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Healthcare Operations

Management
An Integrated Approach to
Improving Quality and Efficiency
Chapter 13. Supply Chain
Management
Daniel B. McLaughlin
Julie M. Hays

Chapter 13
Supply Chain Management
What is Supply Chain Management (SCM)?
Why is SCM Important for Healthcare
Organizations?
Tracking and Managing Inventory
Forecasting
Order Amount and Timing
Inventory Systems
Procurement and Vendor Relationship
Management
Strategic SCM
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Supply Chain Management (SCM)


The management of all activities and
processes related to both upstream vendors
and downstream customers in the value
chain
Tracking and managing demand, inventory,
and delivery
Procurement and vendor relationship
management
Technology enabled
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SCM in Healthcare
In 2006, the United States will spend over
$2 trillion on healthcare.
Annual cost/family for health insurance is
forecasted to be $22,000 by 2010.
By 2016, it is predicted that one dollar of
every five dollars of the U.S. economy will
be devoted to healthcare.

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SCM in Healthcare
Supply costs in hospitals account for 1525
percent of operating costs (HFMA 2002;
HFMA 2005).
Transaction costs are estimated at $150 per
order for buyer and seller (HFMA 2001).
There is 35 percent inconsistency between
hospital and supplier data, and it costs $15
to $50 to research and correct a single
order discrepancy.
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Inventory
Inventory is the stock of items held to meet
future demand.
Inventory management answers three
questions:
- How much to hold
- How much to order
- When to order

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Functions of Inventory
To meet anticipated demand
To level process flow
To protect against stockouts
To take advantage of order cycles
To help hedge against price increases or to
take advantage of quantity discounts
To decouple process steps
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Effective Inventory Management

Classification system
Inventory tracking system
Reliable forecast of demand
Knowledge of lead times
Reasonable estimates of:
- Holding or carrying costs
- Ordering or setup costs
- Shortage or stockout costs

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ABC Classification System


Classifying inventory according to some measure
of importance and allocating control efforts
accordingly
Pareto Principle

-A very important
-B moderately
important

-C least important

High (80%)

Annual
$ volume
of items

A
B
C

Low (5%)
Few
(20%)

Many
(50%)

Number of Items

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Inventory Tracking
Track additions and removals
- Bar-coding
- Point of use or point of sale (POS)
- RFID

Physical count of items


- Periodic intervals
- Cycle count
- Find and correct errors

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Forecasting

Exercise
Averaging methods
Trend, seasonal, and cyclical models
Model development and evaluation
VVH example

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Forecasting
Exercise I

Identify the pattern and construct a


formula that will predict successive
numbers in the series.
What is the next number in the series?
(a) 3.7, 3.7, 3.7, 3.7, 3.7, 3.7, 3.7, 3.7
(b) 2.5, 4.5, 6.5, 8.5, 10.5, 12.5, 14.5, 16.5
(c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5

What is the formula for the next number in


the series?

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Exercise IGraphs
Series b

18

16

Series a

14

12

10
Series1
8

0
1

Series c

10.0

9.0

8.0

7.0

6.0

Series1

5.0

4.0

3.0

2.0

1.0

0.0
1

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Exercise I Solution
a)

3.7, 3.7, 3.7, 3.7, 3.7, 3.7, 3.7, 3.7


-

Constant

Next number is 3.7

b)

2.5, 4.5, 6.5, 8.5, 10.5, 12.5, 14.5, 16.5


-

c)

0.5 + 2x, where x specifies the position (index) of the number in the
series
Next number is 18.5

5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5


-

4.5 + 0.5x + Cs, where x specifies the position (index) of the number in
the series
Cs represents the seasonality factor
C1 = 0, C2 = 2, C3 = 0, C4 = 2
Next numbers: 9, 11.5, 10, 8.5

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Exercise II
Identify the pattern and construct a formula
that will predict successive numbers in the
series.
What is the next number in the series?
(a) 4.1, 3.3, 4.0, 3.8, 3.9, 3.4, 3.5, 3.7
(b) 2.9, 4.7, 6.8, 8.2, 10.3, 12.7, 14.2, 16.3
(c) 5.3, 7.2, 6.4, 4.5, 6.8, 9.7, 8.2, 6.3

