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

Chapter 11: Quantitatve Chapter 11: Quantitatve Methods in Health Care Methods in Health Care ManagementManagement

Yasar A. OzcanYasar A. Ozcan 11

Chapter 11.Chapter 11.Supply Chain & Inventory Supply Chain & Inventory

ManagementManagement

Chapter 11.Chapter 11.Supply Chain & Inventory Supply Chain & Inventory

ManagementManagement



OutlineOutline 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



Healthcare Supply ChainHealthcare Supply ChainIn 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).



Improve operations Increasing levels of outsourcing Increasing transportation costs Competitive pressures Increasing globalization Increasing importance of e-commerce Complexity of supply chains Manage inventories

Need for Healthcare Supply Chain ManagementNeed for Healthcare Supply Chain Management



Manufacturers/Suppliers

Distributors

Providers

End Users

Ups

tre

amD

own

stre

am

PharmaceuticalMedical-SurgicalDevices

WholesalersGroup Purchasing Organization (GPOs)e-Distributors

HospitalsHospital SystemsPhysiciansIntegrated Delivery Networks (IDNs)

Patients/IndividualsEmployersInsurersHMOsDrug Benefit AgenciesGovernment

Figure 11.1 Healthcare Supply Chain



Healthcare Supply ChainHealthcare Supply ChainManufacturers/Suppliers. Manufacturers of medical

supplies can be classified in three categories: 1) drugs/pharmaceutical, 2) medical-surgical supplies, and 3) devices.

Some manufacturers produce supplies in more than onecategory or in all categories.



Healthcare Supply ChainHealthcare 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 aredistributed to providers (hospitals and other institutionalsettings) via distributors.

Medical-surgical companies produce items such as injectionsyringes 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 oftheir products through distributors.




Medical devices can be described as very high priced,technologically sophisticated and advanced apparatus thatare used for diagnosis and therapies.

Medical devices include surgical and medical instrumentsAnd apparatus, orthopedic, prosthetic and surgicalappliances (for example, shoulder, knee, and hipreplacements), X-Ray apparatus, tubes, irradiationapparatus, electro-medical and electro-therapeutic devices.

Dupuy, Ortho Biotech, Medtronic, and Zimmer are examplesof the companies that manufacture such devices (Burns,2002; p.244).



Supplier

Supplier

Storage} Service Patient

Typical Supply Chain for a Healthcare ServiceTypical Supply Chain for a Healthcare Service

Operating RoomImplantsReplacement kneeReplacement valve




Distributors for medical-surgical supplies are independentintermediaries who operate their own warehouses; theypurchase the products from manufacturers/suppliers to sellto providers.

Similarly, pharmaceutical intermediariespurchase the drugs/pharmaceuticals from manufacturersand wholesale them to pharmacies or to providers. Well known distributors of pharmaceuticals includeAmriSource/Bergen Brunswig, Cardinal Health/BindleyWestern and McKesson.

The intermediaries are called distributor or wholesalersdepending on whether the products’ final resale has anotherlayer before reaching the customer (Burns, 2002; p.127).Cardinal Health, Owens&Minor, and McKesson are majordistribution companies in hospital market.

Distributors and Wholesalers




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.130-131).

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.



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

Electronic Data Interchange (EDI)Electronic Data Interchange (EDI)

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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. 60-64).




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.




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.




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.



Contemporary Issues in Medical Inventory ManagementContemporary 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.



Inventory Is. . .Inventory Is. . .Inventory Is. . .Inventory Is. . .STOCK OR STORE OF GOODSSTOCK OR STORE OF GOODS

Or Stock Keeping Items (SKUs)Or Stock Keeping Items (SKUs)STOCK OR STORE OF GOODSSTOCK OR STORE OF GOODS

Or Stock Keeping Items (SKUs)Or Stock Keeping Items (SKUs)

