14 DESIGNING AND MANAGING THE SUPPLYCHAIN

MeditechSurgical

Three years after Meditech was spun off from itsparent company, Meditech captured a majority of theendoscopic surgical instrument market. Its primarycompetitor, National Medical Corporation, had prac-tically invented the $800 million market just over a

. decade ago. But Meditech competed aggressively,developing new, innovative instruments and sellingthem through a first-class sales force. The combina-tion paid off, and Meditech had become a phenomenalsuccess in a short period of time.

Despite the success, Dan Franklin, manager ofCustomer Service and Distribution, was concernedabout growing customer dissatisfaction. Metlitech hadrecently introduced several new products that werecentral to the entire Meditech product line. New prod-uct introductions, which were critical to Meditech'sstrategy of rapid product development, needed to beintroduced flawlessly to protect Meditech's reputationand sales of other products. But Meditech consistentlyfailed to keep up with demand during the flood of ini-tial orders. Production capacity became strained ascustomers waited over six weeks to have t.heirordersdelivered. Poor delivery service, which is fatal inthe health care industry, was jeopardizing Meditech'sreputation.

COMPANY BACKGROUND

Endoscopic surgical techniques fall under a class ofsurgical procedures described as minimally invasive.Minimally invasive surgery, as opposed to traditionalopen surgery, requires only small incisions to per-form an operation. As a result, procedures usingendoscopic techniques often provide substantial ben-efits for the patient both physically and financially.The procedures often shorten patient recovery, whichcan translate into reduced surgical expenses over-all. Despite the benefits and the multidecade historyof endoscopic technology, the procedures have onlybecome popular in the last 10 years.

Only three years ago, the market for endoscopicsurgical instruments was expected to double its sizein five years. Growth beyond five years also lookedpromising. Largo Healthcare Company, Meditech'sparent company, decided to spin Meditech off as anindependent company focused solely on producingand selling endoscopic surgical instruments. Largomanagement hoped that the new company would pros-per without the distractions of other Largo businessesand capture market share of endoscopic instrumentsas quickly as possible. .

Since its inception just over six years ago, Meditechhas produced innovative, low-cost products. Newproducts were brought to the market quickly andpushed by an aggressive sales force. Old productswere updated with innovative features and presented.to the market as new products. Consequently, thecompetition between Meditech and National Medicalcentered on the continuous development and intro-duction of new products by both companies. A dozenor more new products would typically be introducedby Meditech in any given year.

While the development strategies were similar, thesales strategies differed dramatically. National Med-ical concentrated on selling to surgeons. Meditecl!.:ss~s force conce~trated on sellil!&.!2.hosp.itals m~-ial manag~_aS.JYelL!.$ tP s.urg~oo$.-Material man-agers tended to be more concem~d_wth £9st~ap.ddelivery perforrpance:-'The surgeons, on the otherhand, fociiSed on ,Product {~::I~s. As the pres-sures increased on health care costs, the ~o~!llan~t:~JmJ.£.b.~sing. position .alsoincreased. Meditech was well positioned to take--aovaiiiage of this important shift.

The success of Meditech's strategy quickly becameevident. Within six years" Meditech had capturedthe leading share in the endoscopic surgical instru-ment market. This was no small feat by any market'sstandards, but with surgical instruments this wasespecially impressive. Market share changes in theprofessional health care industry tended to 'take placegradually. Surgeons and doctors often held onto pre-ferred manufacturers. Hospitals frequently used gJ1)upp~chasing org,anizations (GPOs) that took advantageof extended contracts with suppliers. The process of~ -

Source: Copyright @ 1995 by Massachusetts Institute of Technology. This case was prepared by LFM Fellow Bryan Gilpin under the directionof Professor Stephen C. Graves as the basis for class discussion.

"converting" a hospital to a new supplier often tookmonths of negotiation and convincing.

Most endoscopic surgical instruments are smallenough to fit into the palm of a surgeon's hand.They are mechanical in nature, typically having sev-eral intricate mechanisms to provide the requiredfunctionality. Materials used to produce the instru-ments include plastic injection-molded parts, metalblades, springs, and so forth. In all cases of use,surgeons use the instrument for one op~atiAD.-andtheruwme-diately dispose of it Instruments are neverresterilized and reused for another patient. All inall, the Meditech product line consists of over 200-sep~ate end-oLQd!lcts.

