JWI 551 – Mason and Owens & Minor Supply Chain Merger Essay

JWI 551: It’s All About the Patient: Improving the Patient Experience Academic Submissions and Evaluations Assignment 3: HBS Case Study — Supply Chain Partners: Virginia Mason and Owens & Minor Due by Sunday, Midnight of Week 9 Overview In this assignment, you will read and analyze a case study about a supply chain partnership between two organizations: the Virginia Mason Medical Center in Seattle, Washington, and Owens & Minor, a vendor of medical and surgical supplies. This partnership was created in 2004 as part of the larger project setting up the Virginia Mason Production System (VMPS). Scenario You have joined Virginia Mason Medical Center as their new Chief Financial Officer (CFO). Virginia Mason has now been in partnership with Owens & Minor for 13 years. You are conducting a review of the partnership for the Board. In particular, they have asked you to assess whether the project met Virginia Mason’s three (3) major goals in creating the partnership: better control of costs, an improved supply chain, and a better patient experience. Instructions Write a 3 to 5 page paper that analyzes the Supply Chain Partners: Virginia Mason and Owens & Minor case study. Be sure to answer the questions below in your paper: 1. Why did Virginia Mason and Owens & Minor initially join together? Was there strategic alignment between these two organizations or another reason for the partnership? Be specific. 2. Describe the Total Supply Chain Cost (TSCC) program developed by Virginia Mason and Owens & Minor. How did this program help Virginia Mason from an operations efficiency standpoint? 3. How would you evaluate the Total Supply Chain Cost (TSCC) program developed by Virginia Mason and Owens & Minor? Did the program achieve its 3 major goals? 4. What changes would you have made to the contract, based on the knowledge you have gained during the partnership? 5. What effect has this partnership had on patient care and the patient experience? © Strayer University. All Rights Reserved. This document contains Strayer University confidential and proprietary information and may not be copied, further distributed, or otherwise disclosed, in whole or in part, without the expressed written permission of Strayer University. This course guide is subject to change based on the needs of the class. JWMI 551 – Assignment 3 (1196) Page 1 of 4 JWI 551: It’s All About the Patient: Improving the Patient Experience Academic Submissions and Evaluations Formatting Your assignment must follow these formatting requirements: • Typed, double-spaced, using Times New Roman font (size 12), with one-inch margins on all sides. • Include a Cover page containing the assignment title, student’s name, professor’s name, course title, and date. • Include a References page in a format appropriate for any business or academic setting. Note: The Cover and References pages are not included in the required page length. © Strayer University. All Rights Reserved. This document contains Strayer University confidential and proprietary information and may not be copied, further distributed, or otherwise disclosed, in whole or in part, without the expressed written permission of Strayer University. This course guide is subject to change based on the needs of the class. JWMI 551 – Assignment 3 (1196) Page 2 of 4 JWI 551: It’s All About the Patient: Improving the Patient Experience Academic Submissions and Evaluations RUBRIC – Assignment 3: HBS Case Study – Supply Chain Partners: Virginia Mason and Owens & Minor CRITERIA Unsatisfactory Low Pass 1. Why did VM and O&M join together as partners? What was the reason for the partnership? Does not explain why VM and O&M became partners. Does not identify the reason for the partnership. Partially explains why VM and O&M became partners, and/ or partially identifies the reason for the partnership. Satisfactory explanation of why VM and O&M became partners, and identifies the reason for the partnership. Good, detailed explanation of why VM and O&M became partners, and identifies the reason for the partnership. Exemplary explanation of why VM and O&M became partners. Explains fully the reason for the partnership. Does not describe the TSCC program, or does not explain how the program helped VM, from an operations efficiency standpoint. Partially describes the TSCC program, and/or partially explains how the program helped VM, from an operations efficiency standpoint. Basic description of the TSCC program, and satisfactory explanation of how the program helped VM, from an operations efficiency standpoint. Fully describes the TSCC program, and how the program helped VM, from an operations efficiency standpoint. Exemplary description of the TSCC program, and excellent explanation of how the program helped VM, from an operations efficiency standpoint. Does not evaluate the TSCC program. Does not assess whether the program achieved its 3 major goals. Partially evaluates the TSCC program. Partial assessment of whether the program achieved its 3 major goals. Evaluates the TSCC program. Provides a basic assessment of whether the program achieved its 3 major goals. Fully evaluates the TSCC program, and provides a good, detailed assessment of whether the program achieved its 3 major goals. Exemplary evaluation of the TSCC program, and excellent assessment of whether the program achieved its 3 major goals. Does not suggest changes that could have been made to the contract. Minimal suggestion about changes that could have been made to the contract. Suggests reasonable changes that could have been made to the contract. Suggests changes that could have been made to the contract and explains them in detail. Exemplary explanation of changes that could have been made to the contract. Weight: 15% 2. Describe the TSCC program. How did the program help VM, from an operations efficiency standpoint? Weight: 15% 3. Evaluate the TSCC program. Did the program achieve its 3 major goals? Weight: 25% 4. What changes would you have made to the contract, based on the knowledge you have gained? Pass High Pass Honors Weight: 15% © Strayer University. All Rights Reserved. This document contains Strayer University confidential and proprietary information and may not be copied, further distributed, or otherwise disclosed, in whole or in part, without the expressed written permission of Strayer University. This course guide is subject to change based on the needs of the class. JWMI 551 – Assignment 3 (1196) Page 3 of 4 JWI 551: It’s All About the Patient: Improving the Patient Experience Academic Submissions and Evaluations 5. How has this partnership impacted patient care and the patient experience? Does not explain the impact of the program on patient care and the patient experience. Partially explains the impact of the program on patient care and the patient experience. Clear and logical explanation of the impact of the program on patient care and the patient experience. Good, detailed explanation of the impact of the program on patient care and the patient experience. Excellent explanation of the impact of the program on patient care and the patient experience. Multiple mechanical errors; much of the text is difficult to understand or the text does not flow; fails to follow formatting instructions. Several mechanical errors make parts of the text difficult for the reader to understand; the text does not flow; the discussion fails to justify conclusions and assertions. More than a few mechanical errors; text flows but lacks conciseness or clarity; assertions and conclusions are generally justified and explained. Few mechanical errors; text flows and concisely and clearly expresses the student’s position in a manner that rationally and logically develops the topics. None to limited minor mechanical errors; text flows and concisely, clearly and exemplarily expresses the student’s position in a manner that rationally and logically develops the topics. Weight: 15% 6. Clarity, Logic, Writing Mechanics, Grammar, and Formatting Weight: 15% © Strayer University. All Rights Reserved. This document contains Strayer University confidential and proprietary information and may not be copied, further distributed, or otherwise disclosed, in whole or in part, without the expressed written permission of Strayer University. This course guide is subject to change based on the needs of the class. JWMI 551 – Assignment 3 (1196) Page 4 of 4 9-109-076 REV: JUNE 24, 2010 V. G. NARAYANAN LISA BREM Supply Chain Partners: Virginia Mason and Owens & Minor (A) It was June 2007, and the last 18 months had been both exciting and challenging for Michael Stefanic, director of cost management at Owens & Minor (O&M), and Daniel Borunda, materials systems manager at Virginia Mason Medical Center (VM) in Seattle. They had been working together from across the country to build a more coordinated supply chain, a move they believed would give both VM and O&M the competitive edge they needed to survive and thrive in the coming years. VM had signed O&M as their medical/surgical supply alpha vendor over a year before, spending an average of $15 million per year for products stored and delivered by O&M. Together, O&M and VM had developed an activity-based pricing model that captured the costs involved in the just-intime/low- unit-of-measure (JIT/LUM) service that O&M provided for VM. The two were about to meet with members of VM’s finance team to convince them to accept the total-supply-chain-cost (TSCC) contract. While the fees appeared nominally higher under the TSCC (versus the traditional cost-plus), Borunda explained that the new contract exposed costs that had been hidden in the past— costs that could be reduced through more efficient practices. We have to get away from the concept of the purchase price being the cost. We have to think of cost as total landed cost—how much does it really cost us to get this product to the patient? TSCC gives both O&M and VM the incentives to concentrate our energy on the process cost, because our fees go down when we order and replenish supplies more efficiently. Stefanic had flown in from O&M’s headquarters near Richmond, Virginia, to accompany Borunda at the meeting. He had spent a considerable amount of time developing the TSCC model with Borunda and had a lot at stake: TSCC is the future for bringing efficiency to the supply chain, and we can be at the forefront. With TSCC we found cost drivers that no one in this industry had identified, but were major drivers of supply chain costs. We hope to roll this out to other customers and show them the cost savings that can result. Borunda had prepared a reconciliation to compare the cost-plus contract with the new TSCC program, hoping to convince VM to go forward with TSCC. Both he and Stefanic believed that TSCC, coupled with the alpha vendor concept, was a crucial tool in battling out-of-control healthcare costs, but could they convince leadership at both their companies to invest in TSCC? Could they persuade VM that total landed cost, not fees paid, was the best way to evaluate the success of the alpha vendor? Could they convince O&M’s leaders that profit margin was just as important as sales in determining the viability of this relationship? ________________________________________________________________________________________________________________ Professor V. G. Narayanan and Research Associate Lisa Brem prepared this case. Data provided in this case has been disguised. