McKesson: Order Entry and Fulfillment

1
McKesson Order Entry and Fulfillment

• Background
• Business Process Redesign Process, IT
• Key Performance Indicators
• Implications

2
McKesson Is the Worlds Largest Distributor of
Pharmaceuticals and Health Care Products
MCKESSON BACKGROUND

• McKessons core division, Distribution Services,
  is composed of three business units
• McKesson Drug Co.leading U.S. distributor of
  pharmaceuticals and health care products
• Medis Health and Pharmaceutical Serviceslargest
  Canadian distributor of pharmaceuticals
• McKesson Service Merchandisinglargest
  independent distributor of health care products
• McKesson has formed other successful businesses
  using the technology and the distribution systems
  developed in its core business
• PCSthird largest claims processor in U.S.
• Water Productssecond largest bottled water
  company in the U.S.
• Armor Allleader in the U.S. automotive
  appearance market

Source 1992 annual report.
3
95 of McKessons Revenues Come from
Distribution
MCKESSON BACKGROUND
1992 Operating Profit Total 253.9 Million
1992 Revenues Total 10.3 Billion
PCS 1.0
Armor All 1.4
Armor All 8.4
Water 2.3
Water 9.5
PCS 12.2
Distribution 69.9
Distribution 95.3

• Distribution Services has a 27 share of the
  36.2 billion pharmaceutical distribution market
• Between 1987 and 1992, Distribution Services
  revenues increased at a 12 CAGR

Operating margins have fallen from 2.3 in 1991
to 1.8 in 1992 reflecting mounting industry
pressures.
Source 1992 annual report. Note Operating
profits exclude restructuring and other
non-recurring charges.
4
McKessons Operating Margins Are Being Squeezed
More and More
MCKESSON BACKGROUND

• Government
• Reducing rate of pharmaceuticals price increases
  through managed care strategies
• New Federal health care plans

• Pharmacies/Hospitals
• Increased power due to consolidation
• Increased emphasis on price
• Threat of failure of independent stores has
  capped price increases

McKessons Margins

• Competitors
• Intense cost and service competition from
  Bergen-Brunswig
• Formation of regional competitors into buying
  groups to match purchasing power of major players

• Manufacturers
• Increased power due to consolidation
• Threat of vertical integration
• Capped forward inventory purchases in
  anticipation of price increases

5
The Distribution Services Division Seeks Highest
Economies of Scale
MCKESSON BACKGROUND

• Consolidated three business units in Distribution
  Services
• Reduced the number of distribution centers from
  more than 100 in 1970 to 40 by end of 1993
• Strengthened order fulfillment through
  fully-automated Megacenters
• Cover an average area of 600,000 S.F., double
  that of the old distribution centers
• Serve large geographic areas
• Uses automated order fulfillment systems

By providing best-in-class supply chain
management through intensive use of technology,
McKesson plans to be the strategic intermediary
for the health care industry.
Source 1992 annual report.
6
McKessons Order Entry and Fulfillment Process Is
Cost Effective and Accurate
MCKESSON BUSINESS PROCESS
Key Design Characteristics
Specific Examples

• High capacity
• Cost effective
• Quick
• Reliable
• Accurate
• High value-added

• System manages inventory of over 25,000 SKUs
• On-line order entry and automated order
  fulfillment have dramatically reduced labor
• Orders are delivered to customer the same or next
  day
• Data center has power and computer redundancy to
  ensure zero downtime
• Orders are fulfilled with over 99.5 accuracy
• Products are packed according to customers aisle
  layouts, reducing customer stocking time and
  efforts

7
Distribution and Quality Directors Continue to
Improve and Propagate Best Practices
MCKESSON BUSINESS PROCESS

• Responsibilities include
• Optimize order entry and fulfillment practices,
  working with employees to develop new processes
• Ensure quick implementation of best practices
• Update and distribute operations manuals
• Check warehouses use of proper procedures
• Train employees on new processes
• Design layouts for new warehouses and configure
  old ones