DISTRIBUTION

Meditech distributes all its goods from a central ware-hou e sin wo rim channels-dome tic dealersand international affiliates-to distribute its pro uctstroiiithe central warehouse to end-customers (i.e.,hospitals). The first channel, for domestic sales only,uses domestic distributors, or dealers, to ship to hos-pitals. The dealers order and receive products frommultiple manufacturers, including Meditech, typi-cally stocking hundreds of different products. Stockedproducts range from commodity items, such as surgi~cal gloves and aspirin, to endoscopic surgical instru-ments. By using dealers to supply products, hospitalsdo not need to order directly from manufacturers fortheir diverse needs. Additionally, since dealers main-tain regional warehouses all over the United States, thedistance between dealer warehouses and most hospi-tals tends to be quite small. T~ short distance oermitsfrequent replenishments of hos ital inven ries; insome c s, c s from dealers drop off suppliesonce or twice per day. Hospitals enjoy the frequentrepleOlshments, which reduce hospital inventory and,consequently, reduce material costs.

The regional dealer warehouses act as indel2.eJ)dententitie.§ autonomously determining when to ordernew supplies and how much to order. Therefore, whileMeditech only uses four or five major distributioncompanies, it still receives orCJersfrmn, andsflips to,hilridreds of re ional, individually run warehouses.Each warehouse in tUrn s 1 s a ou a ozen or

more hospitals, resulting in thousands of hospitals thatreceive Meditech products.

The distribution channel for international sales

uses Largo Healthcare's interpational affiliates.

CHAPTER 1: INTRODUCTION TO SUPPLYCHAIN MANAGEMENT 15

International affiliates are wholly owned subsidiariesof Largo Healthcare residing outside of the UnitedStates. As with domestic dealers, affiliates distrib-ute to hospitals in their regional area. However, incontrast with domestic dealers, which may locatewithin just a few miles of customer hospitals, an affil-iate ships product throughout an entire country. FromMeditech's point of view, affiliates' orders essentiallylook no different than dealers' -international affil-iates submit orders to Meditech and Meditech fillsthem with available product.

INTERNAL OPERATIONS

The production processes to manufacture endo-scopic instruments are composed of three majorsteps: ~mbling of c°I!!l!°n~Dt parts.Jnto individ-ual or "bulk"'"lOstruments, packaging one or more

. bulk instruments into a packaged good, and steril-izing the packaged goods. Each of these steps isdescribed below.

Assembly

The assembly process is manually intensive. Compo-nent parts arrive into the assembly area from suppliersfollowing a brief inspection by Quality Assurance(QA). The parts are placed into inventory until readyfor use by one of several assembly lines. Each assem-bly line is run by a team of cross-trained productionworkers who can produce ahYof severalinstrumentswithin a product family. Line changeovers within afamily are quick and inexpensive, merely requiring awarning from the production team leader and a sup-ply of the appropriate component parts. The typicalcycle time for assembly of a batch of instruments-the time required to schedule assembly of a batch ofinstruments and then actually assemble them, assum-ing that component parts are available in componentparts inventory-is on the order of two weeks. Leadtime for component parts is on the order or ~weeks. Assembled instruments are moved from theassembly area into bulk instrument inventory, wherethey wait to be packaged.

Packaging

The packaging process makes use of several largepackaging machines. The machines direct bulk instru-ments into plastic containers and then adhere a flexiblesheet of material over the top of the container. Theentire plastic container is then placed into a finished

16 DESIGNING AND MANAGING THE SUPPLY CHAIN

cardboard container and shipp~d immediately to thesterilizer. Capacity. at the packagmg area has-notr~ output.

Sterilization

The sterilization process uses a large Cobalt radia-tlon steriJiz~r. After batches of packaged instruments(cardboard container, plastic container, and instru-ments) are placed into the sterilizer, the sterilizeris turned on for about an hour. The radiation pene-trates cardboard and plastic to destroy any potentiallyharmful contaminants. The sterilizer can sterilize asmuch product as will fit inside its four walls. Capac-ity limitations have not been a problem thus far.Sterilized instruments are immediately moved intofinished goods inventory.

The Operations Organization

The entire operations organization reports up throughthe vice president of Operations, Kenneth Strangler(see Figure 1-3 for an organization chart for Opera-tions). Functions immediately reporting to Stranglerinclude several plant managers (one for each ofMeditech's four manufacturing facilities), a directorof supplier management, and a director of planning,distribution, and customer service. Other vice pres-id~~~n) ex~sLJormarketing and ~es,

product development, andJipl-n~. All vice presi-<;1eIitsreport to the highest officer in the company,the president of Meditech. The plant managers in theorganization have responsibility for production per-sonnel, engineering technicians, quality assurance,support services, and material supply for their respec-tive facilities. Reporting directly to the plant managersare sever,albusiness units. Each business unit has fullresponsibility either for the assembly of a particu-lar product family or, in the case of packaging andsterilization, for an entire production process. Themost important job of each assembly business unit isto meet the production schedule every week.- Meet-ing the schedule ensures a constant supply of bulkinstruments to the packaging/sterilization process.The process of determining assembly and paek-ag-ing/sterilization schedules will be discussed below.

