003_SupplyChain_InventoryManagement (1).ppt

Chapter 11.
Supply Chain and Inventory Management
Chapter 11: Supply Chain &
Inventory Management
1

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
 Classification Systems
 Reorder Point Chapter 11: Supply Chain &

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).

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

Manufacturers/
Suppliers
Distributors
Providers
End Users
Upstream
Downstream
Pharmaceutical
Medical-Surgical
Devices
Wholesalers
e-Distributors
Hospitals
Hospital Systems
Physicians
Integrated Delivery
Networks (IDNs)
Patients/Individuals
Employers
Insurers
HMOs
Drug Benefit Agencies
Government
Group Purchasing
Organizations (GPOs)
Figure 11.1 Healthcare Supply Chain

 Manufacturers/Suppliers. Manufacturers of medical
supplies can be classified in three categories:
1) drugs/pharmaceutical,
2) medical-surgical supplies, and
3) devices.
 Some manufacturers produce supplies in more than one
category or in all categories.

 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 settings) 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.

 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.
 Boston Scientific, Dupuy Synthes, Medtronic, and Zimmer
are examples of the companies that manufacture such
devices.

TYPICAL SUPPLY CHAIN FOR
A HEALTHCARE SERVICE
Supplier
Supplier
Storage
} Service Patient
Operating Room
Implants
Replacement knee
Replacement valve

 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 purchase the drugs/pharmaceuticals
from manufacturers and wholesale them to pharmacies or to providers. Well
known distributors of pharmaceuticals include AmeriSourceBergen, Cardinal
Health, 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, Owens&Minor, and McKesson are major distribution
companies in hospital market.

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.
 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.

ELECTRONIC DATA INTERCHANGE
(EDI)
 Hospitals gain better efficiency with the use of EDI to create purchase
orders and large, distributors provide high use supply items such as
syringes, needles, dressings, catheters, and etc., that are used across
multiple clinical units. Using the traditional inventory management
analytics periodic automated replenishment (PAR) levels are established
for these items.
 Hospitals also deploy materials management information systems (MMIS)
to manage their PAR either using two bin systems or other methods such
as automated distribution units (ADU). The MMIS are capable of
automatically generating purchase orders for routine stock items.
 ADUs represent the most efficient method currently available for
managing healthcare inventory orders. Routine order requisitions in
hospitals with advanced supply chain practices released without requiring
any manual intervention. The automated requisitions generated by MMIS
(i.e., Infor Lawson Supply Chain Management for Healthcare) transmitted
via EDI intermediary companies such as GHX to distributors (Hospital
Procurement Study, 2012). Chapter 11: Supply Chain &

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
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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).

GROUP PURCHASING ORGANIZATIONS
(GPOS)
 Over 600 GPOs operate in the United States; perhaps
half of them focus their business on hospitals.
 It is estimated that GPOs mediate contracts for over
70% of spending by hospitals on medical-surgical
supplies.
 The contract negotiations for pharmaceuticals cover
almost 90 percent of what hospitals spend on them.
 The largest GPOs are MedAssets, Amerinet, Novation,
MAGNET, HealthTrust, and Premier.

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 GHX, and OmniCell.
 These firms provide e-Catalog, e-Request for
Proposal (eRFP), e-Auction, and e-Specials.

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 company’s
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.

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. Chapter 11: Supply Chain &

INVENTORY IS. . .
TRADITIONAL INVENTORY
MANAGEMENT
STOCK OR STORE OF GOODS
Or Stock Keeping Items (SKUs)

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 hadn’t corrected the ordering
patterns for seasonal variations. Then, the snow delayed
shipments from supplier, and our safety stocks just
weren’t 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
wasn’t sufficient to permit smooth operations…

THE COO’S 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.

