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Chapter 11. Supply Chain

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Title: Why are we here again? Subject: Inventory Control Author: Yasar A. Ozcan, Ph.D. Last modified by: Yasar Ozcan Created Date: 2/27/1995 11:11:08 AM – PowerPoint PPT presentation

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Title: Chapter 11. Supply Chain


1
Chapter 11.Supply Chain Inventory Management
2
Outline
  • Healthcare Supply Chain
  • Manufacturers/Suppliers
  • Distributors, Wholesalers
  • Group Purchasing Organizations (GPOs)
  • e-Distributors
  • Flow of Materials in Supply Chain
  • Supply Chain Management Issues for Providers
  • Contemporary Issues in Medical Inventory
    Management
  • Just-In-Time (JIT) Stockless Inventories
  • Single vs. Multiple Vendors
  • Traditional Inventory Management
  • Requirements for Effective Inventory Management
  • Inventory Accounting Systems
  • Universal Product codes (UPCs)
  • Lead Time
  • Costs
  • EOQ Model
  • Reorder Point

3
  • Healthcare Supply Chain

In healthcare organizations, supply chain is a
new way of conceptualizing medical supply
management. A supply chain is defined as a
virtual network that facilitates the movement of
product from its production, distribution and
consumption (McFadden and Leahy, 2000).
4
Need for Healthcare Supply Chain Management
  • Improve operations
  • Increasing levels of outsourcing
  • Increasing transportation costs
  • Competitive pressures
  • Increasing globalization
  • Increasing importance of e-commerce
  • Complexity of supply chains
  • Manage inventories

5
Figure 11.1 Healthcare Supply Chain
Pharmaceutical Medical-Surgical Devices
Manufacturers/ Suppliers
Upstream
Wholesalers Group Purchasing Organization
(GPOs) e-Distributors
Distributors
Hospitals Hospital Systems Physicians Integrated
Delivery Networks (IDNs)
Providers
Downstream
Patients/Individuals Employers Insurers HMOs Drug
Benefit Agencies Government
End Users
6
  • Healthcare Supply Chain
  • Manufacturers/Suppliers. Manufacturers of
    medical supplies can be classified in three
    categories
  • drugs/pharmaceutical,
  • medical-surgical supplies, and
  • devices.
  • Some manufacturers produce supplies in more than
    one
  • category or in all categories.

7
  • Healthcare Supply Chain

Well known pharmaceutical manufacturers include
Abbott, Aventis Pharma, Bristol-Myers Squibb, Eli
Lilly, Merck, GlaxoSmithKline, Hoffmann-La Roche,
Janssen, Johnson Johnson, Pfizer,
Schering-Plough and Wyeth. Twenty-five percent
of pharmaceutical products are distributed to
providers (hospitals and other institutional setti
ngs) via distributors. Medical-surgical
companies produce items such as
injection syringes and needles, blood and
specimen collection kits, hospital laboratory
products, wound management products, and
intravenous solutions. 3M, Abbot, Baxter,
Johnson Johnson are a few of the well known
medical-surgical companies that sell majority
of their products through distributors.
8
  • Healthcare Supply Chain

Medical devices can be described as very high
priced, technologically sophisticated and
advanced apparatus that are used for diagnosis
and therapies. Medical devices include surgical
and medical instruments And apparatus,
orthopedic, prosthetic and surgical appliances
(for example, shoulder, knee, and
hip replacements), X-Ray apparatus, tubes,
irradiation apparatus, electro-medical and
electro-therapeutic devices. Dupuy, Ortho
Biotech, Medtronic, and Zimmer are examples of
the companies that manufacture such devices
(Burns, 2002 p.244).
9
Typical Supply Chain for a Healthcare Service
Implants Replacement knee Replacement valve
Operating Room
10
  • Healthcare Supply Chain