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2009, 2010 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-5457685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) The Medical Supply Distribution Industry The medical supply distribution industry steadily consolidated in the first decade of the new millennium, as distribution companies sought to take advantage of larger size to better negotiate with suppliers and group purchasing organizations (GPOs). In 2008, the United States had 6,000 distributors with combined annual revenue of $53 billion.1 Distributors competed in the industry through high-volume purchases of supplies, which they stored in regionally located warehouses and delivered to customers in company-owned or leased trucks. Efficient processes that allowed companies to purchase, store, and deliver equipment and supplies at a minimal internal cost were crucial for maintaining profitability in this highly competitive, low-margin business. Other elements of success in distribution were economies of scale, merchandising, customer service, and well-developed infrastructure and IT capabilities. IT was a major differentiator among distributors, with the most sophisticated using automated ordering systems such as electronic data interchanges (EDIs), inventory management, order analysis, pricing, delivery scheduling, and automated billing.2 Distributors in general experienced volume growth in the last decade, due to both increased demand for medical services and acquisitions. In addition, acute-care hospitals, in reaction to space and budget constraints, moved more inventory and inventory functions to distributors. The market after the turn of the twenty-first century favored efficient companies that absorbed more sales volume while keeping expenses under control, and large-scale companies that had the infrastructure to market and perform value-added services, such as consulting, outsourcing, computer systems, and software sales. Savvy distributors continually sought to maintain or enhance their viability as valueadding, indispensable links in the crowded healthcare supply chain. The Healthcare Supply Chain In both the number of participants and their interrelationships, the healthcare supply chain was unique. Few industries fragmented functions quite so much as healthcare, and the relationships between organizations were typically arm’s length or outright adversarial. The players in the healthcare supply chain are described below: • Manufacturers (such as Johnson & Johnson and Kimberly Clark) either sold to distributors, which stored and delivered supplies to providers, or sold directly to providers, using a delivery service to supply end users. Manufacturers negotiated both with providers directly (through sales representatives) and with group purchasing organizations. Manufacturing margins were typically higher than those of providers and distributors. • Group Purchasing Organizations (GPOs) (such as Amerinet and Novation) used the collective bargaining power of their member healthcare providers to negotiate lower prices from manufacturers and distributors. Most U.S. hospitals belonged to a GPO, which charged a fee for membership and contracted with distributors to deliver items for a fixed price or for a percentage (usually between 5% and 7%) of the unit price (known as “cost-plus”). All GPO price negotiations with manufacturers and distributors were based on bulk units of measure (UOM). While providers typically belonged to only one GPO, distributors inked contracts with multiple GPOs. Integrated healthcare networks (IHNs) were entities similar to GPOs 1 First Research, “Industry Profile Medical Equipment Distributors,” September 8, 2008, p. 1, accessed November 18, 2008. 2 Ibid. 2 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. Supply Chain Partners: Virginia Mason and Owens & Minor (A) 109-076 made up of commonly owned or managed healthcare providers in a specific geographic market. • Value-added networks (VANs) (such as Global Healthcare Exchange (GHX)) processed orders from providers to distributors and manufacturers. VANs evolved to act as data interpreters, converting product data from various entities into a standardized language that could be transferred easily to the many different companies along the supply chain. VANs kept and tracked data on item price, order frequency, volumes of purchase orders, and various other metrics. VANs also tracked efficiency indicators, such as backorders, single-line purchase orders, and pricing errors. There had been significant consolidation among VANs during the 2000s, with GHX emerging as the dominant player in the marketplace. • Distributors (such as Cardinal and O&M) acted as the inventory buffers of the supply chain. Providers placed orders (through the VAN) with distributors, who in turn maintained inventories in distribution centers throughout their service areas. The large national distributors had contracts with most GPOs and carried products from hundreds of manufacturers and, in some cases, self-manufactured products or their own private labels. Some of the larger distributors bolstered their revenue by offering value-added services to customers, such as inventory management. • Providers (such as hospitals, clinics, and rehabilitation and nursing facilities) delegated purchasing to an in-house purchasing office, which either negotiated directly with manufacturers or worked through a GPO, many times doing both simultaneously. Purchasing and inventory-control staff placed orders either directly or through a VAN to both manufacturers and distributors. In addition, end users, such as physicians, nurses, and technicians, could negotiate local contracts directly with manufacturer sales representatives. End users were notoriously rigid in their preferences for certain items, such as gloves and sutures. It was difficult for inventory managers to focus end users on cost containment if it meant forgoing preference items. The entire medical supply industry struggled to maintain consistent and accurate data, but errors were frequent and costly. Manufacturers changed prices, product numbers, descriptions, and units of measure on items and failed to give timely notice to distributors and/or providers. Providers (or end users) and manufacturer representatives could agree to a price outside of the standard contract and fail to notify the distributor. Rounding errors occurred in a low-unit-of-measure environment because GPO contracts were based on bulk UOM. Providers tended to distrust pricing provided by distributors because pricing was opaque and difficult to track. Most distributors included the cost-plus fee in the product cost, rendering the distribution fee invisible to the provider. This higher product cost then became the basis for future price increases. Distributors, as the middlemen between providers and suppliers, were continually squeezed to cut costs. GPOs negotiated bulk purchases for their members, cutting into distributors’ ability to negotiate their own volume discounts and resell at a higher price, while manufacturers sometimes cut the distributor out entirely by selling directly through their own sales teams. Distributors were at the mercy of pricing contracts developed between the manufacturer, the GPO, and the provider. As Borunda explained: 3 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) Sometimes—particularly with high dollar specialty items—end users will commit to using a product and then turn over the negotiation to purchasing to establish price. Of course, the purchasing team had its primary leverage removed because the physician had already committed to using the vendor’s product. Both Virginia Mason, using the Toyota Production System, and O&M, using Six Sigma and activity-based costing and pricing programs, had invested in programs designed to promote more transparency and cooperation while eliminating costly defects in the supply chain. Virginia Mason Virginia Mason was founded in 1920, when a group of physicians decided to pioneer a new approach in a medical practice. Their goal: to work as one team. — Virginia Mason history3 The two founding physicians—James Mason and John Blackford—named the hospital after their daughters, who were both named Virginia. The founders envisioned their 80-bed, six-physician clinic in Seattle, Washington, to be a “‘one-stop shopping’ place for virtually any medical problem or need.”4 By 2007, VM—a midsized, private, nonprofit organization in Seattle—had 336 licensed beds, employed 5,000 people, including 400 physicians, and earned $665 million in revenue. VM offered both primary and specialized care, was affiliated with the University of Washington as a teaching site, and operated both a clinic network throughout western Washington and the state-of-the-art Benaroya Research Institute. Nearly a century after its founding, VM continued to be a largely consensus-driven organization. Its logo included the term “Team Medicine” and the concept of teamwork remained central to its mission. While most hospital-based physicians in the United States contracted with the provider through a separate physicians’ organization, Virginia Mason’s physicians were directly employed by the health system—a staffing model that VM leadership felt promoted a team orientation: The hallmark of Virginia Mason’s nearly 5,000 staff members is a spirit of teamwork. [ . . . ] This staffing model is the exception, not the norm, in health care. We believe that having one staff, working side-by-side, every day, results in superior patient care.5 VM’s stated vision was “to be the quality leader and transform healthcare,”6 providing the “best outcomes available anywhere.”7 The Virginia Mason Production System (VMPS), a modified version of the Toyota Production System that VM had systematically implemented since 2002, had been integral in helping VM work toward its goal to be the quality leader, focusing on line-level employee work groups and continually striving for a zero defect rate. Value-stream mapping was a main component and first step of VMPS. It defined a process by visually mapping—creating a flowchart—of the information, materials, workflow, and other medical3 Virginia Mason, “Our History,” https://www.virginiamason.org/home/body.cfm?id=122, accessed December 9, 2008. 