Health Care Supply Chain The developments in health care encompassed vertical and horizontal integration, managed care pressures, and the rise of e-commerce. There have also been many other changes, few of them are:  Hospitals and hospital systems vertically integrated into the health insurance business, such as starting up their own Health Maintenance Organizations (HMOs) and ambulatory care practices, in the process of developing Integrated Delivery Networks (IDNs). Attempts to integrate downstream towards the patients to capture a greater portion of patient flows and insurance premiums lead to the development of HMOs. Initially such attempts were futile and providers had to integrate upstream with the wholesalers and distributors to improve their financial position.  Every major player along the value chain horizontally consolidated to form large organizations. Hospitals merged to form hospital systems or joined other systems. Group purchasing organizations (GPOs) started catering to different systems and distributors started building warehouses where demands from various systems are consolidated. A typical healthcare supply chain is a complex network consisting of many different parties at various stages of the value chain. The three major types of players are: Producers (product manufacturers), Purchasers (group purchasing organizations, or GPOs, and wholesalers/distributors), and health care providers (hospital systems and integrated delivery networks, or IDNs). This chain is shown in Fig 1.

Manufacturers make the products; GPOs and distributors aggregate a large number of hospitals in an attempt to leverage the economies of scale while funding their operations through administration fees and distribution fees; the provider, such as hospitals, consume the products while providing patient care; and finally the payers, such as the individual patient and his employer, pay for the services of the provider. Within the health care value chain, the products (drugs, devices, supplies, etc.) are transported, stored, and eventually transformed into health care services for the patient. The health care value chain as described above has various inherent flaws. Third party GPO’s negotiate on behalf of providers but are funded by administration fees paid by the manufacturer, usually based on a percent of sales. This arrangement raises the question as to how aggressively a GPO will truly negotiate. Major full-service distributors tend to operate on a percent of sales distribution fee as well. Hence, the distribution fee for a small sized fast moving item could cost the hospital many times more than a bulky slow moving item. Another issue is that many distributors are also major manufacturers, allowing them to leverage the margin on self-manufactured products to discount the distribution fee. The distributors, in such situations, can also cut the inventory levels of competing product, with full knowledge that they can support stock-out substitutions with highly profitable selfmanufactured goods. If this happens very often, the hospital may be forced to switch to the readily available distributor of manufactured goods even if they are considered inferior. These issues should

not be blamed fully on the purchasers since the hospitals are willing to pay the extra amount for these services every day. The main issue is that most health care providers have been unwilling to challenge the traditional model for fear of the risk associated with throwing away a well-established model. In a traditional distribution model, suppliers ship their products to distributors. At the distributor’s warehouse, the products are packed into pallets and shipped to each hospital’s warehouse. The hospital warehouse then receives the pallets, breaks them down into smaller quantities, and stores the products until they are needed by the hospital. Sometimes items are also ordered directly from suppliers. Figure 2 shows this model.

In this traditional model, there is a large amount of inventory in the system. This keeps the number of deliveries relatively low, which keeps transportation and ordering costs low. However, there is a high cost in both holding inventory and the significant amount of material handling required. An initiative by HealthyLife1 Hospitals An example of a health care system that has benefited from streamlining their inventory and distribution process is the HealthyLife Hospitals. The HealthyLife Hospitals created a new supply chain division called Resource Optimization and Innovation (ROi) to establish the supply chain as an area of value for the business. ROi has simplified the health care supply chain by reducing its dependence on third party intermediaries, such as GPO’s and distributors. The ROi created its own GPO, which purchases products directly from suppliers for all products, eliminating the need for third-party GPO’s. The result is a new model that has more closely linked the makers and users of health care products in a way that provides greater value for the essential trading parties. In the newer model used by HealthyLife Hospitals, a centralized warehouse system replaces the distributor and the need for a hospital warehouse is eliminated. In this model, the suppliers ship directly to the central warehouse called the central service center (CSC), which for HealthyLife Hospitals is located in Springfield, MA. The CSC breaks down the shipments into smaller units and repackages them for use in the hospitals. The materials are then shipped directly to the hospitals, called strategic service units (SSU). The network consists of approximately ten hospitals across four states. If

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the hospitals are not close enough to the CSC the materials are cross docked in an intermediate location. Figure 3 shows this model. In this newer model, the CSC takes full responsibility of material handling and inventory management. The CSC at Springfield, receives shipments from the suppliers and which are then broken down, repackaged, bar coded and stored. The CSC receives the orders for the next day’s demand through the central server every evening. These orders show up on the pick list and are picked, sorted, packed based on their destination, and shipped early in the morning. The trucks return to the CSC at the end of the day.

Figure 3: The New Model In the new model, there are many improvements over the traditional model. No third parties between the suppliers and hospitals are used, increasing efficiency and eliminating third party mark-up fees. HealthyLife Hospitals owns its own trucking fleet in order to further reduce cost. Inventory holding costs and material handling costs, which make up a large portion of total costs, are greatly reduced over a traditional system. The CSC’s large warehouse, which stores products for all its hospitals, allows bulk-purchasing discounts to further reduce costs. In this new system, 3,000 nursing level stock outs per week were eliminated over HealthyLife Hospitals’s old system and next day, first time fill rates improved from 85-90% to 99% . Since the CSC uses automatic repackaging equipment to repackage products into smaller, bar coded containers, the inventory management system is also greatly improved. The improved inventory management system included medicine cabinets, which automatically pick the medicines for the nurses, and a bed-side scanning system which verifies the medication by scanning the nurse’s badge, the patient’s arm band, and the medication. This annually eliminated more than 178,000 medication errors such as giving medication to the wrong patient or giving the patient the wrong dosage. In addition, the CSC polls all the medicine cabinets each night and automatically downloads replenishment orders for needed medicines. Because of the new system, the onus on HealthyLife Hospitals to maintain sufficient stock increased. The managers started keeping buffer inventory. Sometimes they were required to dispose expired medication items. Because of increase in the number of staff, the wages to staff also increased. Dr. Jack Anderson, CEO of HealthyLife Hospitals, heard about the Vendor Management Inventory (VMI), and is impressed by its benefits. He thought of implementing VMI in place of existing new system. He wishes to take a second opinion, before making final decision.