Distributors for medical-surgical supplies are
independent intermediaries who operate their own
warehouses they purchase the products from
manufacturers/suppliers to sell to providers.
Similarly, pharmaceutical intermediaries purchas
e the drugs/pharmaceuticals from
manufacturers and wholesale them to pharmacies or
to providers. Well known distributors of
pharmaceuticals include AmriSource/Bergen
Brunswig, Cardinal Health/Bindley Western and
McKesson. The intermediaries are called
distributor or wholesalers depending on whether
the products final resale has another layer
before reaching the customer (Burns, 2002
p.127). Cardinal Health, OwensMinor, and
McKesson are major distribution companies in
hospital market.
Distributors and Wholesalers
11
  • Healthcare Supply Chain

Electronic Data Interchange (EDI)
Linking providers through electronic
communication to their distributors is formally
defined as electronic data interchange (EDI).
EDI provides direct, real-time computer to
computer electronic transmission of purchase
orders, shipping notices, invoices and the like
between providers and distributors. Over
seventy-five percent of distributors use EDI, and
seventy to eighty percent of their business
volume is handled through EDI (Burns, 2002,
pp.130-131). EDI is also proliferating to
manufacturer transactions with other parts of the
health care supply chain more than one-third of
their business transactions use EDI. The cost
for standardized EDI transactions for a purchase
order, as compared to costs with manual systems,
saves operational costs for both providers and
distributors.

12
Electronic Data Interchange (EDI)
  • Increased productivity
  • Reduction of paperwork
  • Lead time and inventory reduction
  • Facilitation of just-in-time systems
  • Electronic transfer of funds
  • Improved control of operations
  • Reduction in clerical labor
  • Increased accuracy

13
  • Healthcare Supply Chain

Group Purchasing Organizations (GPOs).
Group purchasing organizations provide a critical
financial advantage to providers, especially
hospitals and hospital systems, by negotiating
purchasing contracts for products and non-labor
services. A typical GPO has many hospital
organizations as its members and uses this as
collective buying power in negotiating contracts
with many suppliers of pharmaceuticals,
medical-surgical, supplies, laboratory, imaging,
durable medical equipment, facility maintenance,
information technology, insurance, food and
dietary products and services. The contracts
usually last three to five years, giving
providers price protection (Burns, 2002, pp.
60-64).

14
  • Healthcare Supply Chain

Group Purchasing Organizations (GPOs).
Over 600 GPOs operate in the United States
perhaps half of them focus their business on
hospitals. The two largest GPOs are Novation
and Premier, which are nonprofit. AmeriNet, HSCA
and Consorta are the other sizable non-profit
GPOs. The two investor-owned, for-profit GPOs
are HCA/Health Trust and Tenet/BuyPower. A
provider may be member of multiple GPOs. The
average Hospital GPO membership ranges 1.6 to 2.6
GPOs in US.

15
  • Healthcare Supply Chain

e-Distributors.
e-commerce in health care can be viewed from
different perspectives. Here we will concentrate
on two aspects business to business (B2B)
commerce and business to customer (B2C)
commerce. Examples of B2B firms are Medibuy,
Neoforma, MedAssets, OmniCell, and Promedix.
These firms provide e-Catalog, e-Request for
Proposal (eRFP), e-Auction, and e-Specials.

16
  • Healthcare Supply Chain

Flow of Materials
It is important to note that depending upon the
type of medical supply, the flow of materials in
the supply chain may take more direct routes to
providers or end users. Suppliers may bypass
GPOs by not contracting or negotiating price
arrangements. High-end implants and medical
devices, specialty items of low volume but high
price, are good examples of such medical supplies
for which suppliers use direct delivery, usually
via express services (like FedEx, UPS, or DHL) or
have their own local/regional sales
representatives make the just-in-time (JIT)
delivery and serve as consultants to physicians.
In some cases, the companys representatives
provide technical participation with surgeons in
implanting devices surgically. Other cases in
which suppliers may bypass GPOs in contracting
are for small-volume, esoteric items, and for the
brand-name, specialty drugs used to treat cancer
and cardiovascular problems.

17
  • Contemporary Issues in Medical Inventory
    Management

Just-In-Time (JIT) and Stockless Inventories.
Inventory management in healthcare organizations
is becoming increasingly decentralized. JIT means
that goods arrive just before they are needed.
Stockless inventory means obtaining most of
supplies from a single source (a prime vendor) in
small packaging units ready to be taken to the
user departments. Single versus Multiple
Vendors. The essence of the purchasing function
is to obtain the right equipment, supplies and
services, and of the right quality, in the right
quantity from the right source at the right price
at the right time.