4 Ibid., “About Virginia Mason,” https://www.virginiamason.org/home/body.cfm?id=93, accessed December 9, 2008. 5 Ibid., “Our Staff,” https://www.virginiamason.org/home/body.cfm?id=223, accessed December 9, 2008. 6 From “Our Strategic Plan,” internal company document (2009) provided by Virginia Mason. 7 Virginia Mason Health System, 2007 Annual Report (Seattle: Virginia Mason, 2007), “Fast Facts.” 4 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. Supply Chain Partners: Virginia Mason and Owens & Minor (A) 109-076 center metrics involved in a process. Work teams then engaged in a five-day rapid process improvement workshop (RPIW) that eliminated waste and improved efficiency in the process. Another tool in the VMPS arsenal was the “everyday lean idea” concept, which relied on all VM employees to continually attempt to reduce waste and add value in every facet of their jobs.8 In 2005, VM expanded the VMPS infrastructure to include the kaizen promotion office (KPO), which led RPIWs and lean initiatives in corporate, hospital, and clinic environments. All VM employees were continually trained and educated in VMPS, which included everyday lean ideas and value-stream mapping.9 Due in part to its deep cultural commitment to quality improvement, VM was able to achieve success with VMPS. Throughout 2007, VM continued improvement activities by launching 116 RPIWs. Highlights of process improvements in 2007 were: • General internal medicine reduced average time for patients to access physicians from nine to two days. • Reduced by 35% average time from when a patient received surgery to when the patient was billed. • Reduced average patient length of stay at the acute hospital by 2.5%, to just over four days. Financial metrics also showed progress. VM increased its patient care net revenue from $587 million in 2006 to $635 million in 2007. Operating income grew from $12 million in 2006 to $18.4 million in 2007, with the profit margin growing to 3.6% from 3% the same year, its highest margin in five years. In VM’s annual report, CEO Gary Kaplan, MD, attributed the improved financial results in part to VMPS: Through the diligent work of our staff members and the employment of our management methodology, the Virginia Mason Production System, we were able to make great progress toward our financial goals and see incredible financial results this past year.10 Owens & Minor Owens & Minor (O&M) was the leading distributor of medical and surgical supplies to the acutecare (hospital) market. The company operated in the medical/surgical supply industry, which was characterized by disposable supplies, a leading segment that accounted for $34.5 billion in revenues in 2005.11 The company also offered supply chain management services and private-label products. According to the company’s 2007 Annual Report: In its acute-care supply distribution business, the company distributes over 180,000 finished medical and surgical products produced by over 1,200 suppliers to approximately 4,100 healthcare provider customers from 45 distribution centers nationwide. The company’s primary distribution customers are acute-care hospitals which account for approximately 90% of O&M’s revenue. [ . . . ] The company typically provides its distribution services under 8 Richard M.J. Bohmer and Erika M. Ferlins, “Virginia Mason Medical Center,” HBS No. 606-044 (Boston: Harvard Business School Publishing, 2006), pp. 8–9. 9 Ibid., p. 11. 10 Virginia Mason Health System, 2007 Annual Report (Seattle: Virginia Mason, 2007), pp. 17–18. 11 Datamonitor, “Health Care Equipment and Supplies in the United States,” May 2006, p. 8, via Business Source Complete, November 18, 2008. Figures based on manufacturer revenues generated through the sale of disposable equipment, such as syringes, catheters, electrodes, sutures, and bandages. 5 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) contractual arrangements with terms ranging from three to five years. Most of O&M’s sales consist of consumable goods such as disposable gloves, dressings, endoscopic products, intravenous products, needles and syringes, sterile procedure trays, surgical products and gowns, urological products and wound closure products.12 O&M’s distribution centers (DCs) served customers within a 200-mile radius, using mostly leased trucks. The largest distribution centers delivered $400 million in goods per year, while the smallest delivered between $50 million and $60 million per year. In addition to warehouse workers, each center had sales, logistics, credit management, and operations personnel on site or near site. Distribution centers received a customer service bonus if they achieved a high rating in an annual customer service survey. In addition, DCs strove to meet certain corporate goals on retention, productivity, and picking accuracy. O&M sought to position itself as a provider of value-added services to its customers. O&M offered expertise in lowering costs for providers through “services designed to streamline the supply chain,” such as inventory management (including just-in-time and stockless services), activity-based pricing, consulting, and outsourcing services.13 In order to gain the economies of scale required to offer these sophisticated services on a nationwide basis, O&M launched an aggressive merger and acquisition campaign throughout the late 1990s and early 2000s, culminating with the acquisition of a major competitor, McKesson Medical-Surgical Inc., in 2006. The majority of O&M’s customers paid fees on a cost-plus basis, meaning that O&M’s fees were a fixed percentage of the product cost negotiated between the GPO/IHN and the manufacturer. The fixed percentage was largely dependent on purchase volume (the contracts also determined a minimum purchase volume) and was set for the life of the contract—typically three to five years.14 O&M also had pioneered a new type of pricing contract, one that was based on customer activity. Customers using the activity-based pricing model—called CostTrackSM—generated 32% of O&M’s revenue in 2007.15 O&M leadership considered CostTrack to be superior to the cost-plus pricing model and a strong differentiator in the market. Customers on CostTrack received immediate feedback, since their monthly fees went up or down depending on the amount and type of activities, such as lines per purchase order, number of monthly deliveries, and number of monthly purchase orders. Most of the customers using CostTrack were also on low-unit-of-measure (LUM) and just-in-time (JIT) programs.16 CostTrack more accurately represented the service O&M provided for these customers because it based fees on number of purchase order lines per month and payment terms, which were major cost drivers in a LUM/JIT environment. As Stefanic explained: The number of lines is the trigger for how much activity a JIT/LUM customer generates. Some JIT/LUM customers might order an average of $5 per line (100,000 lines per month), while others average $50 per line (10,000 lines per month). Contracts for JIT/LUM usually add 12 Owens & Minor, Inc., 2007 Form 10-K (Mechanicsville: Owens & Minor, 2007), p. 3. 13 Ibid. 14 Ibid., p. 6. 15 Ibid. 16 In a JIT/LUM environment, the customer holds minimal inventory and has frequent and small-quantity deliveries of product close to the point and time of use. JIT/LUM eliminates the customer labor involved with handling and managing the product, and reduces the cost of holding inventory. 6 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. Supply Chain Partners: Virginia Mason and Owens & Minor (A) 109-076 an additional markup to the cost-plus percentage. For the efficient customer (the one that averages $50 per line) CostTrack would be a less expensive contract than cost-plus. The less efficient customer ($5 per line) would pay more initially on CostTrack, but it would incent them to become more efficient by increasing their purchases per line and lowering their lines per month. Lowering lines per month also significantly lowers the customer’s internal cost. In the basic CostTrack model, lines, orders, and deliveries produced 25% to 30% of a customer’s monthly fee, with the remaining fee based on the product cost (cost-plus). (Exhibits 1a, 1b, and 1c show sample CostTrack and cost-plus customer fee statements.) Total Supply Chain Costs/Alpha Vendor Michael Stefanic loved talking to customers about CostTrack because he felt it was one of O&M’s strongest competitive advantages. However, he knew the CostTrack model currently in use was limited to deliveries, purchase orders, and lines per order. He was hoping to find a customer that would be willing to expand CostTrack. By 2004, he had presented CostTrack to many hospitals and other providers, but his hopes of finding a truly innovative partner had thus far been in vain. Across the country in Seattle, Daniel Borunda was also frustrated. He had been trying to find a forward-thinking medical/surgical distributor to implement Virginia Mason’s vision of the “alpha vendor,” a program VM