Owens & Minor along with other distributors provide inventory storage and management services for hospitals and other healthcare providers. Manufacturers typically don’t want the responsibility of holding inventory and prefer to ship product as soon as its finished. The role of distributor has changed over time and they are now doing more for the customers. At one point distributors were just responsible for a small percentage markup to deliver product infrequently to the hospital docks.

What are the services rendered by the distributor to manufacturers and hospitals?
Distributors like Owens & Minor provide hospitals with the purchasing of materials, along with its warehousing as well as product returns. They also offer additional services such as managing JIT and stockless inventory programs for hospitals. Its typical for a distributor to also manage the product from the manufactures delivery to the hospital’s dock. This service is much better positioned with a distributor as they have the systems and visibility to manage this process and it’s a byproduct of their own service to their customers.

O&M also tracks and verifies customer contracted purchases at contracted prices and volumes. They also monitor agreements between end users and manufacturers. O&M is also adding warehousing and transportation services for their customers. They handle receiving, put-away, tracking, order management and shipping for their customers while carrying the financial risk burden for the inventory. O&M also track and claim rebates between customers and manufacturers.

The cost plus pricing doesn’t incentivize the customer to change any of the inefficient requests. The customers went from cost plus a fee with just a delivery requirement of a pallet at their dock to pushing the management of the inventory and associated administrative activities to the distributors. The ABP cost model would force changes in behavior across all nodes of the supply chain. The manufacturer may need to delivery differently and the customer will most definitely need to change the way they order, stock, delivery and re-order inventory from the distributor. They also need to rethink the services from the distributor and whether or not its most economical for them to take on some services to reduce their costs.

The pricing model in Exhibit 5 demonstrates how more purchases orders and more lines per month add more cost. The cost differential for 30-50 PO’s with a range of 975to 1249 lines would generate a cost of $12, 869 for the month services as compared to 650-670 PO’s with a range of 19750 to 20249 lines at a cost of $89,491 per month. This will help the customer decide how much service they need and how much they can absorb within their current infrastructure without adding additional or more cost than they are facing. The pricing matrix works as outlined above. The number of PO’s and the number of monthly line items have all been given a cost which increases across volume.

The differential in the exhibits demonstrates the difference in cost for ABP fees opposed to the straight percentage added on to the manufacturer’s cost. The cost drivers are activities and not product values. All the cost detail in exhibit 4 has been summarized in Exhibit 5 pricing matrix. The details of orders, lines, receiving, put-away, order picking and shipping aren’t detailed. The number of orders or PO’s is tied to the fixed administrative fee and the number of lines is tied to variable costs summed up for simplicity in the matrix model.

O&M has to face several significant challenges one being that no other distributor at this time if following this ABP model. Another is that Ideal’s systems didn’t lend themselves to flexible pricing. O&M also needed to link its to Ideal via EDI. Another major concern is that employee habits around purchasing and managing of inventory would not change. Of course another concern is that they may have to adjust personnel to fit the capacity and new business needs. If Ideal doesn’t adjust their behavior then they won’t benefit from the program. ABP works well for customers that need and want to manage their cost base and optimize their services. O&M should utilize their internal support services like the logistical services team to help partner with Ideal to manage implementation and use the simplified cost matrix method to help them manage their internal costs and transfer costs.
Offering this type of service will help them transition Ideal and also keep competitors at bay. It won’t be easy for a competitor to compete on the same level of service and partnership if they offer their services for shared benefits, thus keeping the knowledge base internal to O&M.

A comparison of Hospital Alpha to Hospital Beta demonstrates the cost differentials based on type, amount of service, frequency of service and size of each request has on activity and therefore cost.

The cost differential for a cost plus margin compared to an ABP fee is $22,500 vs. $57, 933 for 400 PO’s per month with 11K line items and $22,500 vs. $89,491 for 660 PO’s and 20K line items per month, respectively.
O&M was clearly on the right track when they started pricing based on activity level which drove their costs as opposed to product value which had no strong direct relationship to their resource requirements.