Case Study

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Alternative 1: The Value of Going with TSCC
Virginia Mason (VM) and Owens & Minor (OM) are considering adopting a new activity-based pricing model. The value of going with the Total Supply Chain Cost (TSCC) activity-based pricing program lies not in the current savings but rather in the deeper understanding of the distributor – provider supply chain relationship. The activity-based pricing of this program will provide managerial decision making benefits and cost benefits going forward for both sides. Additionally, the TSCC program when tied with the already existing alpha-vendor program produce synergic benefits as a result of the increased collaboration TSCC ensures. Adopting the TSCC program also produces side benefits including increased knowledge that can be used with other partner relationships, reinforced company values (especially for VM) and increased inter-industry power. As a whole the TSCC program is a sensible and good alternative to the current cost-based pricing system for both VM and OM because it provides long-run benefits and increases the value of the current alpha-vendor program. The largest and most feasible benefit of adopting TSCC is the increased information this pricing system provides. TSCC derives and monitors cost drivers that contribute to different expenses including but not limited to occupancy, manufacturing, delivery and administrative expenses. OM then derives a monthly fee for VM based on the expenses it incurs. OM and VM are both encouraged to streamline supply processes as a result of the in-depth understanding of the costs associated with these cost drivers. This is done through different monetary incentives. The first and most obvious one is the lower fees that lower expenses will bring. Because OM derives the fee charged to VM based on these derived cost-drivers, VM knows exactly how to lower its fee. They are able to concentrate their efforts on creating efficiencies in areas where expenses (and thus fees) are highest (refer to Exhibit 1 for a breakdown of some of the different cost drivers and their associated expenses that are exposed and tracked through TSCC). For example, VM knows that if it orders less Stock Keeping Units (SKUs) it can lower its fee substantially. Therefore, VM knows to order more products from fewer manufacturers. Second, OM is encouraged to help VM in this process because its expenses are directly lowered and because of the companies’ “gain-share” agreement where OM shares in savings generated through TSCC. As a result, a large degree of translucency on both sides is beneficial. For example, OM will give VM detailed information on which SKUs are best to order so that VM may lower its fee because OM knows that if VM’s supplier costs are lowered as a result of a lower fee it will share in VM’s savings. The final direct monetary incentive established in TSCC involves the shared-cost of eliminating errors. Because the companies share (50-50) the costs of eliminating errors in the supply chain, the TSCC program can benefit and become more efficient without hostility’s about who caused or fixed what error. All of these monetary incentives are augmented by the fact that the TSCC agreement has no punitive legal measures. Therefore the companies do not have to fear one another if either make a mistake; teamwork and clarity is encouraged. The primary difficulty with TSCC is that these cost benefits are not immediately evident right away. As shown in Exhibit 2, the current fee of the cost-plus fee structure is better for VM. But overtime, as efficiency increases, the fees of TSCC will decrease. The cost-plus fee program will not have these same returns (in fact the fees will grow as VM orders more) and as a result the TSCC program will generate lower fees in perpetuity. Increased information has cost benefits as noted above but it also has managerial decision-making benefits. For example, understanding the underlying costs in the supply chain with...
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