Medical Device & Diagnostic Industry Magazine | MDDI Article Index

An MD&DI May 1997 Feature

LOGISTICS

The Supply Chain: Operational Efficiency is No Longer Just an Option

Sherrie Steward

The shape of the health-care industry has changed, blurring once-definitive boundaries between hospitals, distributors, suppliers, manufacturers, and even competitors. Smaller device companies are often turning to their larger counterparts to share activities that might otherwise overburden a small operation. At the same time, technological advances have begun to force new ways of taking orders, delivering products, and working with customers. Such a significant transformation of the industry over the last several years has compelled several industry organizations to focus on how the health-care industry as a whole could create a value-oriented supply chain. The participants in the health-care supply chain--the device manufacturers, distributors, and customers--often have conflicting goals and functions. Although manufacturers must focus on developing safe and effective devices, they also face huge buying groups demanding the lowest possible prices. Distributors must determine how to deliver these products quickly and efficiently.

The variety of distribution options for delivering materials and products to customers has expanded to a new level, and logistics has become a fine art in the process of planning, implementing, and controlling the efficient flow of raw materials, in-process inventory, finished goods, and services to customers. Companies must consider location, inventory management, and transportation and distribution of their products to ascertain the best method for getting the product through the chain to the consumer. All of these elements can have strategic and operational consequences when companies determine production schedules and maintenance of their customers' critical medical device products. Integrating logistics strategies enables companies to add value to their products. Improved customer service through faster delivery and more efficient order fulfillment helps reduce the ultimate cost to the consumer and can be a very useful tool for gaining market share.

This article examines three key areas that manufacturers can focus on to improve their logistics programs and eliminate duplicated steps in the supply chain. Forming partnerships and alliances within the supply chain and with competitors will be crucial to operational efficiency. Implementing electronic technologies and adopting standardized codification will enable companies to eliminate unnecessary tasks. Finally, basing the final product price of each shipped product on the actual costs of manufacturing and delivering that specific product will provide more value to their customers.

THE TIES THAT BIND

Achieving the highest level of operational efficiency will require manufacturers to collaborate to a much greater degree than before with their partners and their competitors throughout the supply chain. They will need to seek those within their chain that specialize in functions that complement their own. Device companies that share customers can ally themselves to share warehousing or transportation to save costs. More flexible relationships will also allow companies to tailor products or consolidate operations to meet customer needs. According to the Efficient Healthcare Consumer Response (EHCR) study, partnering reduces the pressure of limited resources, market changes, competition, and a company's lack of a strategic competency.¹ The study recommends that partners strive to develop a high level of intimacy using measurable, agreed-upon performance standards, such as how and when short-dated products will be handled between the manufacturer and the distributor. It is important that partners identify a common vision of what an improved future will entail and that all partners be equally committed to the projected outcomes. Communication reinforces trust and enables companies to modify an alliance as needs change. If a merger leads to a new line of products, manufacturers may need to restructure on short notice their warehousing or distribution operations to accommodate special storage needs or time-sensitive parts. Long-term warehousing leases that don't accommodate such changes could hinder a company's ability to service this new customer base.

Collaboration and partnership have become an integral piece of the efficient operating equation. "Operational efficiency is in a state of convergence just like quality was at one point," says Dick Theis, director of logistics, customer service, and information technology for 3M Health Care (St. Paul, MN). "We must behave on what is best for reducing cost in the entire health-care chain, not just what is good for an individual manufacturer or distributor. Very soon, operational efficiency will be on the same level as quality. If you don't do it, you're not going to be in business." Theis says that manufacturers who try to lean too much on operational efficiency as a competitive advantage will find that the advantage will be short-lived.

"One thing that's never been done extensively in the health-care supply chain is talking to each other, especially communicating with competition that may be using the same supply chain," says Vincent Gulisano, vice president of business development for USCO Distribution Services (Naugatuck, CT). "We discovered that two of our customers had products at the same warehouse, shipping on separate trucks to the same facility. Combining their shipments removed 25% of their combined transportation costs."