rolled out successfully with Office Depot for its office supply needs. The seeds for the alpha idea came from a GHX conference in 2003 at which Dell Computer’s Ray Archer, vice president of supply chain management, explained the alpha concept. The alpha vendor program created exclusive relationships with a few key vendors that acted as partners in the supply chain, and offered on average the lowest costs of both goods and services. Alpha vendors dovetailed nicely with the Virginia Mason Production System/lean manufacturing ideal of spreading lean concepts throughout an integrated and smoothly functioning supply chain. Borunda, Tom Nance, VM’s director of purchasing, and John Donnelly, administrative director of supply chain at VM, turned to the medical/surgical supply company that had been VM’s primary distributor for 15 years to assess its ability to move into an alpha vendor partnership, but they were disappointed in what they heard. As Donnelly explained: We had a different vision. This was a manufacturer/distributor and their focus was to use their products, people, and places. There was a lack of interaction between the two companies in their vision of the future. It was more about them controlling the process. O&M’s CIO had also attended the GHX 2003 conference and tried to sell VM on a similar O&M program called “The Last Mile,” which was a vendor-managed inventory concept. Borunda recalled that initially he had a lukewarm reaction to O&M’s program: We weren’t crazy about it because with vendor-managed inventory, hospitals abandoned all responsibility for the supply chain. When you outsource a key management function, it is very difficult to recover quickly if the relationship doesn’t work out. Then we went to see what O&M was doing at the Stanford Medical Center. They had an O&M employee embedded in the Stanford Medical Center purchasing department. They were working to drive the same efficiencies that we wanted to work on; they were communicating and they were talking about eliminating defects. We thought that we could work with this. 7 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) In March 2004, Borunda, Nance, Donnelly, and a VM team of supply chain personnel visited O&M’s corporate offices near Richmond, Virginia, to learn more about the Last Mile and CostTrack. Stefanic gave his CostTrack presentation and was amazed at the reaction from VM: First of all, they brought six people to Virginia, when most companies send one or two. To send six people across the country showed us they were serious. When they came out for the first visit, I used a CostTrack presentation I’d used for two years; one that I’d made to at least 20 other customers. I’d talk about partnering for research and going to the next level of detail and most customers responded by saying, “That sounds like a great opportunity but we don’t have the resources to devote at this time.” Instead, Virginia Mason asked insightful questions about the model and our methodologies. I knew then that this was a sophisticated organization that understood the potential cost savings involved with participating in a project like this. Soon after the meeting at the O&M corporate office, VM decided to engage O&M as its medical/surgical supply alpha vendor. In July of 2004, VM transferred the existing LUM and JIT deliveries throughout the organization to O&M. VM decided to use a temporary cost-plus contract while in talks with Stefanic about how they could capture more activity-based costs in the pricing model. In February 2005, Borunda flew to Richmond and worked with Stefanic over several days to hammer out a comprehensive activity-based pricing method, which they called total supply chain costs (TSCC). Rather than the CostTrack norm of 25% of fees being activity-based, TSCC sought to generate 100% of fees from supply chain activities. As Stefanic recalled: This was the first time I had worked directly with a customer to design a pricing program. This had not been done before in our company, and we were not aware of this approach by any other distributor. It was very exciting, and it was a lot of fun, because for the first time I had someone who understood Activity Based Management and could challenge the methodologies and push us to make this product fair and practical, not just from O&M’s point of view, but from the customer’s point of view as well. One of our guiding principles was that we harm no one in this contract. If we found something harmful to either party in the model, then we would correct it. It was a fluid document. Borunda talked about his motivation for TSCC: We wanted to reduce rework and inefficiencies in our supply relationship. We knew that for every dollar we spend on supplies, we spend 13 cents on administrative processes. VM pays vendors $70 million every year and we spend an additional $9.1 million in distribution and purchasing functions. Of that $9.1 million, 7.4% is rework. That’s nearly $700,000 in waste or errors every year. We had to get a handle on those costs. SKU: A Hidden Cost Driver During those intensive meetings, Borunda and Stefanic identified new methods to use to trace and assign several other cost drivers, such as occupancy, delivery, and supplier costs. During a discussion of occupancy costs, Stefanic and Borunda discovered several critical facts that O&M had not considered before when calculating customer profitability. They realized that one of the largest drivers of costs in the distributor/provider relationship was the number of stock keeping units (SKUs)17 on hand. As Stefanic explained: 17 A unique item stored in inventory. 8 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. Supply Chain Partners: Virginia Mason and Owens & Minor (A) 109-076 We looked at two customer groups with four hospital locations each, let’s call them Customer A and Customer B. They were similar in that they both purchased $1,500,000 per month and they had the same average number of lines and orders per month. Customer A purchased 2,900 different SKUs, while Customer B purchased 8,000 different SKUs. The effort and expense required to forecast, purchase, handle, store, and maintain computer transaction records was much greater for Customer B. O&M’s cost of servicing Customer B was higher than for Customer A, but the distribution fees for both customers were the same either with a cost-plus or CostTrack pricing model. This was a real “aha” moment for us. We had been focusing on deliveries, purchase orders, and lines. When we began to look at the SKU costs, we realized they were the driver of many of our costs, but this had been hidden from us. No one in the industry was talking about SKU costs, no one had tried to capture and quantify them, and there were no incentives to control them. If 50 different hospitals wanted 600 different gloves, that’s what they got—even if we could meet their needs with 60 SKUs. It didn’t matter to anyone in the supply chain, except now we started to understand how much this was costing us. Stefanic and Borunda identified the elements that fed into the SKU costs. These were: number of SKUs on hand, number of SKUs purchased, number of storage locations, number of locations occupied, number of empty locations, and cost of capacity. They also looked at SKU-related expense drivers, such as the cost for storage space per SKU, related inventory holding costs, and IT costs. Stefanic also realized at that time that O&M was absorbing the inefficiency of their suppliers. In order to incentivize VM to pick efficient suppliers, they included a supplier factor in the TSCC. Although O&M had used the supplier-evaluation process to rate suppliers for several years, this was the first attempt to incorporate it into a pricing program. The supplier factor used 23 parameters to assign an efficiency weighting to that supplier (see Exhibit 2a). If VM chose a more efficient supplier, the TSCC model rewarded them with a discount. O&M used delivery method, payment terms, advance ship notifications, multiple deliveries per purchase order, lead time, fill rates, and EDI sets as some of the parameters used to assign the weighting (see Exhibit 2b). It took nearly a year before Stefanic and Borunda had a TSCC model and contract they felt would work. Borunda explained why the model took so long to develop: The last model (version 17C) was developed in June 2006. Up until that time we revised the model about once a month. The model had to be built on reliable information, and that took some time and trial and error to make sure we had the correct data. We also had to overcome fear. People were afraid of something this new, and we didn’t really understand how the model would impact certain things. One of the things that took the longest was getting the contract through our respective legal departments. We did not want any punitive language in the contract—that was something the lawyers had a hard time understanding. They kept asking, “Don’t you want a penalty if they don’t perform?” They didn’t understand that this was a new relationship that had to be built on common objectives, shared incentives, and trust. 