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Serina Robnett Jillian Bakker Conner Black Ryan Atkinson Case Study #2
Virginia Mason (VM) is a not-for-profit, private hospital located in Seattle that
uses Owens & Minor (O&M) for their services. VM is known for their specialized
and primary care and their clinical operation networks throughout western
Washington, as well as their affiliations with the University of Washington and
Benaroya Research Institute. VM places a high value on teamwork, even
including the term, “team medicine,” as part of their mission statement. VM
follows a Toyota Production System (TPS) model for efficiency, which is based
off the concept of lean systems. This model is called Virginia Mason Production
System (VMPS), and it was implemented in 2002. VMPS is an integral facet in
VM’s ability to accomplish organizational goals. Additionally, VM uses value-
stream mapping—a strong tool in identifying activities that do and do not add
value to the company’s service flows—which is an effective way of eliminating
waste and improving efficiency. Furthermore, VM has a five-day training
program— Rapid Process Improvement Workshop (RPIW)—which focuses on
engaging work teams in ways to improve efficiency by eliminating waste—
anything that does not add value to the processes of a company. VM places a
large emphasis on reducing waste continually and adding value to every aspect
of employees’ jobs—known as VM’s “everyday lean idea.” Owens & Minor (O&M)
is a healthcare distributor operating in the surgical and medical supply industry
with a distributing center (DC) located in Seattle, Washington. O&M serves its
customers within a two-hundred-mile radius of their distributing centers. Their
services are
2. 2. provided on a contractual basis—usually lasting anywhere from three to five
years. They are the leading distributor of medical and surgical supplies and are
primarily characterized by their distribution of disposable supplies such as
gloves, syringes, and gauze, for example. Furthermore, O&M also provides
supply-chain management services and private label products—products that
are manufactured by one company and provided under the brand of another
company. O&M utilizes lean systems—also known as Just-in-Time services—in
their efforts to position themselves as a provider that offers “…expertise in
lowering costs for customers through ‘services designed to streamline the supply
chain’” (Narayanan 5). In this case study, the objective that is presented is as
follows: O&M wants to reduce health care and total landing costs through the
implementation of lean systems by co-developing an Activity-Based Costing
(ABC) system with Virginia Mason—one of O&M’s providers. This ABC system
was named Total Supply Chain Cost (TSCC), and its purpose was aimed at
uncovering hidden costs originally omitted when using the cost-plus pricing
system. This is achieved by providing a substantially more detailed financial
statement that includes 100% of all the fees generated from supply chain
activities. This shifts the emphasis from purchasing price as the cost to the total
landing cost; costs such as transportation fees, customs, taxes, insurance,
currency conversion, crating, as well as handling and payment fees are brought
into focus. TSCC additionally aims at reducing waste by identifying it at the
source, improves efficiency throughout the supply chain, and increases
profitability simultaneously. Before TSCC was created, VM had a vision of using
their “alpha vendor” program with a medical and surgical distributor; the alpha
vendor concept had been successfully implemented with Office Depot for VM’s
office supplies needs, offering lower costs for goods and services. The alpha
 vendor concept is balanced on the idea of developing exclusive relationships
with
3. 3. distributors and acting as business partners with those distributors, while
receiving goods and services at a lower price in return. The benefit of the alpha
vendor concept is that it aims at creating a leaner, more efficient supply chain;
O&M is the distributor that hopped on board with this idea. While developing the
TSCC, the largest hidden cost that came to light was the Stock Keeping Units
(SKUs). Michael Stefanic, the director of cost management at O&M, and Daniel
Borunda, materials systems manager at VM in Seattle, discovered that under the
cost-plus price system, customers with larger SKUs were charged the same
distribution fees as customers with lower SKUs—this was a monumental
problem because servicing customers with large SKUs was significantly costlier
than servicing customers with low SKUs. The expenses that were omitted in the
cost-plus pricing system included forecasting, purchasing, handling, storage, and
the maintenance of computer transaction records. To accurately charge their
customers, Borunda and Stefanic created the TSCC model that included these
omitted costs. Also, they incorporated O&M’s supplier evaluation method to help
VM identify efficient suppliers to buy from. When VM chose an efficient supplier,
TSCC incentivized them with a discount. Overall, TSCC emerged as a model that
accurately identified 100% of supply chain fees, encouraged lean
thinking/systems, and improved profitability by eliminating waste and
inefficiencies. As previously mentioned, the key to minimizing costs and being as
efficient as possible is getting away from the concept of the purchase price as
being the cost and thinking of the cost as “total landed cost.” New and efficient
practices can expose hidden costs that VM hadn’t realized before. Hidden costs
include storage/occupancy as well as inventory carrying/interest costs.
