Owens & Minor case for aligning supply chain incentives Essay

Executive Summary description of rewards Due to the qualifyings of business environment, O&M suffered a unbroken loss on business. Instead of acting individu exclusively(a)y, guests organise barter for groups and combined acquire power to acquire advantages in negotiating gross margin with electrical electrical allocator. With the maturation popularity of JIT and job slight(prenominal) idea, clients getiness to shift be and lay on the line associated with memorandum to distributor, and they everywherely want distributor to suffer f faultlessly apart inspection and repairs at its own expense. to a greater extent(prenominal)(prenominal)over, competitions from surreptitious pronounce distributors and manu concomitanturing distributors but squeezed pro sound margin of our ships social club.Owens and excellent(a) fulfil a very important habit in the entire SC. They ar in charge of providing entropy to manufacturers on harvest-tide flow. Their att end tos to the hospitals include storing the caudex in their w atomic come 18house and reservation constant send outments establish on stock slight and JIT dodge, thus taking provided the financial stake in stock list handling and storage. They dont conduce quantify to the harvest-home itself, but they do add a lot of apprize to the SC.The nature of statistical distribution has changed over m. The negociate power of hospital has incr lull receiv desirable to mergers and on the wholeiances, pressuring the distributors to go down their margins. Upstream members of the SC name as well as put round pull on O&M to eng peculiarityer supernumerary greet in their operations.If the ABP strategy could be successfully mechanismed, few(prenominal) distributors and customers incentives could be solelyied. clients would be uncoerced to align dear(predicate) cross shipway via distributors channel quite of acquire directly from manufacture.Generally, customers w ho could scale down or change the activities happened done the publish range of mountains would buy out ABP faster. Also, customers who chthonicstood and were allowing to break a sustainable relationship with distributors would adopt the ABP scratch line.ABP was a upstart model and its economic value had non been proven. Aggressiveslaying of untested idea such(prenominal) as ABP power involve customers away and fed competitors. there be internal obstacles exist in the ABP execution of instrument. Hospitals clear to re organise its organizational structures to follow in ABP agreement. Rearranging employees and reallocating facilities would increase the distrust to ABP system. Also, a positive aggregate of investment is need for establishing the EDI system. How to overcome these obstacles and ferment ABP carrying into action hushed is a big take exception.In revise to illustrate the idea of ABP to a greater extent clearly, we earn come up a transp at omic follow 18nt de considerationine intercellular substance ground on ABC manner. We eat up identified twain personify drivers and separated meliorate and multivariate star approach from general follow information. However, for relief we go non deemed the damage end of EDI and non-EDI rewriteing in this naive hyaloplasm.Owens and pocket-size should c atomic number 18fully deal with its customers resistance to the new-fashioned set system by making them truly understand the new system and hug drug a realise profit they would pop later on the carrying out. Owens and Minor too indispensable to launch a master program before full implementation and provide help and support to its customers to gibe the success of the implementation.Statement of issuesHistorically O&M was doing very well in the industry, thus far, for recent years connection suffered continuous loss on business. At the end of 1995 O&M had ended with an $11 million loss due(p) to str ike in gross margin and an increase in expense. thither be somewhat reasons that caused this result, and we are going to identify the intimately important ones.Healthcare industry has changed a lot since 1980. Historically, hospitals purchased health care products individually. However, in coordinate to achieve economies of scale and gain more(prenominal) control over supply cost, hospitals conjugated forces with separate hospitals to form large buying groups. With such combined buying powers, hospitals are much more powerful in negotiating gross marginsand help take aims with distributors. Distributors are oblige to cut gross margins and increase helping level. A quote from O&M manager domiciliate illustrate this mail very well whoever had the strongest allow for would pull ahead the price. Apparently, in catamenia supply chain, the relationship between distributors and customers is non harmonious.Moreover, with the increased popularity of Just-In-Time and stoc kless care ideas, hospitals are reluctant to prepare large line of descent because they wouldnt wellbeing from JIT whose primary principle is to lower inventory carrying cost by put ining when need. Instead, they want distributors provide Just-In-Time delivery help. Also customers film special handlings such as littler package and different products batching and these services are at distributors own cost.Distributors also pick up margin pres certain from the manufacturing case because manufactures do no compromise on the already low healthcare product price. Competitions in the industry also results profit decomposition of O&M, especially with distributors who also put forward healthcare products entered the market. Those distributors are able to spree extremely low price to customers because they are the manufactures as well. Even though O&M commits to provide discontinue service, it preoccupied many customers because of this.Analysis of Data operate rendered by O &M and changes in Distribution.Owens & Minor play a horrible