factors from the time it takes to create the machinery to the speed of the delivery system. Lead time may change according to the season or holiday or overall demand for the product. Lead time can mean the difference between making the sale or watching a competitor sign the contract. If a company can deliver the product weeks ahead of the competition, it stands a better chance of receiving future orders because if this. Management and labor teams routinely hold meetings to discuss lead time improvements.
Shitanda & Sternes (2004), state that in the manufacturing environment, lead time has the same definition as that of supply chain management but, it includes the time required to transport the items from the supplier. The transporting time is included because the manufacturing company needs to know when the items will be available for material requirement planning. It is also possible for lead time to include the time it takes for a company to process and have a item ready for manufacturing once it has been received. The time it takes for a company to unload a product from a truck, inspect it and move it into storage is non-trivial. With light manufacturing constraints or when a company is using JIT manufacturing, it is important for supply chain to know how long their own internal processes take.
According to Dryer (2011), the supply chain management phase built on specification has been coined to describe both the changes within the supply chain itself as well as evolution of the processes, methods and tools that manage it in this age.
2.2.4 Effects of Buyer-Supplier Relationships on the Pricing of Medicines in Nyeri County
According to Jian (1996) , SRM is a process in business by which an organization systemizes its interactions with individuals or organizes the delivery of raw goods and services. SRM is basically a partnership approach between a business and its key suppliers. It works on similar principles to executive account management services from a company to its top customer. Rather than one business simply purchasing products from another, a mutually beneficial relationship is built and maintained between companies.
Dryer (2011) , asserts that the aspects of this business relationship typically include many formal corporate tools such as RFPs and price negotiations. Suppliers provide customized services for their SRM partner client such as extensive sourcing and product knowledge. Buyers in SRM management partnerships communicate with suppliers about products they need so that ordering arrangements can be worked out for them. They do not simply place orders but typically speak with an account executive who handles only the most important customer accounts.
Shitanda & Sternes (2004), states in most industries, a key account manager is given the companys' most profitable client accounts. In many cases, this person will also be given the most valued supplier and distributer accounts to monitor. This action is a common component of SRM. Suppliers in relationship management partnerships with their clients often order their needed supplies from them. For example, an office furniture company with with an electronics store is a top client, would be likely to purchase a new computer it needs from its business with which it has been building a working relationship with.
Lori et. al. (2011), states that buyers and suppliers involved in this beneficial working relationship usually do not limit their contact to phone calls or emails but, will have representatives visit in person at least in one occasion. In-person contact can increase the perceived value of the relationship and also increase profits as it often results in more sales. Since SRM is about building and retaining that business connection, most people want to meet with an account executive in person. Typically, the account executive manger as well as the owner of the company also meets face-to-face with the suppliers at least from time to time.
Jian (1996), states SRM participants work on building mutually beneficial relationships, the attitude between both participants is usually one of mutual respect and appreciation. Alternatively, personalized services and specialized gifts are some of the perks of this type of relationship. Managing the supplier relationship takes communication, planning, implementation, maintenance and follow-through on commitments. SRM helps each partner maximize profits and grow each others' business through loyalty, respect and the best possible service.
According to Lori et. al. (2011), the reality is the buyer and seller are trying to control costs as much as possible while health workers are fighting more for the supplies they want. As a result, pharmacy relationships with patients and supplier may be in jeopardy. It is far too easy for negative outcomes to occur when a focus on price means that quality takes a backseat to margins. This is dangerous; lapse in quality may have a life or death consequence.
Jian (1996), contemplates that though the ability to compete on price is always important, suppliers need better strategies to differentiate them from competitors. The buyer-supplier relationship connection benefits tremendously when it changes from a ralationship based on price to one based on advice. In an advice based relationship, the suppliers high-quality counsel creates a partnership with the buyer that is fundamantally different from a relationship based on price and thus, constantly negotiable. Suppliers that can build meaningful relationships with pharmacies are best positioned for the future, when competing solely based on price will no longer be a visble strategy.
Shitanda & Sternes (2004), states that pharmacies can also benefit from a shift from a price based to an advice based relationship. For example, pharmacies can hold their suppliers accountable for quality and innovation, making these suppliers indispensable and irreplaceable in delivering quality care to patients. Pharmacies gain access to the best supplier and gain collaborators who help them keep costs low in the long term.
Lori et. al. (2011), states the traditional way to managing buyer-supplier relationship focuses on accessing the strength of a customer's relationship with the seller- how engaged a customer is with a retail outlet or a fastfood restaurant, for example. That approach, however, does not fit the dynamics of a pharmacy-supplier relationship. Many pharmacies, for instance,recognize the key role their suppliers play in ensuring quality patient care. Suppliers can reduce risks at key points along the supply chain and provide access to cutting-edge knowledge, processes and technologies. Yet, few pharmacies access strength of their relationships with thier key suppliers.
2.3 Critical Review of Past Studies
According to Data (1996) , controlling inventory does not have to be a complex proposition. It is a process of thoughtful inventory management. There are no hard and fast rules to abide by, but some extremely useful guidelines to help your thinking about the subject. A step by step process has been designed that will help any business bring this potential problem under control, to think systematically throught the process and allow the business to make the most efficient use of possible resources presented. The final decisions, of course, must be the result of good judgement and not the product of a mechanical set of formulas.
Adamson (2007), states that keeping an inventory fresh and up to date requires constant attention by any organization, large or small. Technologically obsolete merchandise should normally be removed from inventory at any cost.
Agri (2009), states in a study on factors and challenges facing suppliers, noted that suppliers provide customized services for their SRM partner clients such as extensive sourcing and product knowledge. Buyers in supply management partnerships communicate with suppliers about products they need so that ordering arrangements can be worked out for them. They do not simply place orders but, typically speak with an account executive who handles only the most most important customer accounts.
2.4 Conclusions and Gaps to be Filled
It is evident that a number of studies have been carried out on various effects of ordering cost, purchasing policy, lead time and buyer-supplier relationship mechanisms in general. A stock control system should keep you aware of the quantities of each kind of merchandise at hand. An effective system will provide you with a guide for what, when or how much to buy of each style, color, size, price and brand. It will reduce the number of lost sales resulting from being out of stock of merchandise in popular demand. The system will also locate slow moving articles and help indicate changes in customer preferences. The size of your establishment and the number of people employed are determining factors in designing an effective stock control plan. Another area of concern, despite much investigation on these factors, is the area of inventory adequacy which appears to have been given little attention. This research aims to fill in these gaps in this study and to provide information to interested stakeholders on key areas on ordering cost, purchasing policy, lead time and buyer-supplier relationship.