Forming alliances allows the activity to be spread evenly across all segments of the chain. Third-party logistics services, such as USCO, Sonic Air (Scottsdale, AZ), and FedEx Distribution Centers (Memphis, TN), offer another avenue for the alliance of potential competitors within the supply chain. For example, Toshiba America Medical Systems (Tustin, CA) works with Sonic Air to conduct cost analyses. Brian Turnbull, vice president of services for Toshiba, says such a partnership enables the company to return much of the cost-savings back to the customer through further efficiencies. According to FedEx, Beckman Instruments (Fullerton, CA) reorganized their parts inventory, using a FedEx distribution center to provide their customers with 24-hour access to time-sensitive parts.

Abbott HealthSystems (Abbott Park, IL) has been sponsoring an annual transportation symposium for its external carrier partners since the mid-1980s to promote the exchange of information between Abbott and its distribution partners. The symposium focuses primarily on transportation issues, including expedited shipments, carrier performance, and claims processing. Abbott uses the information to develop strategies to address issues such as processing and delivering orders more quickly or just more efficiently. Abbott Direct, the company's logistics function, provides an option to customers to receive products shipped directly from Abbott's own plants. In cases where the product is heavy or bulky, this often provides the lowest-cost option. Abbott has five warehouses, staffed with Abbott employees, that all of its divisions use to distribute a variety of products. The company also has more than 40 leased warehouses staffed with Abbott and non-Abbott employees. This combination enables Abbott to get its products close to the customer for faster delivery, especially for critical products. Abbott maintains a small fleet of trucks and trailers that allow it to deliver products itself when this is the most cost-effective method and serves the customer's requirements. "It depends on the product or commodity and specific issues such as shelf life or environmental concerns," says Joe Coffey, senior marketing manager for Abbott HealthSystems. "We designed a packet of information to send to senior executives of health-care organizations describing different distribution and delivery options."

Through Abbott Direct, the company has defined a number of areas to improve delivery logistics for its customers. The company has a staff of supply-chain analysts that assess a customer's needs and present the options for getting a product from Abbott to the customer's facility. These analysts factor in all the costs from the supply chain, then present all delivery options such as scheduled deliveries, emergency deliveries, or inside deliveries; packing list and invoice options; and options that can include electronic order entry, electronic invoicing, and electronic funds transfer. Coffey says the analysts remain "channel neutral" as they approach this task. "They present the facts and numbers to the customer, who then chooses an option based on how it wants to receive and store the product. The team helps customers implement the plan they choose."

THE INFORMATION AGE

The changing industry has made it imperative that companies communicate and align goals. Changes such as economic swings and new competitive pressures have led to the need to redefine the supply chain. To address these changes, the health-care industry, including device manufacturers, must be ready to embrace new technologies. Most important among these are electronic data capture, bar coding and labeling with unique product numbers, and electronic data interchange (EDI) for order placement and invoicing. Each of these has a dramatic impact on a company's ability to develop efficient logistics programs. These technologies encompass scanning point-of-care data, using the Internet and networks to transfer information, and bar coding that includes unique product and company identification for error-free tracking from the manufacturer to the customer.

Adopting any or all of these information technologies will facilitate reducing or eliminating time-consuming manual processes. Standardized codification is particularly critical because the information can be read automatically, improving speed and efficiency of order placement. Many group purchasing organizations (GPOs) have begun requiring a universal product number (UPN) for every medical product. Effective use of this technology will mean that the entire supply chain will need to adopt a standardized data structure and symbology that can be shared across the chain, from picking and shipping, to stock replenishment, to point-of-use data capture.

"We all need to focus on the same components," says Theis. "The challenge has been the lack of acceptance of a set of standards. A fundamental problem is the need to codify industry participants and use that one number to communicate about each other. Distributors need to do this in order to be in compliance with FDA and to provide traceability. Right now, that can often mean cross-referencing 300 sets of numbers." Theis says a health industry number (HIN) would provide a unique identifier for each participant to capitalize on the capabilities of EDI.