2005: Alpha Vendor The Seattle Distribution Center While Borunda and Stefanic were perfecting the TSCC model, the Seattle distribution center (DC) had been working hard implementing bulk, LUM, and JIT services for VM. A midsized center, the Seattle DC was 70,000 square feet and housed 14,000 SKUs for 95 customers in Washington, Idaho, 9 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) western Montana, and Alaska. The Seattle DC had grown considerably, as had the entire company, both from organic growth and acquisitions. It had doubled its business from $70 million in 2003 to $140 million in 2008. As hospitals faced budget and space constraints, they increasingly turned to O&M to provide more services. As Matt Mikesell, Seattle DC general manager, explained: When a hospital has a 14,000-square-foot warehouse with $2 million in inventory, and they are told they have to cut costs, that’s when they come knocking at our door. We eliminate the need for all that expensive space, inventory, and labor. The DC operated from 2 a.m. until 11 p.m., delivering 425 purchase orders (POs) and 5,350 lines on average each day (8,500 orders and 107,000 lines on average per month). The DC’s customers used bulk delivery; the average customer generated five orders and 60 lines per day. VM alone ordered an average of 147 orders and 1,200 lines per day (or roughly 3,000 orders and 30,000 lines per month), and was by far the largest-volume customer at the DC. In the beginning of the relationship, the DC delivered product to VM twice per day, five days per week. (See Exhibit 3 for flowcharts of VM and a typical bulk customer.) The DC was not set up for LUM/JIT customers, and management decided not to invest in major renovations since the lease on the building would expire in 2010. As Mikesell explained: We have done some time and task studies, but since we have 18 months left on our lease here, we don’t want to start tearing down racking, or putting in big capital investments right now. Rather, we are looking for those engineered standards to come out of the Six Sigma team at the home office. Once we move to a new DC, we’ll build it to those standards. O&M placed Shawn Hickman, a customer service specialist (CSS), on site at VM. Hickman worked closely with VM’s alpha buyer, Debbie Johnson, and other inventory-control personnel to anticipate and resolve any problems that arose during implementation. Hickman explained some of the difficulty integrating VM’s large JIT/LUM business into the Seattle DC: VM was doing lean and had top-level buy-in on that, which gave them a lot of power. O&M used Six Sigma, but it hadn’t been implemented in the Seattle DC. Trying to get a fully dedicated lean company to work with a non-lean company was difficult to say the least. O&M was set up for their bulk customers and it just wasn’t organized well for a large JIT/LUM customer. There was a lot of pushing and pulling on both sides. I worked with Debbie Johnson from VM who was knowledgeable in lean and I learned a lot from her. Daniel Borunda was a huge resource as well. Sally Stewart, who was the O&M DC warehouse teammate in charge of the VM replenishment, also recalled the chaos of the first few months with VM: We didn’t have any JIT people available in the warehouse when VM came online, so that was a challenge. It was a nightmare at the beginning. I will never forget the first night we filled the VM order—never! In the beginning we had the whole warehouse, including the general manager and supervisors, plus people from the Portland DC all helping to pick this order. We didn’t get the list of items that VM was going to purchase until about two weeks before they went online. We didn’t know which items were high velocity, and we didn’t have any par levels set. It took us three hours on the first night just to get enough product into the JIT area before we could even start picking the orders. Debbie Johnson, VM’s alpha buyer, agreed: 10 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. Supply Chain Partners: Virginia Mason and Owens & Minor (A) 109-076 VM was on the lowest unit of measure, which was “each.” That’s one each of sutures, bandages, you name it. Their people had to count each one and put it in a box and make sure it didn’t get lost. And it was for a hospital, so it had to be clean. So we had quite a few issues. With JIT you only have limited space, you order what you need, and you have to get it when you need it. It was a hard concept to convey to both the DC staff and to the nursing staff. Nurses had to trust the fact that the product would be there. And the DC absolutely had to get the product to the right location when they needed it. No errors. Inventory Management at VM VM employed one buyer who was dedicated to the O&M alpha vendor account, as well as an inventory business analyst, and several inventory-control staff who keyed in orders, delivered product, and maintained storerooms. Inventory-control personnel processed each day’s orders using Matkon, VM’s inventory-control platform. Every night Matkon downloaded the information to Catalyst, GHX’s interface program. Catalyst dropped the order in O&M’s CSW (client server warehouse) by 6:30 each morning. GHX and CSW then generated several discrepancy reports that Hickman reviewed. Hickman eliminated as many discrepancies as possible before he released the orders for picking at 8:30 a.m. Discrepancies typically came from stock-outs (backorders), mismatched pricing, units of measure, and SKU number. To rectify backorders, Hickman first determined the reason for the stockout and then took action. Often he filled orders from a reserve inventory that the DC held for VM in case of unexpected usage or delayed shipments. Since the reserve inventory did not show up in the CSW normal inventory levels, Hickman had to “force” the purchase orders manually before they could be picked. Hickman also reviewed unit-of-measure aberrations to determine if VM had ordered correctly. Hickman explained: I would get the day’s reports and look through the list of discrepancies. If VM ordered a case of gloves, for example, when they normally ordered a box, I called Debbie and asked her if they really meant to get a case or did they just need a box. Things like that happened all the time. For stock-outs, most of the time I could fill the order from the reserve, or perhaps I knew that a supplier truck would arrive with the product by the afternoon, so I moved that order to the later delivery time. Once in a while we would not have a product they needed, usually because VM had a spike or unexpected usage, or because there was a problem with the manufacturer. In those cases, I talked with Debbie about whether they wanted to wait for the product to come in or if they wanted to try out a substitute. Backorders were defects that greatly affected the supply chain. In a LUM environment, eliminating backorders was a delicate balancing act. As Borunda explained: Backorders are always a point of friction because VM keeps its inventory so low that when backorders happen at O&M, my staff says we’re playing it too close and that we need more safety stock. But more safety stock is too expensive and it defeats the purpose of low unit of measure. In one case, we had a surgeon who was going on vacation, so he decided to do five surgeries in one day, instead of his normal two surgeries. We received 24 hours notice on this, but we only keep three surgery kits on the shelf. The lead time to produce and sterilize these kits was seven days. Had the surgeon kept to a normal schedule we would have been fine. The immediate reaction from my staff was to increase our par levels from three to five. But my 11 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) reaction was to talk to surgery and try to get preliminary schedules. The surgery schedules are published at 2 p.m. for next day’s surgeries, but they have preliminary schedules much earlier than that. Surgery replied: “Why do you need to see the preliminary schedule?” Organizations build silos and people hold on to information; to them it’s so precious. But we need to be able to build accurate forecasts and see anomalies so they don’t take us by surprise. Once the orders were released and picked, O&M’s trucks delivered to VM’s downtown Seattle hospital and surrounding clinics. The hospital’s dock was on a narrow, steep street, and the dock area itself was limited, restricting O&M to small-sized trucks. The O&M driver unloaded products on pallets (for bulk) and in totes (for LUM) to the dock, where VM employees checked and received them. Large, bulk orders went to the main storeroom in the basement, and operating room (OR) orders were delivered to a specialized OR stockroom. VM employees brought the LUM totes to the department listed on the tote and put them away on the storage closet shelves or, in some cases, in patient rooms. Almost immediately, problems began. Stockers were spending time weeding through the totes on the dock, looking for those totes on their delivery route and crowding an already overburdened dock. Nurses were wary of the new vendor, particularly on weekends when no deliveries were scheduled. They began to hoard items and to call for emergency rush orders more frequently. The storage closets were inconsistently organized, depending on department preferences. Dated supplies were expiring before they were used. Because VM was on a cost-plus model, the high level of customer service required by the LUM/JIT orders was negatively impacting O&M’s profitability on this customer. O&M was trying hard to meet VM’s needs, but something needed to be done to contain the cost of doing business from both sides. 2006: TSCC Drives Improvements O&M began using the TSCC pricing contract in June 2006. Borunda and Stefanic decided to run the model parallel with the cost-plus contract so they would be able to compare savings. They tracked the TSCC fees but charged VM cost-plus. TSCC quickly exposed the costs associated with inefficient supply chain practices. Borunda recalled his reaction to seeing some costs show up in the fee schedule: One of the first things that I noticed when we moved to the TSCC model was cab fees. Every time nurses got worried they might run out of product, they called purchasing and demanded a rush order. Purchasing people knew that O&M would deliver the product on Monday, but no one wanted to get yelled at by a nurse, so they called O&M. O&M put the product in a cab and sent it right over. Problem solved, right? Wrong! When we were on costplus we couldn’t see this cost, but on TSCC, it was right there on the spreadsheet: $68 for a cab fee to deliver a box of gloves costing $10! I told Michael, your great customer service is killing us! In addition to ongoing conversations with Stefanic at O&M’s main office, Borunda’s team at VM met weekly to monitor the inventory levels and the progress of the alpha vendor project. Hickman regularly took part in the meetings. O&M also decided to augment the usual sales rep function with a business integration director to identify, develop, and coordinate strategic initiatives among VM, the DC, and O&M’s corporate office. The first person to fill this position was Dave Menne. Menne described his role with VM: We truly approach our relationship, our business, and how we measure things differently with Virginia Mason than we do with our other customers. We don’t focus on ROI. We have