Owens & Minor case for aligning supply chain incentives

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Executive Summary

Statement of issues: Due to the changes of business environment, O&M suffered a continuous loss on business. Instead of acting individually, customers formed buying groups and combined buying power to gain advantages in negotiating gross margin with distributor. With the increased popularity of JIT and stockless idea, customers want to shift cost and risk associated with inventory to distributor, and they also want distributor to provide better services at its own expense. Moreover, competitions from private label distributors and manufacturing distributors further squeezed profit margin of our company.

Owens and Minor play a very important role in the entire SC. They are in charge of providing information to manufacturers on product flow. Their services to the hospitals include storing the inventory in their warehouse and making constant shipments based on stockless and JIT strategy, thus taking all the financial risk in inventory handling and storage. They don't add value to the product itself, but they do add a lot of value to the SC.

The nature of distribution has changed over time. The bargaining power of hospital has increased due to mergers and alliances, pressuring the distributors to reduce their margins. Upstream members of the SC have also put some pressure on O&M to take additional cost in their operations.

If the ABP strategy could be successfully implemented, both distributor's and customers' incentives could be allied. Customers would be willing to order expensive products via distributors' channel instead of buying directly from manufacture.

Generally, customers who could reduce or simplify the activities happened through the supply chain would adopt ABP faster. Also, customers who understood and were willing to develop a sustainable relationship with distributors would adopt the ABP first.

ABP was a new concept and its value had not been proven. Aggressive implementation of new idea such as ABP might drive customers away and fed competitors.

There are internal obstacles exist in the ABP implementation. Hospitals have to restructure its organizational structures to fit in ABP system. Rearranging employees and reallocating facilities would increase the distrust to ABP system. Also, a substantial amount of investment is needed for establishing the EDI system. How to overcome these obstacles and make ABP implementation smooth is a big challenge.

In order to illustrate the idea of ABP more clearly, we have come up a simple pricing matrix based on ABC method. We have identified two cost drivers and separated fixed and variable costs from general cost information. However, for simplicity we have not considered the cost difference of EDI and non-EDI ordering in this simple matrix.

Owens and Minor should carefully deal with its customers' resistance to the new pricing system by making them truly understand the new system and benefits they would get after the implementation. Owens and Minor also needed to launch a pilot program before full implementation and provide help and support to its customers to insure the success of the implementation.

Statement of issues

Historically O&M was doing very well in the industry, however, for recent years company suffered continuous loss on business. At the end of 1995 O&M had ended with an $11 million loss due to decrease in gross margin and an increase in expense. There are many reasons that caused this result, and we are going to identify the most important ones.

Healthcare industry has changed a lot since 1980. Historically, hospitals purchased healthcare products individually. However, in order to achieve economies of scale and gain more control over supply costs, hospitals joined forces with other hospitals to form large buying groups. With such combined buying powers, hospitals are much more powerful in negotiating gross margins and service levels with distributors. Distributors are forced to cut gross margins and...
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