Owens & Minor case for aligning supply chain incentives Essay

Executive Summary avowal of prints Due to the transmits of business environment, O&M suffered a continuous loss on business. Instead of performing individu eithery, nodes organise buying groups and unite buying power to gain advantages in negotiating complete(a) valuation reserve with electrical allocator. With the growing popularity of JIT and stockless(prenominal) idea, customers want to shift personify and moderate a chance gentd with caudex to distributor, and they to a fault want distributor to provide better function at its own expense. More over, competitions from cloak-and-dagger label distributors and manufacturing distributors further squeezed profit margin of our comp whatever.Owens and Minor job a real both-important(prenominal) role in the wide-cut SC. They argon in charge of providing information to manufacturers on incr readiness flow. Their armed serve wells to the hospitals include storing the enumeration in their storage wargonhouse and ma king eonian freights base on stockless and JIT strategy, thus taking all the financial adventure in inventory handling and storage. They dont cast up regard as to the harvest- meter itself, but they do add a lot of valuate to the SC.The nature of distribution has changed over clock. The bargaining power of hospital has change magnitude over due(p) to mergers and alliances, pressuring the distributors to reduce their margins. Upstream members of the SC thrust also puke some pressure on O&M to take supernumerary greet in their operations.If the ABP strategy could be success all-encom angledingy implemented, both distributors and customers incentives could be allied. Customers would be go forthing to vow valu qualified increases via distributors subscriber line instead of buying presently from manufacture.Generally, customers who could reduce or change the activities happened with the cede chain would conform to ABP faster. Also, customers who understood and w ere allow foring to develop a sustainable alliance with distributors would adopt the ABP first.ABP was a new concept and its regard as had non been proven. Aggressive murder of new idea much(prenominal) as ABP ability drive customers away and fed competitors.thither atomic number 18 versed obstacles exist in the ABP implementation. Hospitals amaze to restructure its frameal structures to fit in ABP dust. Rearranging employees and reallocating facilities would increase the distrust to ABP musical arrangement. Also, a substantial amount of enthronement is essential for establishing the EDI carcass. How to overcome these obstacles and make ABP implementation smooth is a big quarrel.In ordination to expatiate the idea of ABP to a greater extent clearly, we defecate come up a simple set matrix based on first principle method. We have identified two court drivers and separated fixed and changeable be from general monetary value information. However, for simplic ity we have not considered the appeal difference of EDI and non-EDI ordination in this simple matrix.Owens and Minor should c arfully screw with its customers resistance to the new determine system by making them unfeignedly understand the new system and benefits they would pose after the implementation. Owens and Minor also needed to launch a vanish program before full implementation and provide help and support to its customers to insure the success of the implementation.Statement of issuesHistorically O&M was doing very well in the industry, however, for upstart years participation suffered continuous loss on business. At the displace of 1995 O&M had ended with an $11 million loss due to decrease in gross margin and an increase in expense. There atomic number 18 many reasons that caused this result, and we are going to identify the nigh important ones.Healthcare industry has changed a lot since 1980. Historically, hospitals purchased healthcare products individuall y. However, in order to achieve economies of scale and gain more control over supply addresss, hospitals joined forces with opposite hospitals to form large buying groups. With such combined buying powers, hospitals are much more powerful in negotiating gross marginsand service levels with distributors. Distributors are forced to cut gross margins and increase service level. A quote from O&M superintendr can illustrate this situation very well whoever had the strongest will would win the price. Apparently, in current supply chain, the relationship between distributors and customers is not harmonious.Moreover, with the increased popularity of Just-In-Time and stockless care ideas, hospitals are reluctant to hold large inventory because they wouldnt benefit from JIT whose primary principle is to lower inventory carrying cost by ordering when needed. Instead, they want distributors provide Just-In-Time delivery service. Also customers require special handlings such as smaller packa ge and different products batching and these services are at distributors own be.Distributors also experienced margin pressure from the manufacturing side because manufactures do no compromise on the already low healthcare product price. Competitions in the industry also results profit decline of O&M, specially with distributors who also produce healthcare products entered the market. Those distributors are able to forther gameyly low price to customers because they are the manufactures as well. Even though O&M commits to provide better service, it lost many customers because of this.Analysis of infoServices rendered by O&M and changes in Distribution.Owens & Minor play a tremendous role in this industrys Supply-Chain. They are in charge of providing information to manufacturers on product flow such as market trends, buying patterns and product penetration, so that their suppliers use this of import information in order to manage their operations and production schedules. By d oing