JWI 551: It’s All About The Patient
Lecture Notes
Towards Operational Efficiency
Operational Efficiency will not just happen by itself. It requires leaders to set clear goals and objectives,
define targets, and then communicate those goals to everyone, so that the knowledge is widely shared.
It also requires leaders to hold people accountable for the results. All the people in the organization
need to understand the end game and how they can and should contribute to it.
The purpose of Operations Management is to support the organization in pursuing and meeting its
strategic objectives. Operations Management is the translation of strategic objectives into actions that
will make it possible to reach the goals. It is the How. In healthcare, as in other industries, objectives can
be wide-ranging. They might include making a profit, serving a particular segment of the population,
promoting the health and wellbeing of a community, growth, and increased productivity. Regardless of
the particular objective, Operations Management helps the organization to get there.
How can leaders know that they are making progress towards their goals? The answer lies in
Operational Analysis. Operational Analysis is the process of examining how the business is actually
running. Is there progress towards strategic objectives? Can performance be better? How? What steps
need to be taken to improve results and get closer to the strategic objective? If the business is off track,
what corrective actions need to be taken to get it back on track?
Metrics, Benchmarks, and Scorecards are all valuable tools for guiding decision-making and for helping
an organization to meet its strategic objectives. The first step, however, is to figure out what metrics are
best suited to the organization’s specific goals. Selecting the right metrics matters.
From Strategy to Action: How to Get There
One of the most critical responsibilities of leadership, once objectives have been defined and agreed
upon, is to communicate the strategy to all departments within the organization. The conversation
needs to be very specific: What are the large scale goals? Which individuals are responsible for what and
by when? Good organization leaders explain to the department leaders below them exactly how they fit
into the picture and what this means for day-to-day activities. The objectives for the department, based
on the broader strategic goals, must be clearly defined: What are the expected results? What are the
costs associated with these objectives? What, if any, additional resources will be needed to ensure that
the goals can be reached? Department leaders must then explain to their teams how they fit into the
picture and how they are expected to contribute to the goals.
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Lecture Notes
Establishing start and end dates for specific actions are critical to success. It causes members of the
team to think about how things will need to be organized for the overall goal to be met. This approach
forces people to consider process and the order in which things will need to be done. It also assists
teams in defining timelines. Timelines create commitment and set up an accountability structure.
Start with Why?
Simon Sinek, author of Start with Why: How Great Leaders
Inspire Everyone to Take Action (2009), a book referenced
earlier in the class, reminds us that every organization can
tell you What they do, some organizations can tell you How
they do it, but very few can tell you Why they do what they
do. He notes that the Why has nothing to do with revenue
or profit. Revenue and profit are results. Why has
everything to do with what the organization stands for—its
values. Thus, it is the Why of an organization that will
inspire others, who believe in what the organization is
doing, to join the cause, either as colleagues, supporters, customers, or clients. Why provides context
and gives meaning to what we do. It is the engine of innovation. This is an important message for all
leaders, especially when it comes to explaining strategic goals and asking others to take action to
implement those goals.
The Balanced Scorecard
The concept of a Balanced Scorecard, like other tools we have discussed in this course, originally came
from large industrial companies in the manufacturing sector, which made a product. In a service
industry such as healthcare, the Scorecard had limited applicability. Companies today do not necessarily
produce a tangible or physical product. They create “value by deploying intangible assets, such as
customer relations, innovative service, high quality operations, information technology, databases, and
employee competencies”1. This change in the nature of the product has led to a shift in how the
1
Kaplan, Robert S and David P. Norton, “The Balanced Scorecard-Measures that Drive Performance” Harvard
Business Review 72, no. 1 (1993): 71-79.
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JWI 551: It’s All About The Patient
Lecture Notes
Balanced Scorecard is used. Rather than focusing on measurement and control, it has become a tool for
implementing strategy. It links strategy to action. In healthcare, an organization’s strategy should build
value for patients and their families. A well-executed strategy leads to the desired results.
The Balanced Scorecard focuses an organization around its strategy. By definition, it is an integrated
strategic planning and performance management system2 that:
Ø Communicates an organization’s mission, vision, and strategy to employees and other
stakeholders
Ø Connects and aligns the day-to-day work to the vision and strategy of the organization
Ø Provides a framework for prioritizing programs, projects, services, products, and resources
Ø Uses strategic performance measures and targets, in order to measure progress against goals
The Balanced Scorecard is focused on four main high-level Perspectives or themes:
Ø Finance
Ø The Customer
Ø Internal Business Processes
Ø Learning and Growth
Any organization that decides to employ a Balanced Scorecard must determine how to translate these
four Perspectives into Metrics. No one of the four Perspectives is more important than another.
Two types of Performance Indicators exist: drivers or Leading Indicators, and outcomes or Lagging
Indicators. Leading Indicators drive financial performance. Lagging Indicators are the end result of
specific actions. There are cause and effect relationships among all Performance Indicators.
What Measures Should a Healthcare Organization Use?
When an organization decides to implement a Balanced Scorecard, they have to examine each of the
Four Perspectives in terms of their particular organization, so as to define what measures should be
collected to act as Performance Indicators of progress against goals.
