1. Chapter 11. Supply Chain & Inventory Management
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

2. 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
Reorder Point
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

3. 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).
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

4. 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
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

5. Figure 11.1 Healthcare Supply Chain
Pharmaceutical
Medical-Surgical
Devices
Manufacturers/
Suppliers
Upstream
Wholesalers
Group Purchasing Organization (GPOs)
e-Distributors
Distributors
Hospitals
Hospital Systems
Physicians
Integrated Delivery Networks (IDNs)
Providers
Downstream
Patients/Individuals
Employers
Insurers
HMOs
Drug Benefit Agencies
Government
End Users
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

6. Healthcare Supply Chain
Manufacturers/Suppliers. Manufacturers of medical supplies can be classified in three categories:
drugs/pharmaceutical,
medical-surgical supplies, and
devices.
Some manufacturers produce supplies in more than one
category or in all categories.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

7. Healthcare Supply Chain
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.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

8. Healthcare Supply Chain
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.
Dupuy, Ortho Biotech, Medtronic, and Zimmer are examples
of the companies that manufacture such devices (Burns,
2002; p.244).
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

9. Typical Supply Chain for a Healthcare Service
Supplier
Storage }
Service
Patient
Implants
Replacement knee
Replacement valve
Operating Room
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

10. Healthcare Supply Chain
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
AmriSource/Bergen Brunswig, Cardinal Health/Bindley
Western 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.
Distributors and Wholesalers
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

11. Healthcare Supply Chain
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.
Over seventy-five percent of distributors use EDI, and seventy to eighty percent of their business volume is handled through EDI (Burns, 2002, pp ).
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.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

12. 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
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

13. Healthcare Supply Chain
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 ).
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

14. Healthcare Supply Chain
Group Purchasing Organizations (GPOs).
Over 600 GPOs operate in the United States; perhaps half of them focus their business on hospitals.
The two largest GPOs are Novation and Premier, which are nonprofit. AmeriNet, HSCA and Consorta are the other sizable non-profit GPOs.
The two investor-owned, for-profit GPOs are HCA/Health Trust and Tenet/BuyPower.
A provider may be member of multiple GPOs. The average Hospital GPO membership ranges 1.6 to 2.6 GPOs in US.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

15. Healthcare Supply Chain
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: Medibuy, Neoforma, MedAssets, OmniCell, and Promedix.
These firms provide e-Catalog, e-Request for Proposal (eRFP), e-Auction, and e-Specials.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

16. Healthcare Supply Chain
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.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

17. 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: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

18. Inventory Is. . . Traditional Inventory Management
STOCK OR STORE OF GOODS
Or Stock Keeping Items (SKUs)
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

19. 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…
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

20. 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.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

21. 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
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

22. Effective Inventory Management
Inventory counting systems can be either:
Periodic
Perpetual
Batch
Line
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

23. 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
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

24. Inventory Counting Systems (Cont’d)
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
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

25. Inventory Counting Systems (Cont’d)
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.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

26. Effective Inventory Management
Universal Product Codes (UPCs).
Only 26 percent of medical-surgical products can be scanned on nursing units, and only fifty percent of drugs have bar codes for unit doses.
According to the final regulation issued by the Food and Drug Administration (FDA) in 2004, drug manufacturers must adopt bar coding to single-dose units within two years, and hospitals must eventually implement bedside scanning systems.
The FDA estimates, however, that it may take up to two decades for all hospitals to implement such systems because of their high costs: from $.5 to $1 million. Only a few more than 100 hospitals currently them.
Yet bar code systems would significantly improve the quality of patient care through reduction of medication errors. It is estimated that over a 20-year period, fully implemented bar code systems would prevent about .5 million medical errors. Moreover, by improving the cost-efficiency of medical supply management, hospitals would also reap $90 billion in savings, which would help to pay for the technology (Becker, 2004).
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

27. Effective Inventory Management
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.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