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

 Inventory counting systems can be either:
 Periodic
 Perpetual
 Batch
 Line

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 monitoring
current levels of each item

 Two-Bin System - Two containers of inventory; reorder
when the first is empty
 Universal Bar Code - Bar code printed on a label that has
information about the item to which it is attached
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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.
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214800 232087768 Chapter 11: Supply Chain &

UNIVERSAL PRODUCT CODES (UPCS)
 Only 26 percent of medical-surgical products can be scanned on
nursing units, and only 50 percent of drugs have bar codes for unit
doses.
 Outside of North America, there are alternative EAN-13 and EAN-8
barcodes. An EAN can be created for a UPC formed in the United
States by prefixing it with a zero.
 The Global Trade Item Number (GTIN) is an identification number
that may be encoded in UPC-A, UPC-E, EAN-8 and EAN-13 barcodes
as well as other barcodes in the GS1 System.
 GS1 is a neutral, not-for-profit, international organization that
develops and maintains standards for supply and demand chains
across multiple sectors

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.

 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 > supply on hand;
opportunity costs of lost customers loss of
goodwill; death of a patient and potential lawsuits

Remember what the costs are?
EOQ 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.

Level
of
Inventory
Q
Reorder Point
R
Reorder Time Order Received
Lead Time
Depletion or
Demand Rate
Time (days)
Order Quantity, Q
Figure 11.2 The Inventory Order Cycle for Basic EOQ Model
Required
safety stock
Cycle 1 Cycle 2 Cycle 3 Cycle 4
2
Q
Average inventory
2
Q
(ROP)
0

0
Many orders, but low average inventory.
Q
Average Inventory
Average Inventory
0
Q
Few orders but high average inventory.
1 year
Average inventory level and number of orders per year
are inversely related. WHY?

TO REFRESH YOUR 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.

Order Quantity Order Quantity
Q
2
H D
Q
S
Carrying costs (H) are linearly
related to order size (Q).
Annual Carrying Cost =
Q
2
H
Ordering costs (S) are inversely
and nonlinearly related to
order size (Q).
Annual ordering costs =
D
Q
S
Holding & Ordering Costs Conceptualized

Holding Cost
Total Cost
Ordering Cost
H
Q
2
S
Q
D
S
Q
D
H
Q
TC 

2
Annual
cost
Minimum
TC
Order Quantity, Q
Economic Ordering Quantity (EOQ)
'
o
C
o
C
o
Q
Qo Flexibility Zone for
Packaging Requirements
Marginal Cost for
Packaging Requirements
Figure 11.3 The Economic Ordering Quantity Model

H
DS
Qo
2

EOQ MODEL
It answers the question,
“How much should I order?”
by allowing you to
determine an optimal Q0.

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 physician’s 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 order’s 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? Chapter 11: Supply Chain &

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 assistant’s time – 3 hours * (9.00+3.25) = $36.75.
Overhead – $4.50.
Total ordering cost – $36.75 + $4.50 = $41.25.
Using formula the EOQ formula:
H
DS
Qo
2

000
,
10
033
.
25
.
41
*
40000
*
2
0 

Q

or
TC 25
.
41
10000
40000
033
.
2
10000


00
.
330
$
00
.
165
00
.
165 


TC
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:
𝐿𝑒𝑛𝑔𝑡ℎ 𝑜𝑓 𝑜𝑟𝑑𝑒𝑟 𝑐𝑦𝑐𝑙𝑒 =
𝐷
𝑄𝑜
=
40,000
10,000
= 4 𝑡𝑖𝑚𝑒𝑠 𝑎 𝑦𝑒𝑎𝑟

FIGURE 11.4. EXCEL SOLUTION TO THE SYRINGE PROBLEM

FIGURE 11.5. MULTI-ITEM INVENTORY EOQ AND ABC ANALYSIS

0
20
40
60
60
40
20
% of
Items
% of
Annual
dollar
volume
The A-B-C Approach: Classifying inventory according to some measure of
importance and allocating control efforts accordingly.
A
B
C
 Inventories are used to satisfy demand
 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
YASAR A. OZCAN 42
CLASSIFICATION SYSTEM

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 4240228

WHEN TO REORDER?
 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?!

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.

CONSTANT DEMAND RATE
AND LEAD TIME
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!
 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.

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
VARIABLE DEMAND RATES AND/OR
VARIABLE LEAD TIMES
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 x 5 day lead time + 4 boxes
ROP = 14 boxes.

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.

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 is determined by a reorder point
model, and varies according to knowledge of
lead times and demand.

The End
50

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