2
The Balanced Scorecard Institute, 1997-2015.
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JWI 551: It’s All About The Patient
Lecture Notes
Finance
Obviously, financial wellbeing and stability is important to every healthcare organization, but what
measures are the most relevant in Finance? Suggestions include:
•
•
•
•
•
•
Days of Cash on Hand
Days in Accounts Receivable
Return on Capital
Net Operating Margin
Gross to Net Ratio
Bad Debt
Select measures carefully! They should be top-level
financial performance measures. As a rule of thumb, include
no more than five (5) financial measures on the Scorecard –
a limit that is also useful for Perspectives. A good question
to ask when trying to choose which measures to use: “How
do we look to our stakeholders?”
Internal Business Processes
Internal Business Processes are considered to be Key Performance Indicators (KPI). A KPI, which is part
of the Balanced Scorecard, should answer the question: “What must we excel at?” Suggestions include:
•
•
•
•
•
•
•
Average Length of Stay
Core Measure Compliance
Readmission Rates
Adverse Events
Harm Events
Operating Room Utilization
Emergency Department patients who leave without being seen
Note: KPIs are different from Strategic Objectives. Objectives provide a target that the organization is
trying to reach. KPIs are specific activities to be monitored, so that performance can be tracked.
Example: the hospital has a goal of being below the Medicare established readmission rate for all
elective hip and knee procedures. In this case, we are monitoring performance, not trying to meet or
exceed a specific target, so this is an example of a KPI.
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JWI 551: It’s All About The Patient
Lecture Notes
Learning and Growth
This section of the Balanced Scorecard is about the people in the organization. The question to be
answered here is: “Can the organization continue to improve and create value?” Suggestions include:
•
•
•
•
•
•
Employee Turnover
Employee Satisfaction
Premium Labor Costs
Training and Learning opportunities
Internal Promotion Rate
Absenteeism
Learning and growth occur at two levels: the individual level (employee training) and the corporate level
(cultural attitudes). People are the main resource in a knowledge or service organization. In today’s
environment, workers must learn continuously if the organization is to be successful.3
The Customer
The Customer category refers to metrics related to patients and physicians. It answers the question,
“How do customers see us?” Suggestions include:
•
•
•
•
•
•
Inpatient Satisfaction
Outpatient Satisfaction
Emergency Department Satisfaction
Physician Satisfaction
Likelihood to Recommend
Market Share
These measures are considered Leading Indicators because they tell us what will happen in the future.
Specifically, if patients are dissatisfied with the care they receive, they will make another choice of
provider in the future. Note that, even in scenarios where the financial profile of an organization is
strong, declining scores in Leading Indicators can serve as a warning sign of future decline.
3
It is important to note that learning is more than training. Learning means people have access to tutors and
mentors within the organization; people can easily get the help they need to solve a problem and they have access
to technological tools (Kaplan and Norton, 1990).
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JWI 551: It’s All About The Patient
Lecture Notes
A Visual Example of a Balanced Scorecard in Healthcare
Examine the below Balanced Scorecard to see how the four Perspectives are used.
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JWI 551: It’s All About The Patient
Lecture Notes
Defining Healthcare Benchmarking
Benchmarking is the process of comparing an organization’s performance metrics (quality, cost, and
operational efficiency) to those of other peer organizations4. It is a tool for finding, adapting, and
implementing Best Practices5 in an effort to achieve operational excellence.
The three core principles of Benchmarking are Maintaining
Quality, Customer Satisfaction, and Continuous
Improvement.
Types of Benchmarking
There are two primary types of Benchmarking: Internal and
External. Internal Benchmarking is about making
comparisons within an organization. For example, after
collecting measures for two departments in the same
organization, you might discover that one department is
doing something particularly well, while the other one struggles with that same aspect of operations.
Through good communication, the department that is struggling can learn what the other department is
doing to achieve better results.
Learning first what is going on inside the organization is important. Some advantages of Internal
Benchmarking are that the process involves:
Ø
Learning what it is doing well (useful to do this before comparing itself to other organizations)
Ø Dealing with other people who share a common language, culture, and systems
Ø Ready access to the needed data, since it belongs to the organization
Ø Creation of a baseline for future comparisons
External Benchmarking calls for comparison to other outside organizations. The purpose is to discover
new ideas, methods, products, and services. The objective is Continuous Improvement in performance.
4
Burns, Lawton Robert, Elizabeth H. Bradley and Bryan J. Weiner (2012). Shortell and Kaluzy’s Health Care
th
Management Organization Design and Behavior, 6 Edition. Clifton Park, NY: Cengage
5
There is no single best practice. The best practice should be perceived or accepted to be among those practices
producing superior outcomes and being judged as good examples in a particular focus area (Kay, 2007).
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JWI 551: It’s All About The Patient
Lecture Notes
This type of Benchmarking creates opportunities for learning from the experience of other organizations
that are demonstrating strong performance and achieving good results.