Also reporting to the vice president of Operationsare Supplier MaQagement and Planning, Distribution,and Customer Service. Supplier Management workson relationships with suppliers, including establish-ing purchasing contracts and finding new suppliersif necessary. The Planning, Distribution, and Cus-tomer Service department does everything it can toensure that customers receive product when needed.The positions within the Customer Service depart-ment include the manager of Customer Service and

DirectorSupplier

Management

DirectorPlanning, Distribution, and

Customer Service

Central Planning(J. Bolbrede)

Customer Serviceand Distribution

(D. Franklin)

Inventory(c. Stout)

Logistics(B.Slokoski)

FIGURE 1.3 The Meditech Organization Chart for operations.

Distribution, Dan Franklin; the manager of CentralPlanning; the manager of Inventory; and a managerof Logistics. Customer Service deals with everythingfrom occasional customer complaints to establishingstrategies to improve delivery service to customers.Customer Service representatives work with dealersand affiliates to keep them updated on product deliv-ery schedules and problems. Often this responsibilityplaces the Customer Service representative in directc2iltact with hQSromlpe!sonne1. .

While Customer Service handles issues concern-ing the movement of product out of finished goodsinventory, Central Planning ensures that adequatefinished goods are available to meet incoming orders.They develop monthly production...~afare usedby the business units to determine weekly and dailys~edul~ ~

Charles Stout, the Inventory manager, determinesthe finished goods inventory policy and establishesparts and bulk inventory guidelines for the businessunits. When a mandate to reduce inventory is passeddown from higher levels of management, the Inven-tory manager must determine where inventory canbe reduced and then begin enforcing those reduc-tions. Through recent efforts, Stout had successfullYeliminated several milli<2,n~o!!ars~ ob~olete_alldslow-movmg inventory.------PRODUCTION PLANNING AND SCHEDULING

The production planning and scheduling processis broken down into two parts: planning, basedon monthly fore<:~£f ~~!!!J2!L~1 comp-onemparts or~ and daily scheduling of pacbging and~erilization based on finisfied goods inventory levels.

~rTrig the fourth quarter of each fiscal year, themarketing and finance organizations determine anannual forecast. The annual forecast is then brokendown prooortionateJy, based on the number ot weeksin the month, into monthly forecasts. As the year pro-gresses, the Central Planners work with the Marketingorganization to make forecast adjustments accordingto market trends and events. At the beginning of eachmonth, the month's forecasts are adjusted and agreedupon by the Marketing organization and the CentralPlanners. .

The planning of assembly for a particular instru-ment begins with the monthly demand forecasts.Based on the, month's forecast, the Central Plan-ners determine the amount of product that needs

CHAPTER 1: INTRODUCTION TO SUPPLYCHAIN MANAGEMENT 17

to be transferred from bulk inventory into finishedgoods inventory to "meet" the expected demand.This amount, termed the finished goods "transferrequirement," is determined by subtracting the currentfinished goods inventory level from (1) the demandforecast for the month plus (2) the required safetystock. (The current safety stock policy is to maintainthree weeks' worth of rlF:m~).

The transfer requirements, once completed forall 200-plus product codes, are passed throughout theorganization for approval. This process typically takes

1place one to two weeks into the current ll1..QJ$.Whilenot actually used to schedule assembly or to alterthe packaging and sterilization processes, the ~r~~rement~ pr~)Vid~~ _.estimate Qf.!h~ requireiJoverall production for the~~th. Any problems inbeing~able to deliver to the plan can then be identifiedand resolved.