Traditional Inventory Traditional Inventory ManagementManagement

Traditional Inventory Traditional Inventory ManagementManagement



An Inventory Disaster!An Inventory Disaster!An Inventory Disaster!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,..Sorry sir, but when she (the patient) came into the ER, we were out of syringes. Our anticipationwe were out of syringes. Our anticipation stocks stocks were were depleted because we hadn’t corrected the ordering depleted because we hadn’t corrected the ordering patterns for patterns for seasonal variationsseasonal variations. Then, the snow delayed . Then, the snow delayed shipments from supplier, and ourshipments from supplier, and our safety stockssafety stocks just weren’t just weren’t good enough! You know we usually order in bulk to take good enough! You know we usually order in bulk to take advantages of large advantages of large economic lot sizeeconomic lot size and lower our and lower our ordering cycleordering cycle. . Our last order was especially large Our last order was especially large because we wanted to because we wanted to hedge against predicted price hedge against predicted price increasesincreases! ! In the final analysis, our inventory just wasn’t In the final analysis, our inventory just wasn’t sufficient to sufficient to permitpermit smooth operationssmooth operations……

..Sorry sir, but when she (the patient) came into the ER,..Sorry sir, but when she (the patient) came into the ER, we were out of syringes. Our anticipationwe were out of syringes. Our anticipation stocks stocks were were depleted because we hadn’t corrected the ordering depleted because we hadn’t corrected the ordering patterns for patterns for seasonal variationsseasonal variations. Then, the snow delayed . Then, the snow delayed shipments from supplier, and ourshipments from supplier, and our safety stockssafety stocks just weren’t just weren’t good enough! You know we usually order in bulk to take good enough! You know we usually order in bulk to take advantages of large advantages of large economic lot sizeeconomic lot size and lower our and lower our ordering cycleordering cycle. . Our last order was especially large Our last order was especially large because we wanted to because we wanted to hedge against predicted price hedge against predicted price increasesincreases! ! In the final analysis, our inventory just wasn’t In the final analysis, our inventory just wasn’t sufficient to sufficient to permitpermit smooth operationssmooth operations……



The COO’s ResponseThe COO’s Response(i.e., Inventory objectives and requirements)(i.e., Inventory objectives and requirements)

The COO’s ResponseThe COO’s Response(i.e., Inventory objectives and requirements)(i.e., Inventory objectives and requirements)

I hope you do realize that it is your I hope you do realize that it is your duty to both duty to both maintain a high level maintain a high level of customer service of customer service and and minimize minimize the costs of ordering and carrying the costs of ordering and carrying inventoryinventory! All I ask of you is that ! All I ask of you is that you make two fundamental you make two fundamental decisions-- decisions-- when to order and how when to order and how much to ordermuch to order. .

I hope you do realize that it is your I hope you do realize that it is your duty to both duty to both maintain a high level maintain a high level of customer service of customer service and and minimize minimize the costs of ordering and carrying the costs of ordering and carrying inventoryinventory! All I ask of you is that ! All I ask of you is that you make two fundamental you make two fundamental decisions-- decisions-- when to order and how when to order and how much to ordermuch to order. .



Effective Inventory ManagementEffective Inventory ManagementEffective Inventory ManagementEffective 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

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




Inventory counting systems can be Inventory counting systems can be either:either:– PeriodicPeriodic– PerpetualPerpetual

BatchBatch LineLine

Inventory counting systems can be Inventory counting systems can be either:either:– PeriodicPeriodic– PerpetualPerpetual

BatchBatch LineLine



Inventory Counting SystemsInventory Counting Systems Periodic SystemPeriodic System

Physical count of items made at periodic intervalsPhysical count of items made at periodic intervals Perpetual Inventory System Perpetual Inventory System

System that keeps track System that keeps track of removals from inventory of removals from inventory continuously, thus continuously, thus monitoringmonitoringcurrent levels of current levels of each itemeach item



Inventory Counting Systems (Cont’d)Inventory Counting Systems (Cont’d) Two-Bin System - Two-Bin System - Two containers of Two containers of

inventory; reorder when the first is inventory; reorder when the first is emptyempty