so, manufacturers are able to produce the right quantity of supplies, which in unit of ammunition reduces stock out(p)s and/or excess stock costs, in other(a) words O&M provide the necessary tools for the upstream members to have adequate inventory production planning.As for their customers, their role is to purchase the products from the manufacturers and ship those aesculapian supplies to their warehouse where they will store them until delivery to the hospitals. So O&M owns and manage the inventory themselves, taking all the financial jeopardize associated with product handling, shipment and storage. O&Ms main operational functions included receiving, put-away, order picking and transportation system.O&M dont add value to the product itself since they just act as an intermediary to pass the products from the manufacturer directly to the hospitals, however they do add value to the Supply-Chain. They ameliorate the SC with the necessary information needed to avoid phenom ena such as the Bullwhip Effect and they bring expertise in stockless and JIT inventory management systems, then lowering costs a coherent the chain.However, it is certain that the nature of distribution, that is, the role of O&M has changed with time and not for the greater good. This change has occurred mainly with its downstream partners the hospitals. They have shifted they costs to their distributors and demanded better and faster service without any additional rewards, this is why O&M relies heavily on its logistics subdivision to make process more efficient. This was made possible for hospitals due to their increase in power by merging or joining forces with other hospitals.Voluntary Hospitals of America member hospitals represented $1.2 billion in one-year r scourue to the company, meaning that O&Ms switching cost is too high. They are able to minimize their own costs by forcing distributors to hold their inventory and transport in smaller units, sending it to the care for and working(a) units instead of leaving it at the loading dock as before. Margin pressures have also been present upstream with manufacturers, which were reducing discounts even as small as 0.5%, thus lowering significantly up to 31% distributors net profits before tax.A main issue taken from this case is that incentives along the Supply-Chain are not aligned. The happens and rewards of doing business are not fairly distributed across the network. Even if the manufacturers and hospitals are better off with the un primed(p) strategy, the whole SC still does not have a win-win situation and they might lose against other Supply Chains. The truth female genitalia this issue lies in that at that place is no trust in the SC, this boldness is made given that nobody wants to share critical information, which enhances furbish up of indeterminate Pricing on the members of the Supply-Chain.On the side of the distributors O&M, engaging in a cost-plus determine strategy means chargin g a 7% markup, meaning that profits lie on expensive products, which they dont have the change to deliver cause Hospitals bypass them and deal directly with manufacturers in order to avoid the 7% increase in prices. The about important aspect to consider about this strategy is that it does not take into account the services added. In addition, this method caused the effect of Distributor fully grown more and better service holding more inventories, which increases carrying costs and risk of damage during storage. Distributors enforce supply-chain speed without any additional profits.On the customers side, cost-plus pricing implies less risk on inventory carrying cost, creating more incentive for hospitals to order frequently due to flat rate. Nevertheless, on that point is some unethical activities in which they can participate. They can avoid compensable high costs on expensive products to their distributors by jumping them through the SC and dealing with manufacturers instead , an activity called cherry-picking.Finally, the manufacturer engaging in cost-plus strategy needed to handle some shipment to deliver, mainly expensive products, to hospitals. This resulted in inefficiency for both parties due to the fact that manufacturers required hospitals to buy in bulk and they did not have the space or management systems as distributors did to handle the product. Mishandling, modify and loosing expensive full stops frequently occurred in the cherry-picking process.Alternative Courses of work for O&M.establish on our five quantitative and qualitative decisiveness criteria cost, time, ease of implementation, customer satisf execution and future benefit for thecompany, we are able to compare the advantages and disadvantages of each choice and help us make the crush decision.1)Status Quo The easiest alternative for O&M is to keep operating as they are, which is not the best option for them for financial reasons. They currently have customers who are not pr ofitable for the company, customers who keep filling for higher service at the selfsame(prenominal) price that would keep profit margins low as force costs increase. For the year of 1995 they take inred a net loss of $11.3 million, which compared to last years profit of $7.92 million represents a dramatic and also unstable change. ground on this data, the assumption is that the upstream and downstream partners will not change their business habits and incentives will keep unaligned and that the company will not be able to reduce costs to an extent where they can offset service costs and generate profits.O&M will keep generating loses for the company and will ultimately yield to bankruptcy. The time to implement is inexistent, since no actions are made. The cost of implementation is also inexistent nevertheless the companys cost on the long run will be very high because cost-plus strategy is not profitable for them. There is no ease of implementation. The customers benefit is hi