Assembly schedules and replenishment orders forparts are based on the monthly demand forecasts andcurrent inventory levels. By mid-month, the com-pleted monthly plans, which. contam .the . !ll..2,nthl'{-forecasts, are sent to the assembly business units. Aplanner in the h~siness unit plugs the ~;tsintoa Materials Requirement Planning (MRP) system,which determines weekly production schedules andcomponent parts orders for each finished product.The MRP system determines assembly schedules andparts orders based on (1Ythemonthly forecasts; (2) thelead times for assembly, packaging, and sterilization,and (3) current parts, bulk, and finished goods inven-tory levels. Although the MRP calculation may be runseveral times each week, the planner is careful not tochange weekly produ~ion §ched~!~~.l:!.F~na weers notIce. (A schedule change often requiresrescheduling workers and procuring more componentparts. O~ week's notice for responding to schedulingchanges, theretore, has been deemed adequate by the5USl~S unit managers.)

In contrast to the forecast-based scheduling of theassembly operation, the packaging and sterilizationoperations are scheduled based on as-needed replen-ishment of finished goods inventory. For purposes ofscheduling, the packaging and sterilization operationsare considered one operation because bulk instru-ments flow through packaging, into the sterilizer, andinto finished goods without being inventoried. (SeeFigure 1-4 for a diagram of the entire productionprocess.) The entire packaging/sterilization processcan be completed for a batch of instruments in about

18DESIGNING AND MANAGING THE SUPPLY CHAIN!l. ~

lW~-

Forecast Forecast -J II1/,.. V-V' ~~

FIGURE 1.4 The Medite6h production process.

Order point/Order quantity

~ d-.J",-..J ~? 1- ~~~

one week. The scheduling of packaging/sterilizationiSCrone an an order point/order quantity (OP/OQ)basis [i.e., when finished goods inventory drops belowthe predetennined order point (OP), a replenishmentorder for more packaged/sterilized product is initi-ated. The size of the order in tenns of number ofinstruments is always equal to the predetenninedorder quantity (OQ).] -

Another way to view the scheduling process is tothink of material as being "pushed" through assem-bly into bulk instrument inventory and' as being"pulled" through packaging/sterilization into fin-ished goods inventory. The push through assembly isbased on the monthly forecast detennined before themonth's demand actually arrives. The pull through

packaging/sterilization simply retlenishes what wassold fr~~nished goo~s~ ~tore.

NEW PRODUCT INTRODUCTIONS,HIGH LEVELS OF INVENTORY,AND POOR SERVICE LEVEL

Over the past several years, Meditech has introduceddozens of new products into the market, mostlyby updating existing products. Meditech plans tocontinue this strategy of continuously obsoletingits own products by constantly introducing inno-vations. While the innovative products have beenwell accepted by the marketplace, each new productintroduction has resulted in a nightmare of supplyproblems. Dan Franklin felt that customers werebeginning to tire of the poor service resulting fromeach introduction. Through many meetings with-

hospital material managers, Dan began to realizethe full scope of his customers' frustrations.

Franklin could not fi¥ure out why Meditechconsistently had shortages with each introduction.Forecasting had definitely been a problem, but deter-mining its extent was difficult. Data to measureforecast accuracy had not previously been tracked, -nor had forecasts and demand infonnation been kept.Data gathering requires a lengthy process of goingback through hard copies of prior monthly plans andentering the infonnation by hand into a computer.Even if a better methodology could be detennined,forecasts can only be improved by so much.

In addition to new product introduction prob-lems, finished ~s inventory levels appeared tobe remarKably high.i\"-cunsiTIffiiiMlaurecently 6eenIllretllo stU~ditech's inventory. Her findingsindicated that overall inventory could be reduced byat least 40 ercent without an impact on the deliv-~!Y.service lev~l (see Igll~e -. esplte t e Ighlevels of inventory, the actual service level over thepast year was disappointing and below corporateobjectives. Management feared that reducing inven-tory would further damage the already subpar levelperfonnance.

Another possible cause of the problem is "panicordering" from dealers and affiliates. Panic orderingoccurs when a dealer or affiliate is unsure of whetheror not ,product will be received in time and thereforeincreases the size of its orders ho ing that Medi chwill elver at least pari of the ord,g. The increasedorders would cause de~d to temporarily rise, help-ing to explain Meditech's problems with demandconsistently exceeding supply. Familiar with pastdelivery problems, dealers and affiliates had every-

INote on replenishment assumption: For simplicity, this chart assumes that finished goods (FG) inventory is replenished once per week with

a lead time of one week. At the beginning of each week, enough product is "ordered" so that the "pipeline" plus FG inventory equals 2~demand-weeks of product. The pipeline in this case refers to in-process product that has not yet reached FG inventory. On average, one week s

worth of demand will reside in the pipeline. This leaves, again on average, 2~ - I = I ~ demand-weeks in FG inventory at the beginning ofeach week.