28. Effective Inventory Management
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
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

29. Effective Inventory Management
The A-B-C Approach: Classifying inventory according to some measure of importance and allocating control efforts accordingly.
A relative importance
classification system
A - very important (15-20% of items; % of $$$s)
B - moderate
C - least important (60-70% of items; 10% $$$s)
Tightest controls and
management should be on
A items 20 40 60
% of
Items
Annual
dollar
volume A B C
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

30. Table 11.1 A-B-C Classification Analysis
Item
Annual
Demand
Unit
Cost
costs
Percent
of Total
A-B-C
Classification 1
20800
2.50
52000
1.2% C 2
83200
0.50
41600
1.0% 3
9100
37.50
341250
8.0% B 4
13000
3.50
45500
1.1% 5
1.75
22750
0.5% 6
790
24.0% A 7
78000
2.25
175500
4.1% 8
114400
0.65
74360
1.8% 9
66040
0.95
62738
1.5% 10
6240
12.50 11
11440
2.00
22880 12
18200
1.50
27300
0.6% 13
910
27.9% 14
315
850500
20.1% 15
65000
3.75
243750
5.7%
Total Annual Costs
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

31. EOQ Model Remember what the costs are? ECONOMIC ORDER QUANTITY 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.
Remember what the costs are?
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

32. Figure 11.2 The Inventory Order Cycle for Basic EOQ Model
Order Quantity, Q
Cycle 1
Cycle 2
Cycle 3
Cycle 4 Q
Depletion or
Demand Rate
Average inventory
Level of Inventory R
(ROP)
Required
safety stock
Time (days)
Reorder Point
Reorder Time
Order Received
Lead Time
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

33. Average inventory level and number of orders per year are
inversely related. WHY?
Many orders, but low average inventory. Q
Average Inventory
1 year Q
Average Inventory
Few orders but high average inventory.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

34. To refresh 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.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

35. Holding & Ordering Costs Conceptualized
Order Quantity
Annual Cost
Order Quantity
Annual Cost Q 2 D Q H S
Ordering costs (S) are inversely
and nonlinearly related to
order size (Q).
Carrying costs (H) are linearly
related to order size (Q). Q 2 D Q
Annual Carrying Cost = H
Annual ordering costs = S
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

36. Figure 11.3 The Economic Ordering Quantity Model
Total cost
Minimum TC
Annual cost
Holding cost
Qo Flexibility zone for
Packaging requirements
Ordering cost
Order Quantity, Q
Marginal cost for
packaging requirements
Economic Ordering Quantity (EOQ)
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

37. EOQ Model ECONOMIC ORDER QUANTITY model--
It answers the question, “How much should I order?” by allowing you to determine an optimal Q0.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

38. 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, of them were used in the office. Each syringe costs $ 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, 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 $ 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: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

39. To calculate EOQ, we need to estimate the holding and ordering costs.
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: *1.5*.06 = $450.
Total annual holding costs = = 1320.
Annual holding cost per syringe: 1320 ÷ = $.033.
Ordering cost
Office assistant’s time – 3 hours * ( ) = $36.75.
Overhead – $4.50.
Total ordering cost – $ $4.50 = $41.25.
Using formula the EOQ formula:
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

40. Total inventory management cost calculated using formula:
Solution:
Total inventory management cost calculated using formula:
Investment cost:
Investment costs = Order quantity * price of the item, or
= Qo * p = * 1.50 = $15,
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:
In other words, order frequency is four times a year.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

41. 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?
Should we order when you are almost out
of inventory?!
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

42. 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.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

43. Constant Demand Rate and Lead Time
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.
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!
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

44. Variable Demand Rates and/or Variable Lead Times
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
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  5 day lead time + 4 boxes ROP = 14 boxes.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

45. 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.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

46. Summary Again
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.
Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan

47. The End Chapter 11: Quantitatve Methods in Health Care Management
Yasar A. Ozcan