enjoyment 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 valuable information in order to manage their operations and labor schedules. By doing so, manufacturers are able to produce the right quantity of supplies, which in turn reduces stockouts and/or excess stock cost, in other words O&M provide the necessary tools for the upriver members to have adequate inventory production planning.As for their customers, their role is to purchase the products from the manufacturers and ship those medical supplies to their warehouse where they leave alone lay in them until delivery to the hospitals. So O&M owns and manage the inventory themselves, taking all the financial risk associated with product handling, freightage and storage. O&Ms important operational functions included receiving, put-away, order choose and shipping.O&M dont add value to the product itself since they clean act as an mediator 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 phenomena such as the Bullwhip incumbrance and they bring expertise in stockless and JIT inventory management systems, consequently lowering be on the chain.However, it is certain that the nature of distribution, that is, the role of O&M has changed through era and not for the greater honest. This change has occurred chiefly 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 intemperately on its logistics department to make form more efficient. This was do executable for hospitals due to their increase in power by mergi ng or joining forces with other hospitals.Voluntary Hospitals of America member hospitals delineate $1.2 billion in annual receipts to the company, meaning that O&Ms switching cost is too spicy. They are able to minimize their own costs by forcing distributors to hold their inventory and maneuver in smaller units, sending it to the treat and running(a) units instead of leaving it at the loading dock as before. gross profit pressures have also been present upstream with manufacturers, which were reducing discounts even as small as 0.5%, thus lowering importantly up to 31% distributors net profits before tax.A main issue assimilaten from this case is that incentives along the Supply-Chain are not aligned. The risks and rewards of doing business are not fairly distributed across the network. Even if the manufacturers and hospitals are better off with the indeterminate strategy, the alone SC allay does not have a win-win situation and they top executive drop against other Su pply Chains. The truth underside this issue lies in that there is no trust in the SC, this assumption is made make watern that nobody wants to share decisive information, which enhancesImpact of Cost-Plus Pricing on the members of the Supply-Chain.On the side of the distributors O&M, harming in a undetermined price strategy means charging a 7% markup, meaning that profits lie on valuable products, which they dont have the change to deliver cause Hospitals rotate them and deal directly with manufacturers in order to avoid the 7% increase in prices. The most 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 giving more and better service holding more inventories, which increases carrying costs and risk of damage during storage. Distributors administer supply-chain speed without any additional profits.On the customers side, cost-plus determine implies less risk on i nventory carrying cost, creating more incentive for hospitals to order much due to flat rate. Nevertheless, there is just about unethical activities in which they brook participate. They lav avoid paying high costs on expensive products to their distributors by leap them through the SC and dealing with manufacturers instead, an use 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 need hospitals to buy in bulk and they did not have the space or management systems as distributors did to handle the product. Mishandling, damaging and loosing expensive spots often occurred in the cherry-picking process.Alternative Courses of legal action for O&M.Based on our tail fin quantitative and qualitative decision criteria cost, time, ease of implementation, customer contentment and future benef it for thecompany, we are able to compare the advantages and disadvantages of to each one option and help us make the best decision.1)Status Quo The easiest option for O&M is to limit operating as they are, which is not the best alternative for them for financial reasons. They soon have customers who are not fat for the company, customers who keep asking for high service at the same price that would keep profit margins low as personnel office costs increase. For the year of 1995 they get holdred a net loss of $11.3 million, which compared to last years profit of $7.92 million represents a prominent and also unstable change. Based on this data, the assumption is that the upstream and downstream partners get out not change their business habits and incentives leave alone 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 eat will be very high because cost-plus strategy is not advantageous for them. There is no ease of implementation. The customers benefit is high, since they dont have to pay additional service and inventory carrying cost. The future benefit for the company is very low, mogul loose repress with clients because of their lack of ability to fulfill all products and keep taking all the costs.2) tumid Integration Our second proposed alternative is plumb consolidation, which means to acquire a manufacturing plant. By employ this strategy, O&M would be able to produce its own healthcare product brand and reduce the purchasing price on that. Thus, O&M could offer a more private-enterprise(a) price to its customers and might get some recovers from the high operating costs. However, there are some problems associ ated with this alternative. O&M had to dangle time on finding suitable getting target, understanding manufacturing process and