Theis explains that data capture can start with the demand--the use of the product at the point of care--at the beginning of the supply chain. The need to replenish the product starts the information flow. The emergence of a technology such as the Internet can provide companies with much of the solution because it transcends the multiple-environment barrier. All parts of the supply chain can capture information at the point of care on a real-time basis, and information can flow back through the chain to the manufacturers to anticipate demand.

FedEx recently introduced a service that allows businesses to post a web catalog on a FedEx server connected back to a seller via the Internet. Orders placed from the web catalog are immediately transmitted back to the seller's inventory management system, which then links a confirmation number to a FedEx tracking number. Both the business and the buyer have real-time access to package order and tracking information from pick-up through delivery.

EDI enables partners to exchange information via computer in standard file formats. Placing an order electronically reduces costs, time delays, and errors. Companies can use EDI to conduct single or two-way transactions such as purchase orders, invoices, rebates, and credit memos. EDI can also be used to provide payment advice, track sales, or request product catalogs. At a higher level, companies can use EDI for continuous replenishment, contract notification, contract awards, or receiving and shipping notices. Companies can also explore other information technologies such as radio-frequency identification for transportation tracking and shared databases that enable the exchange of information regarding products and standards. E-mail, video conferencing, and the Internet are readily available technologies that companies of any size can use to improve communication and access to data.

"Manufacturers need to deliver value," says Nicholas LaHowchic, president of supply chain services for Becton Dickinson (Franklin Lakes, NJ). "Individually and collectively, we need to take costs out of the system. If we uniformly codify, remove costs throughout the administrative and order management processes, we can achieve cost reduction throughout the entire chain. EDI is just one way that we as an industry can make this happen. It's not enough to just reengineer the process. We need to decide that we can eliminate some transactions, not just automate them. We need to determine what critical information--including payments--to pass to each other," LaHowchic says.

A worker scans bar codes for inventory management. Photo courtesy of Sonic Air.

Because EDI and codification standardization are possible with tutorials and off-the-shelf software, LaHowchic believes that these solutions are available to companies of all sizes, and that moving ahead technologically doesn't have to be limited to large device companies. Essentially, this means that companies will be reengineering the ordering process so that it will take fewer people to carry out order placement and order receipt.

"United Parcel Service has implemented EDI technology so that through the Internet you can see the signature of the person that has signed for your package. The use of technology is reducing the overall cost and improving the ability of device manufacturers to better track and provide service to their clients," says Paul Gettings, executive vice president of sales and logistics services for Sonic Air, a subsidiary of UPS.

"For every aspect of EHCR there will be different winners. Rarely will a single initiative serve all masters. The collective savings are what make the difference in the total cost reduction," says Theis. "Small companies, however, may actually have more flexibility. They don't have the political environments and established infrastructures that make change difficult. Today, information technologies are not cost-prohibitive, making implementation accessible to small companies."

A third-party logistics employee uses the company's database to arrange for a courier to perform simple repairs for a customer. Photo courtesy of Sonic Air.

Moving from a fragmented supply chain system to an integrated system will force information that was once proprietary to be now part of an open system. The standardization of a UPN for every product is one of the developing trends toward an open system. Moving from paper-driven systems to radio-frequency environments is creating new opportunities for manufacturers to improve logistics.

THE REAL COSTS

Many device manufacturers are shifting toward a new pricing structure that reflects the actual costs of producing and moving a specific product to customers. This accounting system, called activity-based costing, requires a company to base its product costs on the activities performed surrounding that product's manufacture and delivery. It allocates costs to the products or other overhead, such as customers, markets, or projects. This means a product can be more accurately priced because the allocated costs are actually associated with it rather than calculated as a percentage of the company's labor or machine hours, known as cost-plus, which has been the industry standard.

The EHCR study recommends that activity-based costing be implemented on a small scale at first. Engineering, sales and marketing, and production departments should be involved in implementing such a strategy because they can focus on near-term process improvements that can reduce costs in the supply chain. A tool such as activity-based costing is one that a company of any size can engage in. Inexpensive software is available to implement this accounting system.