Increasing amounts of storage time and warehouse space that Virginia Mason
requires to store its SKUs increases its total costs for VM and O&M. These
services that O&M provide for VM are
4. 4. known as stockless services; a business service in which goods already
purchased remain in the care of the seller until the buyer needs them. In order
for Virginia Mason to be more “lean,” it would need to eliminate these wasted
costs. Transitioning from a cost-plus basis to activity-based costing allows
providers such as Virginia Mason to see these “hidden costs” that are driven from
using O&M’s distribution activities and services. To recap, one of the largest
drivers of costs in the distributor/provider relationship was the number of stock
keeping units (SKUs). A statistical analysis for July of 2007 reveals that as
Virginia Masons total back orders decreases, it’s efficiency rating decreases; this
shows that as the number of orders increases, efficiency increases concurrently.
The analysis also provided evidence that as total lines received decreased,
efficiency increased. This means that Virginia Mason lowers costs and is more
efficient when placing orders from its distributor using the Just-In-Time (JIT), or
Low Unit Measure (LUM) method of ordering. This means that Virginia Mason is
more efficient when purchasing from the distributor more frequently in smaller
quantities, rather than infrequently purchasing from suppliers in bulk and
keeping excess SKUs in storage at a distribution center. For the month of July,
storage/occupancy and inventory carry/interest costs tallied $20,000 alone. In
total, SKU-related costs added up to $47,500 per month. This is a significantly
high amount when compared to just $9,000 for delivery charges within the same
 month. Using the LUM approach, providers order the minimal amount of
supplies that is needed. Therefore, monthly delivery fees will increase as
transportation services are required more frequently to fulfill regular orders,
however, VM will not be keeping a higher quantity of SKUs in storage at a
distribution center, which decreases a heftier expense. Virginia Mason will
significantly lower their SKU-related costs as distributors will have to keep a
smaller inventory, resulting in ultimately lower monthly costs for inventory
storage and occupancy. Not only does this cost
5. 5. method benefit providers by eliminating costs associated with storage and
occupancy, but it also benefits distributors because they will have a lot more
warehouse space for other inventory, enabling them to do business with more
providers. An outstanding sustainability issue that was presented in this case
study was that it would be difficult to have other providers move towards the
TSCC model due to the fact that it nominally looks more expensive; in result, this
model is highly discouraging to other customers, and it would be difficult to
implement it across the supply chain despite its benefits, simply because it
would be extremely difficult for providers that were not involved in the creation
of the method to understand the functions of it. Additionally, due to the fact that
TSCC would require more deliveries being made, the amount of distribution
trucks that are put on the roads would increase, resulting in a decrease in
environmental-friendliness. As far as ethical issues are concerned, the
outstanding ethical issues presented would be ensuring fair negotiation among
Value-Added Networks, distributors, manufacturers, and providers. Since TSCC
involves extensively detailed financial documents and complex pricing methods,
it is also crucial that financial statements are accurately reported to Value-Added
Networks—there is no room for error, however since TSCC focuses on
decreasing the amount of inventory kept in distributing centers at one time, the
likelihood of errors being made decreases. Overall, the TSCC method is a more
efficient way to decrease costs and waste among the supply chain. However, due
to its complexity and difficulty to understand, it is unlikely that the TSCC method
would be able to be executed across the supply chain. Additionally, TSCC would
help distributors expand their services without increasing their existing costs, as
well as cycle out inventory on a more frequent basis, and bring in new products
without having invest in new
6. 6. storage facilities. Despite the setback of widely implementing TSCC, it is the
most profitable, efficient, and mutually-beneficial option for providers and
distributors.