18
Inventory Is. . .
Traditional Inventory Management
  • STOCK OR STORE OF GOODS
  • Or Stock Keeping Items (SKUs)

19
An Inventory Disaster!
Imagine the following scenario, in which the
healthcare supply chain manager has to explain to
a member of senior management why the emergency
room found itself without the syringes.
  • ..Sorry sir, but when she (the patient) came
    into the ER, we were out of syringes. Our
    anticipation stocks were depleted because we
    hadnt corrected the ordering patterns for
    seasonal variations. Then, the snow delayed
    shipments from supplier, and our safety stocks
    just werent good enough! You know we usually
    order in bulk to take advantages of large
    economic lot size and lower our ordering cycle.
    Our last order was especially large because we
    wanted to hedge against predicted price
    increases! In the final analysis, our inventory
    just wasnt sufficient to permit smooth
    operations

20
The COOs Response(i.e., Inventory objectives
and requirements)
  • I hope you do realize that it is your duty to
    both maintain a high level of customer service
    and minimize the costs of ordering and carrying
    inventory! All I ask of you is that you make two
    fundamental decisions-- when to order and how
    much to order.

21
Effective Inventory Management
  • The requirements for effective inventory include
  • A system to keep track of inventory
  • A reliable forecast of demand
  • Knowledge of lead times and lead time variability
  • Reasonable estimates of inventory holding costs,
    ordering costs, and shortage costs
  • A classification system for inventory items

22
Effective Inventory Management
  • Inventory counting systems can be either
  • Periodic
  • Perpetual
  • Batch
  • Line

23
Inventory Counting Systems
  • Periodic System
  • Physical count of items made at periodic
    intervals
  • Perpetual Inventory System System that keeps
    track of removals from inventory continuously,
    thus monitoringcurrent levels of each item

24
Inventory Counting Systems (Contd)
  • Two-Bin System - Two containers of inventory
    reorder when the first is empty
  • Universal Bar Code - Bar code printed on a label
    that hasinformation about the item to which it
    is attached

25
Inventory Counting Systems (Contd)
  • Universal Product Codes (UPCs). The UPCs have
    been around since late 1970s and are used in
    industry. A UPC can have up to 20 character
    numbers that uniquely identify a product, for
    example, of pharmaceutical or medical-surgical
    supply, using bars with different variety and
    thickness that can be read by scanners. The
    order of the information in UPCs identifies the
    type of product, its manufacturer, and the
    product itself.

26
Effective Inventory Management
Universal Product Codes (UPCs).
Only 26 percent of medical-surgical products can
be scanned on nursing units, and only fifty
percent of drugs have bar codes for unit doses.
According to the final regulation issued by the
Food and Drug Administration (FDA) in 2004, drug
manufacturers must adopt bar coding to
single-dose units within two years, and hospitals
must eventually implement bedside scanning
systems. The FDA estimates, however, that it
may take up to two decades for all hospitals to
implement such systems because of their high
costs from .5 to 1 million. Only a few more
than 100 hospitals currently them. Yet bar
code systems would significantly improve the
quality of patient care through reduction of
medication errors. It is estimated that over a
20-year period, fully implemented bar code
systems would prevent about .5 million medical
errors. Moreover, by improving the
cost-efficiency of medical supply management,
hospitals would also reap 90 billion in savings,
which would help to pay for the technology
(Becker, 2004).
27
Effective Inventory Management
Lead Time
Inventories are used to satisfy demand
requirements, so reliable estimates of the
amounts and timing of demand are essential. It
is also essential to know how long it will take
for orders to be delivered (Stevenson, 2002,
p.547). Now that healthcare organizations
increasingly rely on their vendors to maintain
adequate inventory levels in their facilities,
their data relevant to demand must be transferred
to their vendors. Healthcare managers also
need to know the extent to which demand and lead
time (the time between submitting an order and
receiving it) may vary the greater the potential
variability, the greater the need for additional
stock to avoid a shortage between deliveries.
28
Effective Inventory Management
  • Costs of Inventory
  • Holding (carrying costs)-- interest, insurance,
    depreciation, obsolescence, deterioration,
    spoilage, pilferage, warehousing costs
  • Ordering costs-- associated with ordering and
    receiving inventory
  • Shortage costs-- when demand gt supply on hand
    opportunity costs of lost customers loss of
    goodwill death of a patient and potential
    lawsuits