Theis says the ultimate metrics for allocating costs are keeping the total delivered cost as low as possible and the service level as high as possible. This is a cumulative cost of the manufacturer, the distributor (including transportation and requisitions), and the provider. Companies will benefit from calculating cycle times, fill rates, and transportation costs to determine actual costs. Theis cautions that there are some cases where the costs might go up. "If you try to take your inventory too low, you risk a back-order situation, which leads to higher costs."

Coffey says Abbott has always found it more effective to use activity-based costing. "This is an area where Abbott has sometimes stood alone," he says. "We have never accepted the theory that the cost of the product plus a percentage of its price for shipping was the best way to determine the final cost of the product to the customer. If the net cost of shipping is only $4, and the list price of the product is $300, we don't figure a flat 5% of the product to determine a $15 shipping cost. We have always advocated activity-based costing, identifying the costs in the supply channel and assigning a value to each cost, to determine the final cost," he explains. "It's an unpopular position with some competitors not to charge cost-plus. Using activity-based costing has certainly helped us remain competitive, and we've factored this into our overall pricing strategy."

Abbott provides its customers with a supply chain analysis that sometimes promotes the use of outside sources in order to provide the best service level. Abbott's electronic commerce program enables its customers to implement automated ordering and transaction processing at no cost. The program uses EDI, electronic purchase orders, and electronic catalogs. Coffey says customers that use Abbott's EDI system then have the option of using this system with other suppliers.

Improving supply chain management requires that all participants in the health-care chain examine their own inefficient areas of activity. Although eliminating some practices from the supply chain will result in substantial cost-savings overall, it will also mean that some segments of the industry might initially lose revenue. Not all companies will be able to implement every recommendation suggested by the recent EHCR report. The EHCR study examined the functions of all participants to identify how these entities with disparate goals could work together to eliminate overlapping functions and ultimately take billions of dollars out of producing and delivering heath-care products.

The EHCR study stressed the importance of this issue to the entire supply chain in the health-care industry, from device manufacturers to hospitals, and heightened the awareness of the participants. Manufacturers have been concerned with efficient distribution and the costs attached that have led companies in all segments of the industry to begin to reengineer their logistics plans. A medical device manufacturer needs to look at the list of options like a menu and select those methods that it finds most appealing. Some transitions, such as unique product codification, will continue to take place in the industry and will force companies, distributors, and providers to make internal changes in operations.

Among the most important aspects of making supply chain management more efficient is communication with partners in the chain to determine what each participant can contribute to a more productive, less redundant process. Because such initiatives are designed to take place throughout the chain, those who opt not to participate may likely be squeezed out by companies that can deliver their products more efficiently.

Mergers and acquisitions, managed care, and vertical integration have certainly contributed to a developing industry that hasn't changed its methods along the way. Old distribution systems have been made to fit redefined relationships. A key to a healthy future of the health-care supply chain will be flexibility.

"The EHCR study has taken theoretical ideas and provided an excellent platform for indicating a direction of how to achieve these efficiencies. It located the areas for drilling down," says Theis. Device companies that review their current processes may determine that some of the most efficient options for them will be eliminating services that add cost but ultimately no value to the end product. For example, outsourcing certain services may move a product to a warehouse closer to the customer--providing an added value of getting it sooner--and eliminate the possible need for building a warehouse and incurring brick-and-mortar expenditures that would then be incorporated into the cost of product.

For example, Siemens Medical (Iselin, NJ) recently chose FedEx's Logistics, Electronic Commerce, and Catalog Division to solve a distribution dilemma in Asia. "Prior to using FedEx, Siemens Medical had served its customers worldwide using a centralized distribution center in Germany. However, the three- to four-day transit time between Europe and Asia was unacceptable for customers who needed critical replacement parts immediately," says Robert Wilson, manager of sales and marketing for FedEx. Strategically locating inventory in two FedEx Express Distribution Centers in Tokyo and Subic Bay in the Philippines, he says, lets Siemens Medical offer overnight delivery to customers within Asia.

"Clearly there are companies that excel at information sharing, warehouse management, and transportation consolidation," says Theis. "They have an opportunity to optimize these functions. We at 3M share regional distribution centers with Abbott. Such alliances and partnerships are what will make EHCR successful."