a 12 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. Supply Chain Partners: Virginia Mason and Owens & Minor (A) 109-076 collaborative, open relationship that allows us to brainstorm and develop new projects and initiatives here. I’m the one who communicates that message to the rest of the organization. I also work with the distribution center to communicate that message and make sure we understand that our relationship and approach to projects at Virginia Mason is very different from our approach to similar projects with other customers. I will soon receive additional lean training, and learn how to apply lean concepts across the partnership and in our organization. Overall transactional efficiency at VM ranges from 92% to 96% and we are striving for a goal of 100%, or achievement of zero defects. Going lean is an evolutionary process; it takes organizational commitment and time to see the benefits. VM is further along the lean continuum than other customers I work with; they have been committed to lean for many years and the results speak loud and clear. More hospitals are starting to apply lean concepts and they want to partner with us. I have applied our VM learnings about quality measures, defects, and rework to other customers in the Northwest, similar to what we do at VM. The efficiency ratings, which began in the upper 70% range have now improved to close to 90%. These other large organizations are buying into the same concepts we have developed with VM, especially as support for lean concepts expands across our customer base. We are developing work groups similar to what we do at VM. At O&M we are constantly looking to apply our learnings at VM to other projects with a broader customer base. Knowledge transfer is a key value-add we can apply across the supply chain. Menne chaired monthly Project Management Office (PMO) meetings, which were attended by Borunda and other senior VM supply chain personnel as well as various O&M management, sales, and support staff. Stefanic also attended via telephone. During the monthly meetings, the group used data supplied from VM, O&M, and GHX to monitor progress on reducing defects. (Exhibit 4 gives a list of defects and their rates over time in the alpha vendor program.) As Borunda explained: There are really three parties to this program: Virginia Mason, O&M, and GHX. We needed each one in order to do this. We couldn’t have made the TSCC and the alpha vendor projects work without GHX as a scorekeeper and also as an opportunity to unplug. One of the threats of an alpha relationship is that you get so ingrained that you can’t extract yourself. If O&M has a total meltdown, I can simply take all the data being sent to GHX and send it to another distributor. GHX is the universal plug; they work with just about every major manufacturer and GPO around. GHX also provided most of the reports that we use to monitor our progress. All we measure here are defects. The idea is that if you eliminate defects, if you perfect the system, everything else will follow. We consider a one-line PO a discrepancy, because it costs me $56 to generate a PO, and the one line (product) could cost 35 cents. That is a true story. It cost me $56.35 for that item and the insurance company won’t reimburse me the $56. If that one-line PO is backordered, or put into the wrong tote, or received incorrectly, then we have to add even more cost to the product. Each time there is an error someone has to touch it, get involved, and that costs money. That’s why we are absolutely vicious about tracking and reducing errors. If we have a late PO and it has 70 lines on it, we count that as 70 errors, not one, because each item is late. John Donnelly recalled some of the lessons learned from the PMO meetings: One of the things we learned from the start was that we at Virginia Mason were making a lot of the errors we blamed on O&M. The process starts here with the PO; sometimes we hadn’t signed a contract so O&M didn’t have the correct pricing. Other times we hadn’t 13 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) communicated what our needs were going to be, so they didn’t have product on hand. We realized that not all the defects could be assigned to one or the other entity. Since we share in creating the errors, we decided to split the cost of rework and assign 50% of it to VM in the TSCC. We eliminated the potential for an adversarial relationship by putting errors together in one pot—VM and O&M—to see how we could improve the process together. We also instituted a gain share in the contract, so that O&M shared equally in any real savings from this program. [See Exhibit 5 for explanation of the gain share program.] O&M was incented to reduce VM’s costs because of its gain share agreement with VM, which split equally any bottom-line cost savings that resulted from supply chain initiatives. Since VM paid its share of all expenses through the TSCC contract, the gain share ensured that O&M would implement efficient process and keep costs as low as possible. The gain share protected O&M from an increase in bottom-line costs associated with pursuing new initiatives. The contract also incented O&M to keep costs low by guaranteeing O&M a profit percentage based on sales rather than on cost to serve (see Exhibit 6a). SKU Initiatives The TSCC tied much of VM’s fee to the cost of carrying inventory, or the SKU cost. (Exhibit 6a shows a fee summary, and Exhibits 6b and 6c show selected source data (SKU and deliveries, respectively) from the TSCC model.) The costs assigned to each SKU were: inventory cost, interest on inventory, occupancy costs, warehouse costs, and fixed IT (IT overhead). Stefanic updated the TSCC with a three-month moving average of costs obtained from the Seattle DC. The model assigned and aggregated costs for each SKU until it arrived at a total carrying cost for that SKU. The model then allocated a portion of the cost to VM based on the volume percentage that VM purchased of that SKU. For example, if VM purchased 50% of a specific blue latex glove, the TSCC model allocated 50% of the total carrying costs to VM (see Exhibit 6b). This was a strong incentive for VM to reduce the number of unique SKUs they asked O&M to stock. VM created a product-review team that was charged with reducing the number of unique SKUs that VM purchased. The monthly PMO meetings included a standing agenda item on SKU reduction. Stefanic talked about the various ways that VM and O&M tried to control SKUs: We are VM’s alpha vendor, they buy 46% of their SKUs in med/surg supplies from us and they want that number to increase. They want to buy everything they can from us. But even so, they purchase 1,900 SKUs from us and we stock 14,000. So we try to impact this in two ways. In the TSCC model, we assign 100% of the carrying cost for that SKU to VM if VM is the only customer purchasing that product. If VM is buying the best product from efficient, low cost suppliers, we try to get our other customers to move to that product. On the other hand, if there is a better alternative, with a more efficient supplier for example, we try to move VM to that other supplier. They want to share the carrying cost on all products if possible, but a lot depends on the end user preferences, and whether we are able to contract with their preferred supplier. Some suppliers are reluctant to ship through a distributor. O&M has been successful in demonstrating the value of distribution to several new suppliers and that helps us offer a complete line of products for our hospital customers and almost always offers the supplier a more cost effective distribution channel to the hospital customers. That’s why we want to get additional hospitals in Seattle to use the TSCC model. I think we can achieve cost saving synergies that way. Gloves are a good example of the inventory challenge we face: we have 600 different glove SKUs in the DC and we only need 50 SKUs to meet our customer’s needs. We need to get critical mass to standardize. VM is optimizing and 14 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. Supply Chain Partners: Virginia Mason and Owens & Minor (A) 109-076 doing the right things. One customer helps, but if we could get all our customers on this program, VM’s fees would go down and we’d be able to expand our services without adding to our costs. If we can get a majority of our customers buying the same SKUs, we can bring in new products without expanding our walls and greatly reduce our on-hand inventory. Instead, every time we bring in a new customer, we bring in additional products they currently use. It’s not the best solution, but we bring in whatever they want. We just brought in an additional 2,000 SKUs for a new hospital. O&M should say, “We’ll bring in what you want, but we can offer you savings if you use what we already have in stock.” When we purchased the med/surg business from McKesson, we ended up increasing the SKUs we had in the warehouse. We had to lease another warehouse to handle the increased inventory volume. Moving to fewer SKUs was not an easy task in the healthcare environment, as Borunda explained: We actually started with office supplies. We figured that was something we could pull off. We used to have 2,100 SKUs in office supplies and one of the lean initiatives took it down to 850. You would have thought we’d done terrible things to the administrative staff’s friends and families! The outcry was amazing—we had taken away choice. We learned from that experience. This was the administrative staff; can you imagine how a doctor is going to respond? As the monthly meetings continued to address defects, and as TSCC continued to expose cost drivers in the system, O&M’s accuracy rate increased and defects began to come down. The DC ironed out its organizational issues and began to become more efficient at filling VM’s orders. O&M made programming changes and additions to some of its systems, which automated a considerable amount of the manual “line forcing” that Hickman previously did to move product from the VM inventory reserve to back-ordered lines. O&M placed totes on the truck and on the dock according to VM employee delivery route and it added another delivery day (Sunday). Even so, the nursing staff continued to mistrust