Medical Device & Diagnostic Industry Magazine | MDDI Article Index An MD&DI May 1997 Feature LOGISTICS As device companies refine their logistics, focusing on three key areas will enable them to cut costs and provide more value to customers.

May 1, 1997

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

An MD&DI May 1997 Feature


As device companies refine their logistics, focusing on three key areas will enable them to cut costs and provide more value to customers.

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.


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 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.


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.

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