The EHCR study set itself apart from previous analyses because it examined the entire pipeline with a focus on eliminating anything that didn't add value to an end product. "The goal is taking the waste out of the system," says LaHowchic, adding that some supply-chain functions just exist because they have evolved over time.

Abbott has been implementing supply chain cost-cutting initiatives for a number of years. They offer bar code­based receiving systems so that products can be tracked all the way to the patient. They analyze the financial impact of local delivery, plant delivery, distributors, and wholesalers. They address factors such as contract terms, product volumes, and other cost drivers. An analyst presents this information to the customer via teleconference or in person. These services are provided at no cost to the customer. "Divisions within Abbott focus on the lowest total-cost options depending on the product or commodity and what is appropriate for the customer. We help achieve the lowest cost option based on what we can control. We also work with distributors or ship directly depending on the product and the cost the customer is willing to pay to get it," says Coffey.

ROLE OF THIRD PARTIES

Large multinational companies like Abbott may be well prepared for streamlining logistics. Smaller companies, however, may need to turn to third-party logistics providers to be prepared for the new environment. Third-party logistics companies specialize in providing expertise in transportation, warehousing, storage, processing, inventory management, and product fulfillment. These companies act as central materials receiving centers and parts depots. They are often brought in to improve customer service, improve inventory management, and trim overall distribution costs. They use their warehouse locations for a variety of customers and can often store parts closer to hospitals and labs to minimize downtime of critical medical devices. Using technologies such as EDI they can quickly locate the nearest warehouse to deliver a part for a service request. Companies such as FedEx, Sonic Air, and USCO Distribution Services have facilities and transportation networks specifically designed to handle health-care products.

Sonic Air sees services such as transportation as a product offering. It promotes its ability to design logistics solutions that use a number of options. Using common warehousing networks enables the firm to customize the number of locations and types of services around a manufacturer's specific needs, according to Gettings.

One trend is to use software for warehouse site selection. Specific challenges for device companies include varied product size and the need to often deliver a part that is mission critical. Gettings says that a device company may need a logistics plan that enables it to bypass the hospital's receiving dock to get a part to a physican who needs it right away. He says that some products require ensuring that two couriers travel with the part to deliver it efficiently. "Outsourcing becomes a viable option because such logistics often aren't a health-care company's core competency," says Gettings.

Toshiba America Medical Systems forecasts its projected device failure rates against geographical factors to determine the effect on distributed products. The company concluded that it was cost-effective to outsource its logistics to a third party, says Turnbull. Because Sonic Air can provide an analysis of the company's turnaround time and is able to ensure that Toshiba has "the right part at the right place in the right quantity at the right time," Toshiba chose to outsource its logistics to it.

Third-party logistics providers are making flexibility a primary driver for their processes, redefining how the supply chain works. USCO's Gulisano describes a logical outcome of a merger. When two of its large health-care clients merged, USCO combined their two operations into a main distribution center, providing easier access for the company and eliminating duplicated costs.

"The key is that we have multiple customers sharing the costs," says Gulisano. Third-party services often specialize in delivering critical parts, getting the product to the customer's door within an hour, and providing regional stocking locations tied together on an information system to enable real-time order, pick, and delivery in the same day.

"Many companies do outsource a fair amount of their logistics," adds LaHowchic. "Some will continue to do so as they look for centers of excellence because they don't have the critical mass to make it cost-effective to handle internally. But these logistics sources will also evolve into continuous replenishment services. It will have a tremendous impact."

Both large and small manufacturers use third-party services, but their motivation differs. Gettings explains that smaller companies outsource logistics to compete with the infrastructure of a larger competitor. Larger companies outsource much of their logistics because the third-party service can offer economies of scale. Their volume helps provide the greater economies of scale and also provides added flexibility for their clients.

Sonic Air, for example, has an inventory control system, which identifies what inventory is located at all locations. That system allows for global part or product visibility. Most manufacturers have a need for inventory control but many don't have the internal technology. One reason Toshiba chose Sonic Air as its distributor is because Sonic Air has six warehouses where Toshiba has six major offices. Sonic Air provides reports on a monthly basis that summarize the number of parts and the expediency with which orders are filled, says Turnbull.