the replenishment system and emergency orders were tenaciously hard to control. VM placed an employee on the O&M dock to spot-check and receive inventory before it went on the truck. This greatly reduced errors and the time it took to rectify them, since errors were caught before the product left the DC. VM and O&M also came to an agreement about lowest unit of measure. VM moved to boxes instead of “eachs” when appropriate, such as bandages and sutures. VM steadily reduced the number of purchase orders and increased the number of lines per order. As Stewart recalled: After a lot of trial and error we had it running smoothly. We got to the point that three people could pick the entire order in eight hours. We were rock stars. Things were steady, orders were coming in on time, and we had very few backorders. We had experienced people in place on both our end and VM’s end that were working on the orders and things were very, very consistent. New Supplier Decision Borunda was sitting in his office in late 2007 when he received a call from one of VM’s buyers. The buyer had received a very attractive offer from a specialty distribution company that supplied sutures, one of VM’s highest-volume, most expensive products. Borunda recalled: 15 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) He asked me to take a look at the contract, and he was right, it was the lowest cost-plus fee we’d ever seen on this product. It looked like a no-brainer. Still, to be sure, I told him I would run a comparison with O&M’s fees under the TSCC [Exhibit 7 shows the price and fee comparisons between the two vendors.] The whole alpha system was designed around the idea that we push as much product through O&M as possible, so I wanted to make sure that moving sutures to another vendor was unquestionably the right decision. Stefanic described his thoughts on the suture question: In a cost-plus environment, sutures, because they are small and expensive, offset the lower margins generated for large inexpensive space-consuming items. Without the proper mix of products in a cost-plus system, there is the potential for a customer to become unprofitable. With TSCC the costs are passed on to the customer, so losing this contract would be difficult, but not devastating, as it would be on cost-plus. Final Decisions Stefanic and Borunda knew that TSCC was the best contract to use for the alpha vendor program, but on paper, it looked like TSCC generated higher total fees than the cost-plus model they were currently using. Borunda recalled his thoughts as he and Stefanic prepared for the meeting: One problem is the complexity. The relationship and communication I have with Michael makes TSCC work. It is hard to explain the model to others; it is overwhelming for most people. We tried to distill all the factors down to a few basic variables and put high/low ranges on those variables. That is one way we can ensure that when Michael and I die or go away that TSCC can continue. I also anticipated that finance would argue that simply negotiating lower prices on our supply contracts would save the same amount of money as the TSCC contract. My response to that argument is that product and cost-plus contract savings are only as good as the life of the product or the life of the contract. The cost savings from TSCC are an annuity; they just keep on giving. But it is a huge commitment of resources, because we continually have to reevaluate and redefine processes. It was much simpler to just stick with a cost-plus contract. There was a very real possibility that we would not be able to convince people to go with TSCC. I was trying to imagine how well the alpha program would work if we continued to use cost-plus. Stefanic also voiced his worries: VM was tempted to move one of our most profitable products (in a cost-plus contract) to another distributor, but because of TSCC we could show that we were in fact the low-cost provider. What would happen if we continued with the alpha program without TSCC? If we stayed on a cost-plus contract and VM decided to go with the other supplier for sutures, we would lose money on the alpha program and be forced to increase our cost-plus percentage to cover our expenses. We were in real danger of erasing much of the progress we had made in the last year. 16 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. Supply Chain Partners: Virginia Mason and Owens & Minor (A) Exhibit 1 109-076 Owens & Minor Sample Customer Invoices Customer A and Customer B both purchase $2.3 million in product per month with roughly the same number of lines, orders, and deliveries (see Table B). Both customers have multiple delivery locations that require different combinations of service levels, including: JIT/LUM, bulk delivery, or suture management program. Customer A is on a CostTrack contract, while Customer B is on costplus. A typical monthly invoice for each customer is portrayed in the tables below. Table A Customer Invoices (October 2005) Customer A Customer B CostTrack Invoice Product Purchases $2,300,000 Activity Matrix Feea $184,000 Suture Management Program 14,000 Freight in 11,000 Cost-plus Invoice Product Purchases $2,520,000 Total October Fees Total October Fees $2,509,000 $2,520,000 Source: Company records. aThe activity fee is calculated from the matrix shown in Table C. With CostTrack customers, O&M sent the matrix calculation and the customer statistic table with the customer’s monthly invoice. Cost-plus customers received only the monthly cost-plus invoice similar to the one shown in this table. This amount includes the purchase price, O&M distribution fees, and freight. Table B Customer Statistics (October 2005) Customer Location Number 10100 10120 10130 10140 10300 10400 10600 10901 10902 10903 10904 Total October Orders Lines 50 600 325 200 80 722 178 82 40 23 50 300 5,000 2,200 2,000 500 4,000 1,600 600 3,000 3,000 900 2,350 23,100 Lines per Order 6 8 7 10 6 6 9 7 75 130 18 10 Sales per Line ($) $200 100 148 50 100 63 94 25 100 150 111 $100 Sales ($) $60,000 500,000 325,000 100,000 50,000 250,000 150,000 15,000 300,000 450,000 100,000 $2,300,000 Source: Company records. 17 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. $171,350 $172,500 $173,650 $174,800 $177,100 $179,400 $181,700 $184,000 2,001–2,100 2,101–2,200 2,201–2,300 2,301–2,400 2,401–2,500 2,501–2,600 2,601–2,700 2,701–2,800 Source: Company records. $170,200 19,000– 20,000 $186,300 $184,000 $181,700 $179,400 $177,100 $175,950 $174,800 $173,650 $172,500 20,001– 21,000 21,001– 22,000 $188,600 $186,300 $184,000 $181,700 $179,400 $178,250 $177,100 $175,950 $174,800 Activity Fee Matrix Calculation 1,900–2,000 Orders Per Month Table C Exhibit 1 (continued) $190,900 $188,600 $186,300 $184,000 $181,700 $180,550 $179,400 $178,250 $177,100 22,001– 23,000 $193,200 $190,900 $188,600 $186,300 $184,000 $182,850 $181,700 $180,550 $179,400 23,001– 24,000 $195,500 $193,200 $190,900 $188,600 $186,300 $185,150 $184,000 $182,850 $181,700 24,001– 25,000 Lines Ordered Per Month $197,800 $195,500 $193,200 $190,900 $188,600 $187,450 $186,300 $185,150 $184,000 25,001– 26,000 $200,100 $197,800 $195,500 $193,200 $190,900 $189,750 $188,600 $187,450 $186,300 26,001– 27,000 $202,400 $200,100 $197,800 $195,500 $193,200 $192,050 $190,900 $189,750 $188,600 27,00128,000 109-076 -18- Supply Chain Partners: Virginia Mason and Owens & Minor (A) Exhibit 2a 109-076 Owens & Minor Supplier Factor Inputs Supplier Items 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. Inventory turns Service levels EDI sets performed i. Purchase Order ii. Purchase Order Acknowledgement iii. Electronic Price Catalog iv. Contract Notification/Eligibility v. Electronic Invoicing vi. Advance Ship Notification vii. Payment Order/Remittance Advice Payment terms Minimum order requirements One price or tiered pricings Prepaid freight Number of drop-ships Drop-ship fees Restocking fees Number of days for order lead time Number of pricing credits Number of receiving credits (short shipments, damaged goods, incorrect item) Receiving method (quality pallets, substandard pallets, no pallet, pallet charge, etc.) Delivery method Number of days given prior to effective date of price change Outdated and expired merchandise written-off Number of days between PO date and date order is completely filled Number of shipments received per order Number of ship-from locations Number of contracts administered Special handling requirements (temperature control, etc.) Cubic feet required to store product Source: Company records. 19 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) Exhibit 2b Sample Supplier Comparison The following table gives a comparison that VM can use to choose between two suppliers of the same product (Supplier X and Supplier Y). O&M, using a proprietary process, tracks and weighs supplier past performance (as listed below) on these (and other not listed) factors to calculate each supplier’s score. O&M then multiplies that score by a dollar value (dependent on the level of purchases expected) to arrive at a discount unique to each supplier. This discount incents VM to choose the most efficient and low cost suppliers. Supplier Factor Supplier X Supplier Y Service Level to Customersa Fill Rate from Suppliersb % of Accounts Payable Matchedc Cash Discounts Rebates Offered Inventory Turns (per year) % of Excess Inventoryd % of Products over One Year Oldd Carrying Costse % Drop Shipf Number of pricing correctionsg Number of Contractsh 97% 90% 100% 2%, 45 days 1% 19 2.4% 0.4% 0.54% 0.15% 1% 20 86% 79% 89% 0%, 30 days 0% 11 13% 2.2% 0.84% 6.3% 20% 46 $50,000 100 $1,000 $50,000 25 $250 Amount Virginia Mason will purchase from supplier Supplier Efficiency Scorei Supplier Efficiency Factor Discounti Source: Company records. a Service level: ratio of the number of items that O&M was able to send to the customer on the first delivery, to the total number of items ordered by that customer. bFill rate: ratio of items delivered on the first delivery to O&M from the supplier, to the total number of items ordered by O&M. c Percentage of Accounts Payable Matched: ratio of correct lines items (matched by quantity and price) to total line items ordered by O&M per month. d Percentage of Excess inventory: ratio of inventory not sold in 90 days to total inventory from this supplier (calculated monthly). Percentage of Products over One Year Old is the ratio of inventory over one year old to total inventory from this supplier (calculated monthly). e Carrying Costs: O&M internal costs (to maintain supplier inventory, including interest and storage expense) divided by the total inventory from this supplier. f Percentage Drop Ship: ratio of total drop ship orders (cause by supplier shortages) to total number of orders from the supplier. O&M pays for the cost of drop ship orders. g Number of pricing corrections: ratio of total number of pricing corrections per line (due to supplier pricing errors) to total lines ordered by O&M. h Number of pricing contracts between the suppliers and local hospitals; suppliers that have fewer contracts and maintain consistent pricing across customers save O&M processing and administrative costs. i The supplier efficiency score is based on 23 weighted factors (see Exhibit 2a). The methodology used to calculate the weighted score and to monetize that score is proprietary. 