29
Effective Inventory Management
The A-B-C Approach Classifying inventory
according to some measure of importance and
allocating control efforts accordingly.
  • A relative importance
  • classification system
  • A - very important (15-20 of items 60-70 of
    s)
  • B - moderate
  • C - least important (60-70 of items 10 s)
  • Tightest controls and
  • management should be on
  • A items

A
B
C
30
Table 11.1 A-B-C Classification Analysis
Item Annual Demand Unit Cost Annual costs Percent of Total A-B-C Classification
1 20800 2.50 52000 1.2 C
2 83200 0.50 41600 1.0 C
3 9100 37.50 341250 8.0 B
4 13000 3.50 45500 1.1 C
5 13000 1.75 22750 0.5 C
6 790 1290.00 1019100 24.0 A
7 78000 2.25 175500 4.1 B
8 114400 0.65 74360 1.8 C
9 66040 0.95 62738 1.5 C
10 6240 12.50 78000 1.8 C
11 11440 2.00 22880 0.5 C
12 18200 1.50 27300 0.6 C
13 910 1300.00 1183000 27.9 A
14 315 2700.00 850500 20.1 A
15 65000 3.75 243750 5.7 B
Total Annual Costs Total Annual Costs Total Annual Costs 4240228 4240228 4240228
31
EOQ Model
  • ECONOMIC ORDER QUANTITY model--
  • It answers the question, How much should I
    order? by allowing you to determine an optimal
    order quantity in terms of minimizing the sum of
    certain annual costs that vary with order costs.

Remember what the costs are?
32
Figure 11.2 The Inventory Order Cycle for Basic
EOQ Model
Order Quantity, Q
Cycle 1
Cycle 2
Cycle 3
Cycle 4
Q
Depletion or Demand Rate
Average inventory
Level of Inventory
(ROP)
R
0
Time (days)
Required safety stock
Reorder Point
Reorder Time
Order Received
Lead Time
33
Average inventory level and number of orders per
year are inversely related. WHY?
1 year
Average Inventory
Few orders but high average inventory.
34
To refresh memory. .
  • Basic EOQ models minimize the sum of the holding
    and ordering costs of inventory.
  • Several assumptions are important to use for the
    model
  • Only one product is involved
  • Annual usage (demand) requirements are known
  • Usage is spread evenly throughout the year so
    that usage rates are fairly constant
  • Lead time does not vary
  • Each order is received as a single delivery
  • There are no quantity discounts.

35
Holding Ordering Costs Conceptualized
Q 2
D Q
H
S
Ordering costs (S) are inversely and nonlinearly
related to order size (Q).
Carrying costs (H) are linearly related to order
size (Q).
Q 2
D Q
Annual Carrying Cost
H
Annual ordering costs
S
36
Figure 11.3 The Economic Ordering Quantity Model
Total cost
Minimum TC
Annual cost
Holding cost
Qo Flexibility zone for Packaging requirements
Ordering cost
Order Quantity, Q
Marginal cost for packaging requirements
Economic Ordering Quantity (EOQ)
37
EOQ Model
  • ECONOMIC ORDER QUANTITY model--
  • It answers the question, How much should I
    order? by allowing you to determine an optimal
    Q0.