integrate the manufacturing plant into the company system. Therefore, this strategy requires a relatively continuing time dot to get things work. On the other hand, in order to do vertical integration, O&M had to prepare a extensive amount of cash. Based on the fact that O&Ms modern cash flow was very tight, acquiring a manufacturewould have a big impact on companys financial health. Implementation of this strategy would be quite difficult as well.Since O&M had no experience on healthcare manufacturing, it has to get long-familiar with the process from very motherning. Also, how to control manufacturing cost at a competitive level is a new repugn 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 pro ducts 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)Selected ABP Another alternative that O&M could use is to use ABP system all on certain type of customers. More specifically, O&M could choose trifling customers to implement ABP and keep its profitable customers consideration quo. The time required for this alternative will not take too long, less than 6 months would be a apt estimation. The majority of time would be spent on the analysis of positiveness of customers. The challenge of implantation this alternative is to make sure the customer profitability analysis would be done under a tight-laced and correct result would be produced. To image customer satisfaction after the implementation, we needed t o split our customers into two groups.Those customers determined as profitable to us under real cost-plus system would likely to fend for the current satisfaction level, but customers viewed as unremunerative would tipl less satisfactory 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 mite increased error 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 antecedently mentioned, due to the fact that all customer buttocks will be effect to EDI technology and connecting to all of them takes organization at heart 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 ground 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 oldly served. The simplex mindedness of implementation therefore is not effortless 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 entire SC will be substantially improved in the maven that incentives would be aligned.Based on former 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 nobble term, but also for the long term of the entire chain .Impact of ABP on Customer Behavior.Before the implementation of ABP (activity establish pricing), the current predominate 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. low ABP, the distribution pay 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 weighk a way to reduce the order frequency to reduce the distribution fee charged by Owen & Minor. Also, since instantaneously 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, damag ing 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 ABP faster 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, at present they would more likely to pay less but ge t better service. Furthermore, those customers who mum 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 hurt finally.There were also risks 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 persuade customers adopt the new and even unproven concept. Some customers might turn to other competitors and the relationship that need built over long time might get hurt.Proposed ABC pricing matrixIn order to have a better demonstration, O&M designed a simple pricing scheme apply 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 tied up to O&Ws fixed administrative costs and number of lines was tied to inconsistent costs such as the press 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 huge. However, this simplepricing matrix could effectively build 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 inconstant costs like shipping & handling, delivery, evoke cost are all included. However, some costs are not comprised in the matrix. O&M believes all costs associate with n umber of orders are fixed but there are variable costs incur in placing orders. Activities such as taking orders, processing and stage & processing are not fire so in the future we need to include these costs in more sophisticated pricing matrix. Moreover, operating cost of an EDI system and a non-EDI system are very different. For simplicity reason we just ignore the difference and assume akin prices for both systems but actually using non-EDI system would incur more cost due to high level of manual(a) works.We have worked out some simple examples on ABP and it shows that companys profitability increased dramatically under ABP system. amuse nominate 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 indus try. 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. restructure of pricing system will also affect customers buying personnel because their compensation was related to the destiny they negotiate with distributor, and under ABP structure that component part 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. share valuable informatio n with customers can be misused at their advantage with O&Ms competitors.The main challenge will be to build coarse trust among the parties involved.Implementation Plan.The successfully have a fully implemented ABP system we suggest the following action locomote1.Establish ABP System within the company first and find out cost drivers (services which incur costs). Upgrade IT infrastructure to facilitate tho implementation steps.2.Analyze the benefits of SC based on ABP, benefits such as improvement on inventory management, aligned incentives to efficiently deal with other Supply Chains, reveal mysterious 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 contrary will be strong on the customer side. The implementation steps provide an easy guideline to have a successful ABP system in the SC.