Universal Bar Code - Universal Bar Code - Bar code Bar code printed on a label that hasprinted on a label that hasinformation about the item information about the item to which it is attachedto which it is attached

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Inventory Counting Systems (Cont’d)Inventory Counting Systems (Cont’d)

Universal Product Codes (UPCs).Universal Product Codes (UPCs). The UPCs have The UPCs have been around since late 1970s and are used in been around since late 1970s and are used in industry. A UPC can have up to 20 character industry. A UPC can have up to 20 character numbers that uniquely identify a product, for numbers that uniquely identify a product, for example, of pharmaceutical or medical-surgical example, of pharmaceutical or medical-surgical supply, using bars with different variety and supply, using bars with different variety and thickness that can be read by scanners. The thickness that can be read by scanners. The order of the information in UPCs identifies the order of the information in UPCs identifies the type of product, its manufacturer, and the type of product, its manufacturer, and the product itself. product itself.

0

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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).

Universal Product Codes (UPCs).Universal Product Codes (UPCs).




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.

Lead Time





Costs of InventoryCosts of Inventory::– Holding (carrying costs)-- Holding (carrying costs)-- interest, insurance, interest, insurance,

depreciation, obsolescence, deterioration, depreciation, obsolescence, deterioration, spoilage, pilferage, warehousing costsspoilage, pilferage, warehousing costs

– Ordering costs-- Ordering costs-- associated with ordering associated with ordering and receiving inventoryand receiving inventory

– Shortage costs-- Shortage costs-- when demand > supply on when demand > supply on hand; opportunity costs of lost customers hand; opportunity costs of lost customers loss of goodwill; death of a patient and loss of goodwill; death of a patient and potential lawsuitspotential lawsuits

Costs of InventoryCosts of Inventory::– Holding (carrying costs)-- Holding (carrying costs)-- interest, insurance, interest, insurance,

depreciation, obsolescence, deterioration, depreciation, obsolescence, deterioration, spoilage, pilferage, warehousing costsspoilage, pilferage, warehousing costs

– Ordering costs-- Ordering costs-- associated with ordering associated with ordering and receiving inventoryand receiving inventory

– Shortage costs-- Shortage costs-- when demand > supply on when demand > supply on hand; opportunity costs of lost customers hand; opportunity costs of lost customers loss of goodwill; death of a patient and loss of goodwill; death of a patient and potential lawsuitspotential lawsuits




A relative importance classification system

– A - very important (15-20% of items; 60-70% of $$$s)

– B - moderate– C - least important (60-

70% of items; 10% $$$s)

Tightest controls and management should be on

A itemsA items

A relative importance classification system

– A - very important (15-20% of items; 60-70% of $$$s)

– B - moderate– C - least important (60-

70% of items; 10% $$$s)

Tightest controls and management should be on

A itemsA items

0

20

40

60

60

40

20

% ofItems

% ofAnnualdollarvolume

The A-B-C Approach: Classifying inventory according to some measure of importance and allocating control efforts accordingly.

A

B

C



Table 11.1 A-B-C Classification Analysis

Item AnnualDemand

UnitCost

Annualcosts

Percentof Total A-B-C

Classification

1 20800 2.50 52000 1.2% C

2 83200 0.50 41600 1.0% C

3 9100 37.50 341250 8.0% B

4 13000 3.50 45500 1.1% C

5 13000 1.75 22750 0.5% C

6 790 1290.00 1019100 24.0% A

7 78000 2.25 175500 4.1% B

8 114400 0.65 74360 1.8% C

9 66040 0.95 62738 1.5% C

10 6240 12.50 78000 1.8% C

11 11440 2.00 22880 0.5% C

12 18200 1.50 27300 0.6% C

13 910 1300.00 1183000 27.9% A

14 315 2700.00 850500 20.1% A

15 65000 3.75 243750 5.7% B

Total Annual Costs 4240228



EOQ ModelEOQ ModelEOQ ModelEOQ Model

ECONOMIC ORDER QUANTITY ECONOMIC ORDER QUANTITY model--model--

It answers the question, “It answers the question, “How much How much should I ordershould I order?” by allowing you to ?” by allowing you to determine an determine an optimaloptimal order quantity in order quantity in terms of minimizing the sum of certain terms of minimizing the sum of certain annual costs that vary with order costs.annual costs that vary with order costs.