• Highest Quality Service
• Most Efficient Operations

8
McKessons Redesign Process Starts with the
Customer
MCKESSON BUSINESS PROCESS
Step 3
Step 2
Step 4
Step 7
Step 5
Step 6
Step 1
Full scale implemen-tation of new process
Evaluate development and implemen-tation costs
and benefits
Re-evaluate process against original customer
needs
Design process to meet new needs
Test process on limited basis and evaluate
benefits
Identify problems with new process
Identify customer need or service improve-ment
Do benefits outweigh costs?
Does solution meet needs?
Yes
No
Are IT systems required?
Are there significant problems?
No
Yes
Yes
Is it worth it?
No
Yes
No
No
Yes
Define specifi-cations system to meet customer
needs
9
The Order Entry and Fulfillment Process Is
Heavily Supported By State-of-the-Art Technology
MCKESSON BUSINESS PROCESS
Distribution Center
Customer
Data Center
Retailer enters product IDs and order quantities
through handheld electronic order entry devices

• Print and insert price tags

• Sort orders by truck loading in route/stop
  sequence
• Insert tote on conveyor system

• Confirm order through voice synthesizer
• Update prices and inventories
• Sort orders geographically
• Transmit orders to distribution centers via VSAT
  satellite communications system

Automatically transmit order via McKessons 800
watts line to data center in California

• Transport tote to appropriate picking station
• Track tote with barcode scanners

POS terminal or other inventory tracking
system orders product

• Deliver to customer
• Acknowledge delivery with portable data glove

• Send invoice
• Adjust accounts receivable

Order Complete?
Yes
No
10
The Order Entry and Fulfillment Process Is
Heavily Supported By State-of-the-Art Technology
(cont.)
MCKESSON BUSINESS PROCESS
Customized IT systems include

• MAPS
• High-speed automated order-filling system

• Economost
• Electronic order entry and fulfillment system

• FlexMaster
• Semiautomated warehouse management and
  fulfillment system

• AcuMax
• Portable computer system for directing manual
  order fulfillment activities

• How to increase stocking and picking efficiency?
• How to reduce warehouse labor costs?

• How to increase picking efficiency?
• How to reduce picking errors?

• How to increase picking efficiency?
• How to reduce warehouse labor costs?

• How to reduce order entry costs?
• How to enable independent pharmacies, McKessons
  principal customers, to compete better?

11
McKessons Order Entry Process Asks Customers,
not Staff, to Enter Orders
MCKESSON BUSINESS PROCESS
Key Characteristics
Specific Examples

• Cost effective
• User friendly
• High value-added of information
• Flexible

• Order entry costs reduced, since customers enter
  data
• Reduces time customers spend on ordering and
  stocking
• Barcode scanners allow customers to easily enter
  product codes
• Voice synthesizers confirm customer data entries
• System prints price tags and invoices to retailer
  specifications
• Each customer receives monthly profitability
  reports
• Order entry allows variety of formats (e.g.,
  voice, electric device, POS terminal, etc.)

12
Automated Order Entry Benefits Both McKesson and
Its Customers
MCKESSON BUSINESS PROCESS
Benefits to McKesson
Benefits to Customers

• Reduced order entry staff from 700 to 15, despite
  sixfold increase in orders
• Reduced sales people by 50, while sales
  increased more than 400
• Translated into a larger share of customers
  business, increasing sales and operating margins

• Lower transaction costs
• Labor required to enter and stock order reduced
  by 80
• Rationalization of operations resulted in larger,
  less frequent orders with minimal errors
• Reduced product costs through McKessons lower
  operating costs
• Reduced inventory holding costs through more
  efficient ordering from McKesson
• Increased satisfaction through reliable systems
  and quality sales support

13
McKesson Also Targeted Increased Order
Fulfillment Productivity
MCKESSON BUSINESS PROCESS

• Order fulfillment and warehouse systems include
• MAPS
• An automated picking system which loads totes
  according to customers orders
• Handles popular, conveyable SKUs (80 of volume,
  20 of SKUs)
• FlexMaster
• An automated materials storage and retrieval
  system
• Brings inventory to pickers on computer-controlled
  carousel
• Handles less popular, conveyable products
• AcuMax
• A portable radio-linked PC that is worn like a
  glove over pickers hand
• Allows picker to scan product barcodes by
  pointing
• Provides order filling instructions to pickers
• Handles nonconveyable SKUs