20 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. Supply Chain Partners: Virginia Mason and Owens & Minor (A) Exhibit 3 109-076 Owens & Minor Flowcharts Virginia Mason Order Flow (every day except Saturday) Order processing & receiving: 6:30 – 8:30 am •VM generates orders and sends via GHX to OM. •OM customer service specialist (CSS) reviews order and forces lines from reserve inventory as needed. •CSS and VM inventory staff correct any errors. •CSS releases orders to warehouse floor. • One line receiving coordinator replenishes product in JIT area. •$55,000 of product on average received per day for VM. Shipping: 1:30 pm & 4:30 pm Outbound Staging & Receiving: 12:30 pm & 3:30 pm Order Picking: 8:30 am – 3:30 pm •Three JIT order pickers on one 8-hour shift pick items from JIT racking and place into totes. •Totes are addresses to each department storage closet (up to 800 ship to addresses). •CSS sends email to VM to address any stock outs. •Set up for Outbound Shipping •VM employee on OM dock matches packing slip with order and receives order into VM inventory. •Totes (and pallets for bulk orders) placed onto outbound trucks. Bulk Order Flow (Monday through Friday) Inbound receiving: 2 am-12:30 pm •Line receiving coordinators on staggered shifts unload product. •$900,000 of product average received per day. •Orders received throughout the morning from customers both directly and via GHX to OM’s IT system. Shift change: 12:30 pm – 1:30 pm •Overlapping shifts •Clean warehouse •Set up for order picking and outbound shipping. • Deliver order to VM and satellite clinics. Accounts Payable (at VM): 1:30 pm – on •Match invoice vs. received shipment. •Resolve any exceptions. •Wire pay OM within 40-60 hours. Shipping: 11 pm – 2 am Order Picking/Staging: 1:30 pm – 11 pm •Nine order pickers on staggered shifts pick items until 10 pm. •10 pm – 11 pm stage pallets on outbound trucks. •Five trucks and five drivers deliver throughout night to hospitals in Washington, Idaho, and western Montana. •Once weekly barge carriers take product to Alaska. Inventory Control: 11 pm – 2 am •Three inventory control coordinators perform cycle counts on warehouse inventory. Source: Company records. 21 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) Alpha Vendor Selected Defect Rates & Efficiency Rating January 2006–July 2007 Exhibit 4 Total Lines Received 45000 40000 35000 30000 25000 20000 15000 10000 5000 0 Total Back Orders 800 700 600 500 400 300 200 100 0 One Line PO’s 450 400 350 300 250 200 150 100 50 0 Efficiency Rating 98.00% 96.00% 94.00% 92.00% 90.00% 88.00% 86.00% 84.00% 82.00% 80.00% Source: Company records. 22 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. Supply Chain Partners: Virginia Mason and Owens & Minor (A) Exhibit 5 109-076 Gain Share Contract VM Vendor Relations Flexible contracts that adjust to split economic gains fully as market conditions change Three Metrics for Success • Both – Emphasize quality in product and process, quality enables: • Vendor – Increase Profitability • VMMC – Reduce Expense • How – Total Supply Chain Cost (TSCC) Gain Share Calculation: Total Supply Chain Cost = Product Cost (ABC) + n*810,771(FLF) + n*719,500(FLF) + n*702200 (FLF) + n*Finance(FLF) n= Number of FTEs supporting Supply Chain FLF (Fully Loaded FTE) = Cost Centers Total Expense/FTEs • Each time we identify Cost Centers that play a role in the Supply Chain, we add them to the formula. OM Compensation = ((% Total MegSurg Supply Cost – 90%) X MedSurg Spend X Agreed Share Rate) – Distribution Profit $. The formula is self-correcting—OM increase cost shrinks their “OM Compensation.” VM savings must be real and sustainable for OM to realize benefits. Source: Company records. 23 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) Exhibit 6a TSCC Monthly Fee Summary for July 2007 Monthly Activity Cost Assumptions Total Monthly Purchases Number of Monthly Lines Number of Monthly EDI Orders Number of Monthly Manual Orders Number of Deliveries per month Actual Monthly Days Sales Outstanding Cost Categories Order processing, customer service, office administration Warehouse labor and IT SKU Related Costs: (see Exhibit 6b) Warehouse fixed Storage/Occupancy Costs Inventory carrying/interest costs IT fixed Shared services Non-stock credit Interest on accounts receivablea Delivery (see Exhibit 6c) Freight (supplier actual freight cost) Distribution center management Account management Area management and administration GPO fee (% of sales) Value-added Services Patient charge labels Additional support Subtotal O&M Profit before taxes (% of sales) Total monthly fee before discounts Supplier efficiency factor discountb Total Monthly Fee $1.3M 30,500 2,900 0 55 3.47 $8,500 17,000 $9,000 5,000 15,000 6,500 12,000 ($500) 1,000 9,000 4,000 2,500 4,000 5,000 5,500 $1,000 2,000 $106,500 32,500 $139,000 (35,000) $104,000 Source: Company records. a Based on annual prime rate of 8.25% and 31 days per month. b The total monthly discount is the monetized efficiency score of the roughly 225 suppliers used by Virginia Mason. The weighted method of monetizing scores is proprietary. See Exhibits 2a and 2b for more explanation of the supplier efficiency factor discount. 24 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. 1003 1004 1005 1006 1007 1008 1009 1010 1011 1014 001 001 002 003 004 004 005 006 007 008 $1.3M 60 870 10 100 560 10 500 170 200 300 $300 VM 2% 87% 33% 50% 80% 19% 71% 85% 40% 100% 10% VM % of salesa $4.7M 1,000 400 30 110 200 50 150 400 200 200 $3,500 Seattle DC Inventory by SKUa $0.14 2.44 0.07 0.38 1.12 0.07 0.75 2.38 0.56 1.40 $2.45 Monthly Inventory Interestb 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 $3.00 Seattle c DC $2.2M $15,000 $5,000 0.06 2.61 1.00 1.50 2.40 0.57 2.14 2.55 1.20 3.00 $0.30 VMd Monthly Occupancy Costs [Remainder of table omitted] 20 348 10 55 160 10 107 340 80 200 $350 Allocation of Inventory to VM 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 $7.00 Seattle DCe $9,000 0.14 6.09 2.33 3.50 5.60 1.34 5.00 5.95 2.80 7.00 $0.70 VMd Monthly WH Fixed Costs 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 $5.00 Seattle DCf $6,500 0.10 4.35 1.66 2.50 4.00 0.96 3.57 4.25 2.00 5.00 $0.50 VMd Monthly Fixed IT gShared services (primarily of a home office service charge, taxes, licenses, and insurance) per SKU (using 14,000 unique SKUs). fFixed IT costs (portion of home office charge) per SKU (using 14,000 unique SKUs). eMonthly warehouse costs (personnel, maintenance, and equipment expense) per SKU (using 14,000 unique SKUs). dTotal cost multiplied by VM % of sales. cMonthly storage facility costs (rent, utilities, building maintenance, security, and cleaning) per SKU location (using 20,000 SKU storage locations). bInterest cost on inventory: VM allocation of inventory (total inventory multiplied by VM % of sales) multiplied by monthly interest cost (based on annual prime rate of 8.25%). aAverage of prior three months. Inventory is actual inventory on hand. $3.6M 3,000 1,000 30 200 $00 50 700 200 500 300 $3,000 Seattle DC Sales for these SKUsa Source: Company records. TOTAL 1000 VM SKU # Selected SKU Source Data (July 2007) 001 Supplier # Exhibit 6b 13.00 13.00 13.00 13.00 13.00 13.00 13.00 13.00 13.00 13.00 $13.00 Seattle DCg $12,000 0.26 11.31 4.33 6.50 10.40 2.49 9.29 11.05 5.20 13.00 $1.30 VMd Monthly Shared Services 109-076 -25- 109-076 Supply Chain Partners: Virginia Mason and Owens & Minor (A) Exhibit 6c Delivery Costs July 2007 Day Delivery Hours Night Delivery Hours Kirkland Satellite Delivery Hours Total Delivery Hours per Month Inputs 100 50 20 170 Truck Lease per Month Practical Capacity per Month Rate per Hour (lease cost/capacity) Truck Lease Cost per Month $2,340 390 $6.00 VM Miles per Trip VM Miles per Month (45 trips per month) Kirkland Miles per Trip Kirkland Miles per Month (10 trips per month) Total Miles per Month Mileage Lease Fee per Mile Total Mileage Lease Fee per Month 55 2,475 60 600 3,075 0.0325 Fuel per Gallon MPG Fuel per Mile Total Fuel Cost per Month $2.88 8 $0.36 Driver Rate per Hour Driver Cost per Month $25.00 Monthly Cost $1,020 $100 $1,107 $4,250 Courier Delivery Expense July 2007 Cab Fees July 2007 $2,300 $223 Total Delivery Expense $9,000 Source: Company records. 26 This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. This document is authorized for use only by Ashley Murray in It’s All About the Patient at Strayer University, 2020. $7.50 per order – $42,630 $812,430 $3,000 $11,430 $762,000 $36,000 Non-Alpha Cost cAlpha fee is the $350/month cost to purchase sutures from O&M. bSuture activity through O&M does not generate additional purchase orders, but it does add lines to existing purchase orders. a VM’s internal cost to process a purchase order. Source: Company records. Total Annual Cost of Change Variables 400 $762,000 $90 12,000 lines 1.5% Suture Vendor Change Analysis Estimated Purchase Orders 2008 Estimated Purchases 2008 Non-Alpha Purchase Order Costa Alpha Line Cost (at $0.30/line)b Non-Alpha Mark up (Cost-plus % of sales) Alpha Fee c Non-Alpha Shipping Alpha Shipping Product Cost Description Exhibit 7 $769,800 $4,200 $3,600 $762,000 Alpha Cost 109-076 -27-
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