CHAPTER 1: INTRODUCTION TO SUPPLY CHAIN MANAGEMENT 19

4500 Current inventory policy - 3-

/ demand-weeks4000

3500Need this much inventory (-2240 sales units=Hdemand-weeks) at the beginning of

/ each week to remain out of back order

I

3000

2500..............................................................................................................................................

2000

1500

1000

500 Weekly demandAverage weeklydemand

04-Jun 18-Jun 2-Jul 16-Jul 30-Jul

Date13-Aug 27-Aug lO-Sep 24-Sep

FIGURE 1.5 Weekly demand pattern for a representative stable productdemonstrating current levels of inventory versus consultant's recommendedinventory policy.

Weekly Net Orders for a New Product

2)'2~'"<li

r;;C/}

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

Week #

1--0-- Total Net Orders 1

FIGURE 1.6 Typical demand pattern for a new product introduction. The product wasofficially introduced near the end of week #4.

reason to w:mt to panic order. In one conversation\vith a representative from Meditech's largest dealer,the representative had indicated that panic orderingwas a possibility. Given the decentralized nature ofthe regional warehouses, the dealer has little controlover what an individual warehouse actually orders.

Warehouses could therefore panic order without theknowledge of the central dealer. On the other hand,

the possibility of panic ordenng does not mean that iit actually occurs. To make matters worse. dataproving or disproving its existence had been hardto find.

20 DESIGNING AND MANAGING THE SUPPLY CHAIN

10000

(4) Production decreases output

(2) Production increases output -, J(1) Increased demand causes back order \ ,,' 1\ ", . \ ,~ " ,

~ ,'"--- '"'-~ -'" , , ,

, " , '\'- ,,-.,', \

" .- I " ,\ ,

16000

14000

12000

0

.,.'\'c,, " I '-

/- -'

, , ,,'./ ', ... ,

" ,,' ,, \ 5) (Beginning of), " " Steady state,,- ',

,/ (3)FGinventory shoots up,

8000

6000

4000

2000

-2000Month "M~t:)th Month ,Month, ,

0 1', 2,' 3" ,'tt'

Month4

Month5

Month6

-4000

-0- Net Orders ---*- Planned Production - -D-- FG Inventory

FIGURE 1.7 Production reaction to a new product introduction. The product wasintroduced in the last 2 weeks of Month o.

7000

6000

5000

4000

3000

1000

,,,,,,,p',,,

. , IMonth 2-" Month 3 Month 4 Month 5 ,Month 6 Month 7 Month 8 Month 9, ,, ," ,

1J.. '" ," ,

"1J.. ', ," ,

" ,"d

2000

-2000

-3000

-4000--0- Net Orders ---*- Actual Assembly - -0-- FG Inventory

FIGURE 1.8 Production reaction to unexpectedly high demand (not a new productintroduction). The unexpected demand occurred during Month 3, Month 4, and Month 5.Note that only monthly assembly autw!!J..sshown; packaging/sterilization output was notobtained. ....

Dan asked one of his staff members to investigatethe new product introduction problem and inven-tory/service level paradox. The staff member spentseveral months compiling information on demandpatterns, production rates, and forecasts. Consistentwith Meditech's decentralized nature, the information

exi~on m!!!lydifferent systems in sev~ral differ:~ntareas o(the organization. There was no routine way tosee incoming demand, inventory, or production ratesfor a particular instrument. Developing a commonfQrmat for the data had also been difficult. Some datawere expressed in terms of calendar months, otherdata in terms of w~ks, and.m:jlIOth~r.datain teIIDtilftoe corporate financial calend&.(alternating 4-week,4-.weeK,and 5-week §onth0. Once put together, theinformation conveyed the following:- New product demand after an introduction fol-

lowed a consistent pattern of reaching a high peakduring the first few weeks, but becoming relativelystable immediately afterward (see Figure 1-6).

CHAPTER 1: INTRODUCTION TO SUPPLY CHAIN MANAGEMENT 21

It- Variation in production schedules often exceededJ variation in demand (see Figures 1-7 and 1-8).

- Monthly forecasting could be improved substan-tially using a simple statistical method: generatinga linear regression through past data.

With this information in mind, Dan Franklinbegan thinking about how to fix Meditech's deliveryproblems.

CASE DISCUSSION QUESTIONS

1. What are Meditech's problems in introducing newproducts? In manufacturing ALL products?

2. What is driving these problems, both systemicallyand organizationally?

3. Why is the customer service ,manager the firstperson to recognize the major issues?

4. How would you fix these problems?