ECONOMIC ORDER QUANTITY ECONOMIC ORDER QUANTITY model--model--

It answers the question, “It answers the question, “How much How much should I ordershould I order?” by allowing you to ?” by allowing you to determine an determine an optimaloptimal order quantity in order quantity in terms of minimizing the sum of certain terms of minimizing the sum of certain annual costs that vary with order costs.annual costs that vary with order costs.

Remember what the costs are?



Leve

l of I

nve

nto

ry

Q

Reorder Point

R

Reorder Time Order ReceivedLead Time

Depletion orDemand Rate

Time (days)

Order Quantity, Q

Figure 11.2 The Inventory Order Cycle for Basic EOQ Model

Requiredsafety stock

Cycle 1 Cycle 2 Cycle 3 Cycle 4

2

Q

Average inventory

2

Q

(ROP)

0



Average inventory level and number of orders per year areAverage inventory level and number of orders per year areinversely related. inversely related. WHY?WHY?

Average inventory level and number of orders per year areAverage inventory level and number of orders per year areinversely related. inversely related. WHY?WHY?

0Many orders, but low average inventory.

Q

Average Inventory

Average Inventory0

Q

Few orders but high average inventory.

1 year



To refresh memory. . To refresh memory. . To refresh memory. . To refresh memory. . Basic EOQ models minimize the sum of the Basic EOQ models minimize the sum of the holdingholding

and and orderingordering costs of inventory. costs of inventory. Several assumptions are important to use for the Several assumptions are important to use for the

model:model:– Only one product is involvedOnly one product is involved– Annual usage (demand) requirements are knownAnnual usage (demand) requirements are known– Usage is spread evenly throughout the year so Usage is spread evenly throughout the year so

that usage rates are fairly constantthat usage rates are fairly constant– Lead time does not varyLead time does not vary– Each order is received as a single deliveryEach order is received as a single delivery– There are no quantity discounts.There are no quantity discounts.

Basic EOQ models minimize the sum of the Basic EOQ models minimize the sum of the holdingholding and and orderingordering costs of inventory. costs of inventory.

Several assumptions are important to use for the Several assumptions are important to use for the model:model:– Only one product is involvedOnly one product is involved– Annual usage (demand) requirements are knownAnnual usage (demand) requirements are known– Usage is spread evenly throughout the year so Usage is spread evenly throughout the year so

that usage rates are fairly constantthat usage rates are fairly constant– Lead time does not varyLead time does not vary– Each order is received as a single deliveryEach order is received as a single delivery– There are no quantity discounts.There are no quantity discounts.



Order Quantity

An

nua

l Cos

t

Order Quantity

An

nua

l Cos

t

Q2

H DQ

S

Carrying costs (H) are linearlyCarrying costs (H) are linearlyrelated to order size (Q).related to order size (Q).

Annual Carrying Cost =Annual Carrying Cost = QQ22

HH

Ordering costs (S) are inverselyOrdering costs (S) are inverselyand nonlinearly related toand nonlinearly related to

order size (Q).order size (Q).

Annual ordering costs =Annual ordering costs = DDQQ

SS

Holding & Ordering Costs Conceptualized



Holding cost

Total cost

Ordering cost

HQ

2

SQ

D

SQ

DH

QTC

2

Ann

ual c

ost

MinimumTC

Order Quantity, Q

Economic Ordering Quantity (EOQ)

Figure 11.3 The Economic Ordering Quantity Model

'oC

oC

oQ

Qo Flexibility zone for Packaging requirements

Marginal cost forpackaging requirements



EOQ ModelEOQ ModelEOQ ModelEOQ Model

ECONOMIC ORDER ECONOMIC ORDER QUANTITY QUANTITY model--model--

It answers the It answers the question, “question, “How much How much should I ordershould I order?” by ?” by allowing you to allowing you to determine an determine an optimal optimal QQ00..