14
McKesson Also Targeted Increased Order
Fulfillment Productivity (cont.)
MCKESSON BUSINESS PROCESS
Key Characteristics
Specific Examples

• Highly automated
• High capacity
• Quick
• Accurate
• Paperless

• Fulfills and delivers orders to shipping stock
  without human intervention
• System directs and tracks every worker,
  container, component, and item
• Filling system handles over 10,000 items per hour
• Order is delivered within 12-18 hours at speeds
  15 times higher than traditional methods
• Systems eliminate product processing and shipping
  errors
• Pickers receive instructions on computer screen
  on forearm
• Billing is electronic

15
Automated Order Fulfillment Has Reduced Costs and
Increased Efficiency of McKessons Operations
MCKESSON BUSINESS PROCESS

• Increased warehouse staff productivity from
  270K/person to 728K/person over last 10 years
• Reduced working capital per sales dollar by over
  9 since 1987
• Improved operating cost efficiency by 20
  increased capacity fourfold
• Decreased rate of manual mispicks by 72

a
b
a. Compustat database. b. Daly, Jones, What
Happens When Close Enough Isnt Close Enough
Anymore? ComputerWorld, Jan. 4, 1993.
16
McKessons Process Improvements Have Heavily
Impacted the Number and Skills of Its Staff
MCKESSON IMPLICATIONS

• Order Entry
• Transferred order-taking activity to customers
• Significantly reduced staff

• Order Fulfillment
• Simplified and accelerated fulfillment activities
• Increased dependence on IT

• Sales
• Shifted from taking orders to consulting retailers

Process Redesign and IT Investment

• MIS
• Increased responsibilities
• Established as innovators of efficiency

• Customer
• Eliminated customer management of back-room
  inventory

17
McKesson Tracks the Performance of Its Order
Entry and Fulfillment Systems through
Quantitative and Qualitative Metrics
MCKESSON KEY PERFORMANCE INDICATORS

• Quantitative measures
• Line items processed per manhour
• Line items filled ratio
• of stockouts
• Number of times instock item is omitted in order
• mispicks
• returns and allowances
• Qualitative measures
• Customer satisfaction
• Employee satisfaction
• Ease of use of system

18
McKessons Long-Term Commitment to Process
Optimization Has Revitalized the Company
MCKESSON IMPLICATIONS

• Transformed company
• In early 70s, McKesson was an unfocused portfolio
  of poorly managed businesses
• Today, it is the market leader in health care
  product distribution
• Increased McKessons profitability
• Since 1975 sales have increased elevenfold and
  operating expenses only threefold
• Average profit growth of 20 after 1976, compared
  with 2 before

19
And Dramatically Transformed the Drug
Distribution Industry
MCKESSON IMPLICATIONS

• In time of rapid industry growth, McKesson has
  led the consolidation of the wholesale drug
  industry
• Market share of the two largest players (McKesson
  and Bergen-Brunswig) increased from 30 to 45
• Number of drug wholesalers fell from 180 in the
  early 1970s to 90 by 1986
• McKessons productivity has discouraged direct
  distribution by manufacturers
• McKesson has been key to the survival of
  independent drugstores

Source Clemons, Eric K., A Strategic
Information System McKesson Drug Companys
Economost, Planning Review, Sept/Oct 1988.
20
Key Lessons Learned
MCKESSON IMPLICATIONS

• Business Process Redesign
• Need to understand true areas of opportunity of
  existing processes
• Getting customers to handle more activities
  (e.g., enter order data electronically) is most
  productive way to perform these activities
• Need to market process changes internally
• Need to prepare carefully for significant
  downsizing
• IT
• Clear communication of requirements to system
  developers is critical
• Include IT representative on process design team
• Continually check system against original
  requirements
• Underestimated real operation and development
  costs
• Training, upgrading technology, and systems
  maintenance