gh, since they dont have to concede additional service and inventory carrying cost. The future benefit for the company is very low, might loose contract with clients because of their lack of ability to fulfill all products and keep taking all the costs.2) Vertical Integration Our second proposed alternative is straight integration, which means to acquire a manufacturing plant. By utilise this strategy, O&M would be able to create its own healthcare product brand and reduce the purchasing price on that. Thus, O&M could offer a more competitive price to its customers and might specify some recovers from the high operating costs. However, there are some problems associated with this alternative. O&M had to spend time on finding suitable getting target, understanding manufacturing process and integrate the manufacturing plant into the company system. Therefore, this strategy requires a relatively eight-day time period to get things work. On the other hand, in order to do vertical integration, O&M had to make a huge amount of cash. Based on the fact that O&Ms current cash flow was very tight, acquiring a manufacturewould have a big impact on companys financial health. Implementation of this strategy would be kind of difficult as well.Since O&M had no experience on healthcare manufacturing, it has to get familiar with the process from very beginning. Also, how to control manufacturing cost at a competitive level is a new challenge to O&M. Because O&M can create its low-cost private label products under this strategy, it has the incentive to promote private label products to hospitals. However, hospitals do not like private label products since it limits the scope of choice so under this strategy customer satisfaction level is low. In general, vertical integration is effective in reducing companys cost on healthcare products purchasing but requires a substantial investment and long implementation period. Customer satisfaction is also low in this case.3)Select ed ABP Another alternative that O&M could use is to use ABP system precisely on certain type of customers. More specifically, O&M could choose futile customers to implement ABP and keep its profitable customers status quo. The time required for this alternative will not take too long, less than 6 months would be a reasonable estimation. The majority of time would be spent on the analysis of profitableness of customers. The challenge of implantation this alternative is to make sure the customer profitability analysis would be through under a proper and correct result would be produced. To imagine customer satisfaction after the implementation, we needed to split our customers into two groups.Those customers determined as profitable to us under current cost-plus system would likely to maintain the current satisfaction level, but customers viewed as unprofitable would feel less satisfied since they would have to pay more after ABP implemented. The downsides of this alternative are the risk to drive some customers away and the increased complexity of our pricing system which might lead increased mistake rate. The good side is that O&M would benefit in the long run because of the elimination of unprofitable customers. If O&M would have all the information and could develop correct ways to conduct the analysis, this alternative would be a possible choice to lead O&M succeed.4)ABP for all Customers this final alternative considers implanting ABP to all customers, both profitable and non profitable. The cost of this optionis higher than Selective ABP previously mentioned, due to the fact that all customer base will be subject to EDI technology and connecting to all of them takes organization within the company and thus training cost by employees for both O&M and hospitals. The time to implement will be longer compared to Selective ABP however based on our assumption that O&M will be located higher on the learning curve, their time per implementation per customer will be less the more customers they have previously served. The easiness of implementation therefore is not late due to the large customer base dealt and new systems and training needed. However, the future benefits, not only for O&M, but also for the stainless SC will be substantially improved in the sense that incentives would be aligned.Based on previous analysis on alternatives, we conclude that ABP for all customers is the most feasible solution that can maximise companys profits, as well as aligning the incentives along the SC. This is important not only for the short term, but also for the long term of the entire chain.Impact of ABP on Customer Behavior.Before the implementation of ABP (activity based pricing), the current governing form of pricing in the medical/ surgical industry was cost-plus pricing. If the ABP strategy could be successfully implemented, both distributors and customers incentives could be allied. Under ABP, the distribution fee was no longer based on the value of item but the value of service. In that way, Owen & Minors customers would begin to think about the real cost of various activities through the supply chain.Instead of wanting to order as less as possible per time and increasing order frequency, customers would begin to seek a way to reduce the order frequency to reduce the distribution fee charged by Owen & Minor. Also, since now the fee was not determined by product value, customers would be willing to order expensive products via distributors channel instead of buying in bulk directly from manufacture. So the possibility of mishandling, damaging and lost of expensive items would be reduced. From the distributors side, it would be more happy to provide good service because it would be paid based on the service it provided not the value of item.Of course, its unlikely to ask all Owen & Minors customer to turn to the new pricing system at the same time. Depends on the type of customers, some of them might be