According to FedEx, storing critical inventory at a FedEx distribution center enabled Meadox (Oakland, NJ) to respond more rapidly to emergencies at West Coast hospitals. FedEx offers next-flight-out services and specially designed facilities that help device companies ensure quick delivery.

The difference in any two products is often faster delivery for a lower cost. The pressure to provide better service means that some device companies would have to completely reengineer their infrastructures at great expense. An outsourcing and logistics company often provides these services more efficiently simply because it performs them for many customers.

Such third-party providers can add flexibility and convert fixed costs to variable costs because manufacturers can avoid the infrastructure investment. These companies specialize in services that manufacturers often can't perform as efficiently, including order taking, receiving and shipping, inventory management, transportation management, bar coding, and warehousing or site management. They use such tools as 24-hour order fulfillment, EDI, systems interfacing, computerized inventory management, and sales forecasting.

Their multiple processes and multiple customers enable them to provide the flexibility and changes required with events such as a merger or acquisition. Companies often don't want to recreate systems and aren't able to compete with a third party that can spread the overhead over a wide customer base. Manufacturers that outsource logistics are also not tied to long-term leases, which can cause logistics problems with mergers, Gulisano explains.

There are several signals that indicate when manufacturers should consider outsourcing logistics operations. "Determine whether you are meeting your customers' needs," Gettings says. "Is the customer saying, 'We'll buy this, but you need to sell it to me 24 hours a day, 7 days a week?' Many companies, particularly small ones, can't afford to set up an operation to support their clients on a 24-hour basis. Their compromise might be to give Joe a beeper and tell the customer to page Joe. That isn't always a responsive system. By outsourcing, a smaller company can leverage resources that its own business structure can't support. It gets economies of scale by outsourcing a parts warehouse, transportation, or a call center to a company that provides these services to a number of clients."

Therefore, a small manufacturer can appear to have staff people on around-the-clock and can essentially have warehouses all over the country that provide inventory management as well as delivery. They can access this infrastructure without having to pay the cost of setting it up. Outsourcing also enables a company to support a product with parts and service in regions where it many not even have a presence. "It can appear to the customer to be a much larger company capable of being more flexible," says Gettings.

Logistics providers use technologies such as EDI so that companies not only reduce costs associated with supporting the product, but also gain flexibility. Gettings continues: "More and more companies are realizing that logistics is a business unto itself. Manufacturers struggle with delivering products to their customers on time in the proper condition. If it is serviceable equipment, they have to come up with a way to support that equipment, and that often involves spare parts, which means they need to have a responsive logistics system in place. Sometimes that means finding a company whose core competency is logistics." Logistics companies can often provide more security, global tracking systems to trace product movement, and sophisticated inventory management systems.

CONCLUSION

"EHCR has taken sound principles and said we have to apply them, not necessarily in and of ourselves, but as a group. EHCR has dissected a number of trends and presented a new way to put them together," says Gulisano. To find the savings, EHCR focused on three categories: product movement, a savings potential of $6.7 billion; efficient information sharing at $2.6 billion; and efficient order management at $1.7 billion. Theis points out that although efficient information sharing represents the second-largest area for savings, it also represents the necessary component for attaining the larger product-movement savings.

The EHCR study identified four areas--inventory management, order management, physical distribution, and transportation--in which the entire chain could eliminate waste and cut costs. Although much emphasis has been placed on the need to work together to create a value-oriented chain, manufacturers will be able to bring more value to the supply chain, as Abbott has been able to do.

"It's important to note that the EHCR initiatives are not an all-or-nothing series. Efficient operation is equally appropriate for large or small companies. You can take pieces of the EHCR and work with people in the channel," says LaHowchic. He emphasizes that companies that engage in improving logistics in ways the EHCR study suggests will be the big winners by pulling costs out of the entire channel through to the consumer. "Those companies will benefit with competitive positioning and more market share," LaHowchic says.

REFERENCE

1. Efficient Healthcare Consumer Response: Improving the Efficiency of the Healthcare Supply Chain, Cleveland, CSC Consulting, November 1996.