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Exercise II Solution
Same as series above, but with a random
component generated from normal random
number generator with mean 0
(a) 4.1, 3.3, 4.0, 3.8, 3.9, 3.4, 3.5, 3.7
3.7 +

(b) 2.9, 4.7, 6.8, 8.2, 10.3, 12.7, 14.2, 16.3


0.5 + 2x +

(c) 5.3, 7.2, 6.4, 4.5, 6.8, 9.7, 8.2, 6.3


4.5 + 0.5x + Cs +

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Forecasting Methods
Qualitative methods
- Based on expert opinion
and intuition; often used
when there are no data available

Quantitative methods
- Time series methods, causal methods

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Demand Behavior
Trend
- Gradual, long-term up or down movement

Cycle
- Up and down movement repeating over long
time frame

Seasonal pattern
- Periodic, repeating oscillation in demand

Random movements follow no pattern


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Trend

Demand

Demand

Forms of Forecast Movement


Cycle

Random
movement
Time

Seasonal
pattern

Demand

Demand

Time

Time

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Trend with
seasonal pattern
Time

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Forecasting
Averaging Methods

Simple moving average


Weighted moving average
Exponential smoothing
Averaging methods all assume that the
dependent variable is relatively constant
over time; no trends or cycles

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Simple Moving Average


Average over a given number of periods that
is updated by replacing the data in the oldest
period with that in the most recent period

D
Dt n
t 1
t 2
n

Ft = Forecasted demand for the period


Dt-1 = Actual demand in period t 1
n = Number of periods in the moving average

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Weighted Moving Average


Simple moving average where weights are
assigned to each period in the average.
The sum of all the weights must equal one.

Ft w D
t 1

t 1

w t 2 D t 2 w t n Dt n

Ft = Forecasted demand for the period


Dt-1 = Actual demand in period t 1
wt-1 = Weight assigned to period t 1

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Exponential Smoothing
Times series forecasting technique that does not require large
amounts of historical data

F 1 F
t

Ft
Ft-1
Dt-1

=
=
=
=

t 1

Dt 1

Exponentially smoothed forecast for period t


Exponentially smoothed forecast for prior period
Actual demand in the prior period
Desired response rate, or smoothing constant

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Forecasting
Trend, Seasonal, and Cyclical Models
Holts trend-adjusted exponential smoothing
technique
Winters triple exponential smoothed model
ARIMA models

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Holts Trend Adjusted


Exponential Smoothing
Exponentially smoothed forecast that accounts for a trend in
the data

FITt Ft Tt
and
Ft Dt 1 ( 1 )FITt 1
Tt Tt 1 (Ft 1 -FITt 1 )
FITt = Forecast for period t including the trend
Ft = Smoothed forecast for period t
Tt = Smoothed trend for period t
Dt1 = Value in the previous period
0 = smoothing constant 1; 0 = smoothing constant 1

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Forecast Accuracy

Error = Actual Forecast


Find a method that minimizes error
Mean absolute deviation (MAD)
Mean squared error

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Forecasting
Model Development and Evaluation

Identify purpose of forecast


Determine time horizon of forecast
Collect relevant data
Plot data and identify pattern
Select forecasting model(s)
Make forecast
Evaluate quality of forecast
Adjust forecast and monitor results

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VVH Diaper Example

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VVH Simple Moving Average


F
F

t 1

Dt 2 Dt n
n

13

14

D12 D11 D10 D9

5
60 43 53 54 45
51
F 14
5

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VVH Weighted Moving Average


F t w D w D w D
F 14 w D w D w D
F 14 0.5 60 0.3 43 0.2 53 53.5
t 1

13

t 1

t 2

13

12

t 2

12

t n

11

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t n

11

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VVH Exponential Smoothing


F
F
F

Dt 1 1 F t 1

14

D13 1 F 13

14

(0.25 60) (0.75 52) 54

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VVH Comparison
(from the Excel

template)

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Realities of Forecasting
Forecasts are seldom perfect.
Most forecasting methods assume that
there is some underlying stability in the
system.
Service family and aggregatedI see
service
that you will
forecasts are more accurate get an A this semester.
than individual service
forecasts.

