Case Analysis

Chinese Pharmaceuticals (HK) Limited: Effective Forecasting for Optimal

Inventory Management

In this case, Chinese Pharmaceutical faced an out of stock phenomenon due to the low accuracy of its
sales forecast method and inventory management for the company had been predicated on more
circumstance than any systematic inventory management practice.

Forecast Analysis

The General Manager was keen to establish the right forecasting model for the company, which he
hoped would then lead to improved inventory management of the company's best-selling Noto37,
and fewer challenging meetings with purchasing managers. The suggested sales forecast method from
the intern was exponential smoothing. So i tried to re-check the accuracy of this method.

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The following is a graph plotting of the 3 years sales data. The red graph shows the data trendline.
From the data plotting graph, it can be seen that demand has seasonal and trend data types that

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increase from time to time.

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rs e Sales (2009 - 2012)
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12000

10000
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8000
aC s

6000
v i y re

4000

2000

0
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1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37
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Then I used MiniTab software to find out the optimal alpha value for forecasting using the exponential
smoothing method. From running data, it is obtained that Alpha = 1.32 is the optimal alpha value
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which results in the lowest error rate (MAD = 0,399).

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Smoothing Plot for Sales

Single Exponential Method

10 Variable
A ctual
Fits
9
Smoothing Constant
A lpha 1,31971
8
A ccuracy Measures
MA PE 6,49749
7 MA D 0,39969
Sales

MSD 0,25834
6

3
4 8 12 16 20 24 28 32 36
Index

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 However, because the alpha range for exponential smoothing is a maximum of Alpha = 1, then I choose
to re-forecast using maximum value Alpha = 1 and compared it with the forecast results using Alpha
= 0.4.

Forecast Forecast
Year Month Period Sales
Alpha = 0,4 Alpha = 1
July 1 3303 3303 3303
August 2 3360 3303 3303
September 3 3828 3326 3360
2009
October 4 4257 3527 3828
November 5 5508 3819 4257
December 6 5205 4494 5508
January 7 5190 4779 5205
February 8 5058 4943 5190

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March 9 5307 4989 5058

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April 10 4563 5116 5307

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May 11 4512 4895 4563

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June 12 4434 4742 4512

o.
2010
Julyrs e 13 4440 4619 4434
August 14 5178 4547 4440
ou urc
September 15 5277 4800 5178
October 16 6411 4991 5277
o

November 17 7308 5559 6411

aC s

December 18 7275 6258 7308

v i y re

January 19 7065 6665 7275

February 20 7497 6825 7065
March 21 7326 7094 7497
April 22 6207 7187 7326
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May 23 5976 6795 6207

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June 24 5874 6467 5976

2011
July 25 5970 6230 5874
August 26 6666 6126 5970
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September 27 7575 6342 6666

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October 28 8367 6835 7575

November 29 9051 7448 8367
December 30 9696 8089 9051
January 31 9594 8732 9696
February 32 9084 9077 9594
March 33 8955 9080 9084
2012
April 34 8235 9030 8955
May 35 8055 8712 8235
June 36 7767 8449 8055

Then the following is a comparison of the error level between the two alpha values. It can be seen
that the value of Alpha = 1 produces a forecast with a smaller error rate.

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 Alpha Value MAD MAPE
0,4 690,248 10,83%
1 408,333 6,4%

Actual Demand VS Forecast (Alpha = 1)

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10000
8000
6000
4000
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1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

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Sales Alpha = 1

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rs e Actual Demand VS Forecast (Alpha = 0,4)
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10000
8000
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6000
aC s

4000
v i y re

2000
0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35
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Sales Alpha = 0,4

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From the calculation of the error rate and plotting of the demand graph to forecast, it can be
concluded that the level of forecast accuracy more fits and will be better if company use the
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exponential smoothing method with Alpha = 1.

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Inventory Analysis

From this case, it is known that the condition of the company's inventory management is as follows.