ECONOMIC ORDER ECONOMIC ORDER QUANTITY QUANTITY model--model--

It answers the It answers the question, “question, “How much How much should I ordershould I order?” by ?” by allowing you to allowing you to determine an determine an optimal optimal QQ00..

H

DSQo

2



Example 11.1:Example 11.1: Syringe Inventory Syringe InventoryAn orthopedic physician group practice uses 12cc syringes from Sherwood for their cortisone injections. During the each of last two years, 40000 of them were used in the office. Each syringe costs $1.50. 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 $60,000. 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 $4.50. 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?



Solution: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: 5000 *1.5*.06 = $450.

Total annual holding costs = 750 + 120 + 450 = 1320.Annual holding cost per syringe: 1320 ÷ 40000 = $.033.

Ordering costOffice assistant’s time – 3 hours * (9.00+3.25) = $36.75.Overhead – $4.50.Total ordering cost – $36.75 + $4.50 = $41.25.Using formula the EOQ formula:

H

DSQo

2

000,10033.

25.41*40000*20 Q



Solution:Solution:Total inventory management cost calculated using formula:

Investment cost:Investment costs = Order quantity * price of the item, or= Qo * p = 10000 * 1.50 = $15,000.00.

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.

orTC 25.4110000

40000033.

2

10000

.00.330$00.16500.165 TC

Order Frequency is calculated using formula:

In other words, order frequency is four times a year.

D

QCycleOrderofLength 0

monthsthreeeveryoryears25.40000

10000



SummarySummarySummarySummary

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?!

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?!



The The reorder pointreorder point occurs when the occurs when the quantity on hand drops to a quantity on hand drops to a predetermined amount.predetermined amount.

There are 4 determinants of the There are 4 determinants of the reorder point quantity:reorder point quantity:– Rate of demandRate of demand– Length of lead timeLength of lead time– Extent of demand and lead time Extent of demand and lead time

variabilityvariability– Degree of stock-out risk Degree of stock-out risk

acceptable to management.acceptable to management. Demand Rates and LeadDemand Rates and Lead Times can Times can

be be constant or variableconstant or variable..

The The reorder pointreorder point occurs when the occurs when the quantity on hand drops to a quantity on hand drops to a predetermined amount.predetermined amount.

There are 4 determinants of the There are 4 determinants of the reorder point quantity:reorder point quantity:– Rate of demandRate of demand– Length of lead timeLength of lead time– Extent of demand and lead time Extent of demand and lead time

variabilityvariability– Degree of stock-out risk Degree of stock-out risk

acceptable to management.acceptable to management. Demand Rates and LeadDemand Rates and Lead Times can Times can

be be constant or variableconstant or variable..

When to Order?When to Order?When to Order?When to Order?



Constant Demand Rate and Lead TimeConstant Demand Rate and Lead TimeThere is no risk of a stock-out created by increased demand oflead times longer than expected. Thus, ROP equals the product of usage rate and lead time; no cushion stock is necessary.

There is no risk of a stock-out created by increased demand oflead times longer than expected. Thus, ROP equals the product of usage rate and lead time; no cushion stock is necessary.

Example 11.2An 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!



Variable Demand Rates and/or Variable Variable Demand Rates and/or Variable Lead TimesLead TimesVariable Demand Rates and/or Variable Variable Demand Rates and/or Variable Lead TimesLead Times

Example 11.3 A dentist office uses an average of 2 boxes ofgloves (100-glove boxes) per day, and leadtimes average 5 days. Because both theusage rate and lead times are variable, theoffice 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.

Example 11.3 A dentist office uses an average of 2 boxes ofgloves (100-glove boxes) per day, and leadtimes average 5 days. Because both theusage rate and lead times are variable, theoffice 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.

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



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.

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.

Variable Demand Rates and/or Variable Lead Variable Demand Rates and/or Variable Lead TimesTimes



Summary AgainSummary Again Summary AgainSummary 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.

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.



The End

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