adopt the AB P quicker and with less resistance. Generally, customers who could reduce or simplify the activities happened through the supply chain would adopt ABP faster. First, customers willing to simplify or reduce the order frequency would be more likely to adopt the ABP. By doing that, the fee charged by distributor would be decreased.Also, those customers often ordering large amount of expensive items would adopt the ABP first. By doing that, it shits the risk of mishandling, damage and lost to the distributor. Compared with previous fee charged by item value, now they would more likely to pay less but get better service. Furthermore, those customers who understood and were willing to develop a sustainable relationship with distributors would adopt the ABP first. They understood that if distributor was losing money because of the improper pricing system, the entire supply chain would collapse someday and both of them would be damage finally.There were also risks associated with ABP for O wens and Minor. ABP was a new concept and cost-plus pricing system was still a dominant form in the medical/ surgical industry. It was hard to convince customers adopt the new and even unverified concept. both(prenominal) customers might turn to other competitors and the relationship that needs build over long time might get hurt.Proposed ABC pricing matrixIn order to have a better demonstration, O&M designed a simple pricing scheme using activities-based costing. The pricing scheme is based on two major cost driversnumber of purchase orders per month and number of lines per purchase order. The number of orders was fix up to O&Ws fixed administrative costs and number of lines was tied to covariant costs such as the grok handling cost of different products. This is a very primitive matrix because it only listed two cost drives and priced based on them. In reality, there should be a price for every value-adding service provided by distributor and the number of cost drives is hug e. However, this simplepricing matrix could effectively figure our clients that their operating cost is associated with level of service they demand, and lower cost is achievable if they can optimize their behaviors. Because we designed this pricing matrix based on two cost drivers, costs included in matrix are directly related to number of orders and lines.For example, fixed order costs such as procurement, labeling, account management fees and variable costs like shipping & handling, delivery, interest cost are all included. However, some costs are not comprised in the matrix. O&M believes all costs associate with number of orders are fixed but there are variable costs incur in placing orders. Activities such as taking orders, impact and staging & processing are not free so in the future we need to include these costs in more cultivate pricing matrix. Moreover, operating cost of an EDI system and a non-EDI system are very different. For simplicity reason we just ignore the dif ference and slang identical prices for both systems but actually using non-EDI system would incur more cost due to high level of manual works.We have worked out some simple examples on ABP and it shows that companys profitability increased dramatically under ABP system. Please carry on to exhibit 1 fro more details.Risks & Challenges.Although this selected alternative presents many future benefits for the company and the Supply-Chain, certain risks are involved.Risk associated with ABP for Owens and Minor. ABP was a new concept and cost-plus pricing system was still a dominant form in the medical/ surgical industry. It was hard to convince customers adopt the new and even unproven concept. Some customers might turn to other competitors and the relationship that needs built over long time might get hurt.Customers entire internal system such as budgeting and incentive programs are formed based on old cost-plus system, and a change in pricing structure is very time consuming.Restruct ure of pricing system will also affect customers buying personnel because their compensation was related to the constituent they negotiate with distributor, and under ABP structure that percentage disappearedEmployees on the customer side might have problems understanding the system and change their behaviors to reap maximum savings. Organizational structure will be adjusted to fit ABP which means some employees will be reassigned or resigned, but this decision will have negative impact on morale and productivity.EDI system implementation requires a substantial commitment in resources.Sharing valuable information with customers can be misused at their advantage with O&Ms competitors.The main challenge will be to build mutual trust among the parties involved.Implementation Plan.The successfully have a fully implemented ABP system we suggest the following action steps1.Establish ABP System within the company first and find out cost drivers (services which incur costs). Upgrade IT inf rastructure to facilitate further implementation steps.2.Analyze the benefits of SC based on ABP, benefits such as improvement on inventory management, aligned incentives to efficiently compete with other Supply Chains, happen upon hidden costs on activities, and build long-time relationships, among others.3.Communicate to selected customers with the previous benefit analysis.4.Initiate ABP pilot program.5.Setting up EDI and give continuous support.6.Adjust and upgrade ABP system based on feedbacks from pilot program7.communicate to all customers with the success of pilot ABP system8.Full ABP implementation.(For suggested time-line refer to exhibits.).ConclusionIn general, we do see huge potential benefits on the implementation of ABP system. However, risks and challenges will emerge from this alternative and opposition will be strong on the customer side. The implementation steps provide an easy guideline to have a successful ABP system in the SC.