Benchmarking in Healthcare
Like the Balanced Scorecard, the tool of Benchmarking comes from the manufacturing industry. It was
first used in healthcare in the mid to late 1990s. It is a measurement tool used to monitor and evaluate
governance, management, clinical, and support functions. Although now widely discussed and
implemented, there is considerable debate about whether the use of Benchmarking has had any real
impact on healthcare quality and how health systems operate.
Examples of Benchmarking in Healthcare
Clincial Practice Benchmarking is about comparing and sharing Best Practices in Clinical aspects of care.
It provides quality assessement and a CQI approach that supports the development of quality care. Here
people look across the entire field of medicine for evidence of what is a Best Practice. For instance,
entities like CMS have established benchmarks for things like readmission, as it relates to particular
medical conditions. Healthcare organizations are measured against these Benchmarks.
Example: Research shows that a Best Practice in the case of a hip fracture is for the patient to be on the
operating room table within 12 hours of entering the Emergency Department. Patient outcomes are
compromised for every hour in excess of 12 hours.
Patient Experience or Essence of Care Benchmarking is made up of a series of Benchmarks related to
fundamental aspects of care that are critical to the quality of the Patient Experience—key things such as
respect for privacy and dignity. What is unique about this is that the measures include the patient’s
impressions, subjective opinions, and expectations. It is these things which define what a Best Practice is
in this area of Essence of Care.
The idea is that, by looking at other organizations to learn what is working well and what is not, we can
discover how to innovate in our own practices to improve care delivery. Critics suggest that this is a very
subjective approach. Supporters argue that, by understanding things from the patient’s perspective, we
learn how to make real improvements. The information that comes directly from patients is the most
real feedback that we have. As the consumers of care, this information should be used to set standards
and establish metrics for what constitutes a Best Practice.
Before and After Benchmarking: When engaging in a Quality Improvement effort, Benchmarks can be
established both before and after. When the effort is complete, the data from before and after can be
compared, enabling everyone to see the impact of the effort.
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JWI 551: It’s All About The Patient
Lecture Notes
Making It Visual
Data is essential for Benchmarking. Data must be extracted and reported at an agreed interval—
monthly, quarterly, etc. Then the data must be displayed in a visual format that clearly shows those
involved in the process what the Benchmark is, and how the department, area, or organization is
performing against its goals. The visual display of the data provides a quick reference point for everyone.
This snapshot shows stakeholders how things are going and allows them to reflect on their performance.
Example: The data below is used by a medical practice to check if they are meeting their Benchmarks.
From Agency for Health Care Research and Quality, “Measuring and Benchmarking Clinical Performance”
www.ahrq.gov/professionals/prevention-chronic-care/improve/system/pfhandbook/mod7.html#fig7.1
(May 2013).
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JWI 551: It’s All About The Patient
Lecture Notes
Some Sources for Benchmarking
There are a growing number of local, regional, and national sources for Benchmarking in healthcare.
Consider what it is that you want to improve upon, work out what it is that you want to measure, and
then search for good sources of the relevant data. Some suggestions:
Ø
Ø
Ø
Ø
Ø
Ø
Ø
Ø
Ø
Ø
Ø
Local Quality Collaborative
Community Clinic Associations
Health Resources and Services Administration Uniform Data System
National Committee on Quality Assurance
Local and State Public Health Agencies
Health IT Vendors
Data Networks such as DARTNet and SAFTINet
Leapfrog Group
The American Society for Quality (ASQ)
Payers
Professional Organizations such as American Hospital Association, MGMA, and the American
Medical Association
In Closing
There are many examples of Benchmarking that have already been established in the field of healthcare
today. While these are valuable tools, it is equally important to explore what is happening in other
industries and see if any of their Benchmarks are applicable to healthcare.
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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.
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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
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Supply Chain Partners: Virginia Mason and Owens & Minor (A)
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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
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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
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Supply Chain Partners: Virginia Mason and Owens & Minor (A)
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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.
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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.
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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.
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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.
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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,
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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:
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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
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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
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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
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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
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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:
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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.
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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.
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$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.
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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.
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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.
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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.
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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.
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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.
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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-
JWI 551: It’s All About The Patient
Lecture Notes
Supply Chain Costs in Healthcare
The healthcare Supply Chain is under fire. Recent data shows that supplies currently account for up to
40% of a healthcare organization’s annual operating expense. In fact, the supply chain is the second
largest and the fastest growing expense for healthcare providers after labor costs. Some of the latest
reports suggest that, by 2022, supply chain expenses will exceed labor expenses in the healthcare
industry.
The need to manage and reduce healthcare costs in general makes supply chain management a key item
for healthcare operations leaders. The February 22, 2017 report of the results of the annual Cardinal
Health survey of key hospital stakeholders showed that they are consistently concerned about financial
challenges and that they drew a connection between this issue and the supply chain1. Most survey
respondents believed that their organizations could save
in excess of $500K if they were to move away from
manual processes to new, automated, data-driven supply
chain technology. In larger organizations, the savings
estimate was even higher.
The financial facts are noteworthy but what is more
sobering is to realize what changes in supply chain
operations may mean in practice. When a hospital does
not have a critical item available, the impact is directly
seen in less effective patient care, and in some cases the
outcome can be life-threatening.
According to GHX CEO Bob Cox, “Getting a better grip on
...
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