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Order Amount and Timing


How much to hold
How much to order
When to order
Basic economic order quantity (EOQ)
Fixed order quantity with safety stock
More models

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Definitions
Lead timetime between placing an order and
receiving the order
Holding (or carrying) costscosts associated with
keeping goods in storage
Ordering (or setup) costscosts of ordering and
receiving goods
Shortage costscosts of not having something in
inventory when it is needed
Back ordersunfilled orders
Stockoutsoccur when the desired good is not
available
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Definitions
Independent demand is demand that is
generated by the customer and is not
a result of demand for another good or
service.

Dependent demand is demand that


results from another demand.
Demand for tires and steering
wheels (dependent) is related to
the demand for cars (independent).
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Assumptions of the
Basic EOQ Model
Demand for the item in question is
independent.
Demand is known and constant.
Lead time is known and constant.
Ordering costs are known and constant.
Back orders, stockouts, and quantity
discounts are not allowed.

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Inventory Order Cycle


Demand
rate

Order
quantity, Q

Average
amount of
inventory
held = Q/2

Inventory
Level
Reorder
point, R
0
Time

Lead
time
Order Order
Placed Received

Lead
time
Order
Placed

Order
Received

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Reorder Point
The point in time by which stock must be ordered
to replenish inventory before a stockout occurs

R dL
R = Reorder point
d = average demand per period
L = lead time (in the same units as above)

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EOQ Model Cost Curves


Annual
cost ($)

Minimum
Total Cost

Total Cost
Holding Cost = h*Q/2

Ordering Cost = o*D/Q

Q OPT

Order
Optimal
Quantity, Q
Order Quantity
2Do
2(Annual Demand)(Order or Setup Cost)
=
=
h
Annual Holding Cost

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EOQ Model Insights


As holding costs increase, the optimal order
quantity decreases. (Order smaller amounts
more often because inventory is expensive
to hold.)
As ordering costs increase, the optimal
order quantity increases. (Order larger
amounts less often because it is expensive
to order.)

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EOQ Model Implications


Total Cost
Annual
Cost ($)

Holding Cost

Ordering Cost
Q*

Q*
Order Quantity

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EOQ Model Implications


Annual
Cost ($)

Total Cost

Holding Cost

Ordering Cost
Q*

Q*

Order Quantity
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VVH Diaper Example

Cost $5/case
Holding costs 33% or $1.67/case-year
Ordering costs $100
Lead time 1 week
She calculates annual demand as:
D d period
53.5 cases of diapers
2,782 cases

week

52 weeks

year

year

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VVH Diaper Example


She calculates the reorder point as
Reorder point R d L
53.5 cases
1 week 53.5 cases
week

She calculates the EOQ as:


2 o D
Economic order quantity Q*
h
2 $100 2,782 cases

$1.67 case
333,174 cases 2 577 cases

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VVH Diaper Example

Annual demand
Ordering cost per order (setup)
Annual carrying cost per unit
Working days per year
Economic order quantity

D=
S=
H=
=
EOQ =

Actual order quantity


Q=
Increment
DQ =
Number of orders per year
D/Q =
Length of order cycle (days)
Q/D =
Average inventory
Q/2 =
Annual carrying cost
(Q/2) * H = $
Annual ordering cost
(D/Q) * S = $
Total annual cost
TC = $

2,782
100
1.67
365
577.21
577
500
4.8
75.7
288.5
481.80
482.15
963.94

units/year
$/order
$/unit-year
days/year
units

orders/year
days
units

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Reorder Point with Safety Stock


Order
quantity (Q)

Inventory
level
Reorder
point (R)

Safety
stock (SS)

0
Lead
time

Time

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Lead
time

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Reorder Point with Safety Stock


Reorder point

R d L SS
Safety stock

SS z L

where
z is the z-score associated with the desired service
level (number of standard deviations above the
mean)
L= standard deviation of demand during lead time
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Normal(100, 20)
2.5

