Virginia Mason (VM) is a hospital in Seattle that uses the Toyota Production System model to focus on efficiency and eliminating waste. VM worked with distributor Owens & Minor (O&M) to develop the Total Supply Chain Cost (TSCC) model, an activity-based costing system that identifies all fees associated with the supply chain. The TSCC revealed that high stock keeping unit costs were being hidden. VM and O&M analyzed costs and found ordering smaller quantities more often from distributors was more efficient than bulk ordering. While beneficial for VM and O&M, implementing the complex TSCC model across the entire supply chain would be difficult.

1. Serina Robnett
Jillian Bakker
Conner Black
Ryan Atkinson
Case Study #2
Virginia Mason (VM) is a not-for-profit, private hospital located in Seattle that uses
Owens & Minor (O&M) for their services. VM is known for their specialized and primary care
and their clinical operation networks throughout western Washington, as well as their affiliations
with the University of Washington and Benaroya Research Institute. VM places a high value on
teamwork, even including the term, “team medicine,” as part of their mission statement. VM
follows a Toyota Production System (TPS) model for efficiency, which is based off the concept
of lean systems. This model is called Virginia Mason Production System (VMPS), and it was
implemented in 2002. VMPS is an integral facet in VM’s ability to accomplish organizational
goals. Additionally, VM uses value-stream mapping—a strong tool in identifying activities that
do and do not add value to the company’s service flows—which is an effective way of
eliminating waste and improving efficiency. Furthermore, VM has a five-day training program—
Rapid Process Improvement Workshop (RPIW)—which focuses on engaging work teams in
ways to improve efficiency by eliminating waste—anything that does not add value to the
processes of a company. VM places a large emphasis on reducing waste continually and adding
value to every aspect of employees’ jobs—known as VM’s “everyday lean idea.”
Owens & Minor (O&M) is a healthcare distributor operating in the surgical and medical
supply industry with a distributing center (DC) located in Seattle, Washington. O&M serves its
customers within a two-hundred-mile radius of their distributing centers. Their services are

2. provided on a contractual basis—usually lasting anywhere from three to five years. They are the
leading distributor of medical and surgical supplies and are primarily characterized by their
distribution of disposable supplies such as gloves, syringes, and gauze, for example.
Furthermore, O&M also provides supply-chain management services and private label
products—products that are manufactured by one company and provided under the brand of
another company. O&M utilizes lean systems—also known as Just-in-Time services—in their
efforts to position themselves as a provider that offers “…expertise in lowering costs for
customers through ‘services designed to streamline the supply chain’” (Narayanan 5).
In this case study, the objective that is presented is as follows:
O&M wants to reduce health care and total landing costs through the implementation of lean
systems by co-developing an Activity-Based Costing (ABC) system with Virginia Mason—one
of O&M’s providers. This ABC system was named Total Supply Chain Cost (TSCC), and its
purpose was aimed at uncovering hidden costs originally omitted when using the cost-plus
pricing system. This is achieved by providing a substantially more detailed financial statement
that includes 100% of all the fees generated from supply chain activities. This shifts the emphasis
from purchasing price as the cost to the total landing cost; costs such as transportation fees,
customs, taxes, insurance, currency conversion, crating, as well as handling and payment fees are
brought into focus. TSCC additionally aims at reducing waste by identifying it at the source,
improves efficiency throughout the supply chain, and increases profitability simultaneously.
Before TSCC was created, VM had a vision of using their “alpha vendor” program with a
medical and surgical distributor; the alpha vendor concept had been successfully implemented
with Office Depot for VM’s office supplies needs, offering lower costs for goods and services.
The alpha vendor concept is balanced on the idea of developing exclusive relationships with