• Inventory management had been predicated more on circumstance than any systematic and
formal inventory management practice.
• Various factors impacted the stock levels :
1. Biweekly deliveries of different quantities to almost 1,000 retail outlets
2. Intermittent delays in supply of new stock from the manufacturer
3. Drought conditions in Yunnan that could impact supply of the key Notoginseng
4. Company’s weekly promotions plus the company’s own intermittent promotions
contributed to fluctuations in demand and on stock levels.

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 It can be seen that many factors drive demand fluctuations which will have an impact on stock level
fluctuations. So companies need to implement inventory management policies to avoid out-of-stock
product conditions. The suitable policy to be implemented is the Fixed-Order Quantity Model because
the product characteristics are close to the characteristics of this model, namely:

• Lead time (time from ordering to receipt) is constant, namely up to 100 days
• Price per unit of product is constant since there are only one product type of Noto37
• Inventory holding cost is based on average inventory, because company leased out storage
space based on quantity of inventory levels.
• Ordering or setup costs are constant, because the product is uniform.
• All demands for the product will be satisfied. (No backorders or unfulfill demand are allowed)

Due to the limited data on the case, especially the cost of inventory data, I used the reorder points
(ROP) calculation approach to estimate the reorder level and the amount of safety stock.

In this case, it can be seen that the delivery to the customer is done up to 2 times a week, if it is

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assumed that the working days are 6 days, then the lead time between deliveries is constant, namely
3 days. With constant lead time and variable demand, I use the formula 12-15 referring to Chapter 12

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in the Heizer textbook, namely.

o.
𝑅𝑂𝑃 = (𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 × 𝐿𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 𝑖𝑛 𝑑𝑎𝑦𝑠) + 𝑍𝜎𝑑 √𝐿𝑒𝑎𝑑 𝑡𝑖𝑚𝑒
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The following is the calculation result of each factor.

Average Daily Demand 213

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Stdev Daily Demand 61

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Lead time (days) 3

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Service Level 98% (Z) 2,054

The service level (Z) calculation is obtained from the formula = NORMSINV (0.98) in Excel. I use the
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98% service level to increase the expected probability of not hitting a stock-out during the next
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replenishment cycle, and thus, it is also the probability of not losing sales. Here's the ROP calculation.

𝑅𝑂𝑃 = (213 × 3) + (2,054 × 61 × √3 = 638,25 + 217 = 855 𝑢𝑛𝑖𝑡𝑠

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So when the inventory on hand touches 855 units, the company must place an order for the amount
of its EOQ value, leaving 217 units as safety stock in its warehouse.
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In conclusion, here are the strategies that companies need to take in managing their inventory.

• Implement a fixed-order quantity model in inventory to determine the economic order

quantity.
• Prepare a safety stock to anticipate a surge in demand.
• Improve the forecast demand method by considering seasonality and trend.
• Doing good coordination with the sales and marketing department of the company to find out
about product promotion plans in order to anticipate changes in demand.
• Establishing good communication with suppliers to find out information on conditions that
have the potential to cause delays in delivery.
• Implement a fixed delivery schedule for retailers.

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 Appendix

Year Month Period Monthly Sales Daily Sales

July 1 3303 111

August 2 3360 112
September 3 3828 128
2009
October 4 4257 142
November 5 5508 184
December 6 5205 174
January 7 5190 173
February 8 5058 169
March 9 5307 177
April 10 4563 153

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May 11 4512 151

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June 12 4434 148

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2010
July 13 4440 148

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August rs e 14 5178 173
September 15 5277 176
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October 16 6411 214
November 17 7308 244
December 18 7275 243
o

January 19 7065 236

aC s

February 20 7497 250

v i y re

March 21 7326 245

April 22 6207 207
May 23 5976 200
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June 24 5874 196

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2011
July 25 5970 199
August 26 6666 223
September 27 7575 253
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October 28 8367 279

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November 29 9051 302

December 30 9696 324
January 31 9594 320
February 32 9084 303
March 33 8955 299
2012
April 34 8235 275
May 35 8055 269
June 36 7767 259
Avg Daily Demand 213
Stdev Daily Demand 61

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