38
Example 11.1 Syringe Inventory An orthopedic
physician group practice uses 12cc syringes from
Sherwood for their cortisone injections. During
the each of last two years, 40000 of them were
used in the office. Each syringe costs 1.50.
The physicians office annually discards, on
average, 500 of the syringes that have became
inoperable (broken, wrong injection material,
lost). The syringes are stored in a room that
occupies 2 of the storage area. The storage
area constitutes 10 of the leased space. The
annual office lease costs 60,000. The group
practice can secure loans from a local bank at 6
interest to purchase the syringes. For each
placed order, it takes about three hours for an
office assistant (whose hourly wage is 9.00 and
who receives 3.25 in fringe benefits) to
prepare, and communicate the order, and place its
shipment in storage. In addition, each orders
overhead share of equipment and supplies (phone,
fax, computer, stationary paper) is approximately
4.50. In the past, the office assistant always
placed 5,000 syringes in each order. The
deliveries are made in boxes of 1000 syringes and
are always received three working days after the
order is placed. What should be the EOQ for
the 12cc syringe? What are the inventory
management costs for these syringes? What are the
investment costs? How many times in a year should
an order be placed?
39
Solution To calculate EOQ, we need to estimate
the holding and ordering costs. Annual holding
cost 1) Cost of inoperable syringes 1.50 500
750. 2) Storage cost (60000 Lease) .10
(storage area) .02 (syringe) 120. 3)
Interest on a loan used to purchase 5000
syringes 5000 1.5.06 450. Total annual
holding costs 750 120 450 1320. Annual
holding cost per syringe 1320 40000
.033. Ordering cost Office assistants time 3
hours (9.003.25) 36.75. Overhead
4.50. Total ordering cost 36.75 4.50
41.25. Using formula the EOQ formula
40

Solution Total inventory management cost
calculated using formula

Investment cost Investment costs Order
quantity price of the item, or Qo p 10000
1.50 15,000.00. Investment cost is the
amount committed to purchase the syringes. It is
cycled as the cost of the syringes is recovered
from patients and/or third party payers.
Order Frequency is calculated using formula
In other words, order frequency is four times a
year.
41
Summary
  • The two decisions were how much to order, and
    when to order. To determine how much to order,
    you use an EOQ model that minimizes the sum of
    the total ordering and carrying costs.
  • When to order?
  • Should we order when you are almost out
  • of inventory?!

42
When to Order?
  • The reorder point occurs when the quantity on
    hand drops to a predetermined amount.
  • There are 4 determinants of the reorder point
    quantity
  • Rate of demand
  • Length of lead time
  • Extent of demand and lead time variability
  • Degree of stock-out risk acceptable to
    management.
  • Demand Rates and Lead Times can be constant or
    variable.

43
Constant Demand Rate and Lead Time
  • There is no risk of a stock-out created by
    increased demand of
  • lead times longer than expected. Thus, ROP
    equals the
  • product of usage rate and lead time no cushion
    stock is
  • necessary.

Example 11.2 An orthopedist surgeon replaces two
hips per day. The implants are delivered two
days after an order is placed, via express
delivery. When should the supply chain manager
order the implants? Solution Usage 2
implants daily. Lead Time 2 days. ROP Usage
? Lead Time 2 2 4. Thus, order should be
placed when 4 implants are left!
44
Variable Demand Rates and/or Variable Lead Times
Safety Stock-- stock held in excess of expected
demand when demand rate and/or lead time is
variable ROP Expected demand during lead time
safety stock
  • Example 11.3
  • A dentist office uses an average of 2 boxes of
  • gloves (100-glove boxes) per day, and lead
  • times average 5 days. Because both the
  • usage rate and lead times are variable, the
  • office carries a safety stock of 4 boxes of
    gloves.
  • Determine the ROP.
  • Solution
  • ROP 2 boxes/daily ? 5 day lead time 4
    boxes ROP 14 boxes.

45
Variable Demand Rates and/or Variable Lead Times
  • Service Level-- probability that demand will not
    exceed supply during lead time.
  • Service level is the complement of stock-out
    risk 95 service level means a 5 risk of
    stock-out.
  • The greater the variability in either demand rate
    or lead time, the greater the amount of safety
    stock needed to achieve that service level.

46
Summary Again
  • The two decisions were how much to order, and
    when to order.
  • To determine how much to order, you use an EOQ
    model that minimizes the sum of the total
    ordering and carrying costs.
  • When to order is determined by a reorder point
    model, and varies according to knowledge of lead
    times and demand.


47
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