3. distributors and acting as business partners with those distributors, while receiving goods and
services at a lower price in return. The benefit of the alpha vendor concept is that it aims at
creating a leaner, more efficient supply chain; O&M is the distributor that hopped on board with
this idea.
While developing the TSCC, the largest hidden cost that came to light was the Stock
Keeping Units (SKUs). Michael Stefanic, the director of cost management at O&M, and Daniel
Borunda, materials systems manager at VM in Seattle, discovered that under the cost-plus price
system, customers with larger SKUs were charged the same distribution fees as customers with
lower SKUs—this was a monumental problem because servicing customers with large SKUs
was significantly costlier than servicing customers with low SKUs. The expenses that were
omitted in the cost-plus pricing system included forecasting, purchasing, handling, storage, and
the maintenance of computer transaction records. To accurately charge their customers, Borunda
and Stefanic created the TSCC model that included these omitted costs. Also, they incorporated
O&M’s supplier evaluation method to help VM identify efficient suppliers to buy from. When
VM chose an efficient supplier, TSCC incentivized them with a discount. Overall, TSCC
emerged as a model that accurately identified 100% of supply chain fees, encouraged lean
thinking/systems, and improved profitability by eliminating waste and inefficiencies.
As previously mentioned, the key to minimizing costs and being as efficient as possible is
getting away from the concept of the purchase price as being the cost and thinking of the cost as
“total landed cost.” New and efficient practices can expose hidden costs that VM hadn’t realized
before. Hidden costs include storage/occupancy as well as inventory carrying/interest costs.
Increasing amounts of storage time and warehouse space that Virginia Mason requires to store its
SKUs increases its total costs for VM and O&M. These services that O&M provide for VM are

4. known as stockless services; a business service in which goods already purchased remain in the
care of the seller until the buyer needs them. In order for Virginia Mason to be more “lean,” it
would need to eliminate these wasted costs. Transitioning from a cost-plus basis to activity-based
costing allows providers such as Virginia Mason to see these “hidden costs” that are driven from
using O&M’s distribution activities and services. To recap, one of the largest drivers of costs in
the distributor/provider relationship was the number of stock keeping units (SKUs). A statistical
analysis for July of 2007 reveals that as Virginia Masons total back orders decreases, it’s
efficiency rating decreases; this shows that as the number of orders increases, efficiency
increases concurrently. The analysis also provided evidence that as total lines received
decreased, efficiency increased. This means that Virginia Mason lowers costs and is more
efficient when placing orders from its distributor using the Just-In-Time (JIT), or Low Unit
Measure (LUM) method of ordering. This means that Virginia Mason is more efficient when
purchasing from the distributor more frequently in smaller quantities, rather than infrequently
purchasing from suppliers in bulk and keeping excess SKUs in storage at a distribution center.
For the month of July, storage/occupancy and inventory carry/interest costs tallied $20,000
alone. In total, SKU-related costs added up to $47,500 per month. This is a significantly high
amount when compared to just $9,000 for delivery charges within the same month. Using the
LUM approach, providers order the minimal amount of supplies that is needed. Therefore,
monthly delivery fees will increase as transportation services are required more frequently to
fulfill regular orders, however, VM will not be keeping a higher quantity of SKUs in storage at a
distribution center, which decreases a heftier expense. Virginia Mason will significantly lower
their SKU-related costs as distributors will have to keep a smaller inventory, resulting in
ultimately lower monthly costs for inventory storage and occupancy. Not only does this cost

5. method benefit providers by eliminating costs associated with storage and occupancy, but it also
benefits distributors because they will have a lot more warehouse space for other inventory,
enabling them to do business with more providers.
An outstanding sustainability issue that was presented in this case study was that it would
be difficult to have other providers move towards the TSCC model due to the fact that it
nominally looks more expensive; in result, this model is highly discouraging to other customers,
and it would be difficult to implement it across the supply chain despite its benefits, simply
because it would be extremely difficult for providers that were not involved in the creation of the
method to understand the functions of it. Additionally, due to the fact that TSCC would require
more deliveries being made, the amount of distribution trucks that are put on the roads would
increase, resulting in a decrease in environmental-friendliness. As far as ethical issues are
concerned, the outstanding ethical issues presented would be ensuring fair negotiation among
Value-Added Networks, distributors, manufacturers, and providers. Since TSCC involves
extensively detailed financial documents and complex pricing methods, it is also crucial that
financial statements are accurately reported to Value-Added Networks—there is no room for
error, however since TSCC focuses on decreasing the amount of inventory kept in distributing
centers at one time, the likelihood of errors being made decreases.
Overall, the TSCC method is a more efficient way to decrease costs and waste among the
supply chain. However, due to its complexity and difficulty to understand, it is unlikely that the
TSCC method would be able to be executed across the supply chain. Additionally, TSCC would
help distributors expand their services without increasing their existing costs, as well as cycle out
inventory on a more frequent basis, and bring in new products without having invest in new

6. storage facilities. Despite the setback of widely implementing TSCC, it is the most profitable,
efficient, and mutually-beneficial option for providers and distributors.

7. Works Cited
Narayanan, V.G., and Lisa Brem. "Supply Chain Partners: Virginia Mason and Owens &
Minor." Harvard Business School (2011): 11-17. Print.