Safety Stock

2.0

Normal(100, 20)
2.5

1.5

BestFit Student Version


Probability of
meeting demand during
lead time = service level = 84%

Reorder
point

For Academic Use Only

2.0

1.0

1.5

BestFit Student Version

0.5

For Academic Use Only

0.5

<
-Infinity

84.1%

140

120

100

80

60

40

0.0

Probability of
a stockout = 16%
160

1.0

15.9%

>

120.0

<
-Infinity

84.1%

15.9%

160

120

140

100

120

100

80

Example
units

60

40

0.0

>

120.0

Average demand during


Lead time = dL
Z

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Model Insights
As the desired service level increases, the
amount of safety stock increases. (If fewer
stockouts are desired, more inventory must
be carried.)
As the variation in demand during lead time
increases, the amount of safety stock
increases. (If demand variation or lead time
can be decreased, less safety stock is
needed.)
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VVH Diaper Example


Desired service level = 95 percent
- With five orders/year, this means that the hospital would
experience one stockout every four years

Standard deviation of demand during lead = L =


11.5 cases of diapers
Amount of safety stock needed:
SS z L 1.64 11.5 18.9 cases
New reorder point:

R d L SS 53.5 cases

week

1 week 18.9 cases 72.4 cases

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VVH Diaper Example


Average daily
demand

d=

7.64

units

Average lead time

L=

days

Std dev demand during lead


time

L =

11.5

units

Service level

SL =

0.95

Increment

SL =

Stock out risk

0.05

z associated with service level

1.64

Average demand during lead


time

dL =

53.48

units

Safety
stock

SS =

18.9

units

ROP =

72.4

units

Reorder point

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VVH Diaper Example


Average demand
= 53.5
cases/week

Order
quantity (577)

Inventory
level

Safety
stock (19)

Reorder
point (72)

0
Lead
time =
1 week

Time

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Lead
time

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More Inventory Models


Fixed period with safety stock
- Orders are bundled and/or vendors deliver
according to a set schedule

Quantity discounts
Price breaks
Etc.

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Inventory Systems

Simple
JIT
MRP
ERP

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Two-Bin System
When the first bin is empty,
stock is taken from the
second bin and an order is
placed. There should be
enough stock in the second
bin to last until more stock
is delivered.

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JITKanbans

Microsoft Visio screen shots reprinted with permission from Microsoft Corporation.

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Flow and Pull


Continuous or single piece flowmove items
(jobs, patients, products) through the steps of the
process one at a time without interuptions or
waiting.
Pull or just-in-time (JIT)products or services are
not produced until the downstream customer
demands them.
Heijunka (i.e., make flat and level)eliminate
variation in volume and variety of production.
- Level patient demand
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Enterprise Information
Technology Trends
E-Commerce

E-Business

Automation
Data Processing
Computer
Integrated
Manufacturing

Concurrent
Engineering
ERP

Collaborative
Engineering
Business Webs

SCM
Appliances

MRP II
Handheld

MRP I
Microcomputer

CAD/CAM
Minicomputer
Mainframe

Networks TCP/IP

Mobile Networks

196019701980199020002010
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MRP Product Structure


Table
(end item)
Lead time = 1 week

Table top
(1)
Lead time = 2 weeks

Leg
(4)
Lead time = 3 weeks

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MRP Logic
Order
table tops

Order
table legs

Week

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ERP Systems Link Functional


Areas

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Procurement and Vendor


Relationship Management

E-procurement
Value-based standardization
Outsourcing
Vendor managed inventory (VMI)
Automated supply carts
Group purchasing organizations (GPO)
Disintermediation

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Strategic Supply Chain


Management
Many are the same as any other
improvement/change initiative:
Top management support
Employee buy-in
Structure and staffing need to support the desired
improvements
Process analysis and improvement
Need relevant, accurate data and metrics
Training
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Strategic Supply Chain


Management
Need to evaluate cost and benefits of
technology-enabled solutions
Need to highlight the necessity and benefits
of strategic supply chain management
Improved inventory management through
better understanding of the systems
- Consequences of unofficial inventory
- Just-in-time systems
- Improved inventory tracking systems
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Strategic Supply Chain


Management
Vendor partnerships
- Information sharing
- Investigation and determination of mutually
beneficial solutions
- Performance tracking

Continually educate and support a systemwide view of the supply chain and seek
improvement for the system rather than for
individual departments or organizations in that
system.
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