Owens and Minor

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Date: March 12, 2012
Course: Management Accounting & Control
Case: Session 3: Owens & Minor (A)

Date: March 12, 2012
Course: Management Accounting & Control
Case: Session 3: Owens & Minor (A)

Case Background:

Who: Jose Valderas, divisional VP for Owens & Minor (O&M) What: How does O&M sell ABP (activity based pricing) to Ideal? Could they implement ABP to help Ideal? Why: O&M needs to improve margins; by understanding where costs are derived from, they can then pass those costs onto the customer. O&M needs to eliminate the cost-plus system and would like to move to cost-plus zero with monthly fee based on activity levels

Case Overview:
* O&M is a medical and surgical supplies distributor. They focus on distributing one core business line (medical/surgical supplies) rather than expanding to other lines. This gives them an advantage over the competition by being able to offer better products, prices and services to customers. Their customers are predominately hospitals/hospital networks. * Through acquisitions over the years, they have presence across the country and became leader in low cost distributor of healthcare products * They have 49 distribution centers in the US, which warehouse over 300,000 products from over 3,000 manufacturers to over 4,000 customers; each division served customers within a 100-150 mile radius using owned/leased fleet. Customers on average receive 2-6 deliveries/week * At Savage the (Maryland) division, they carry over 50,000 line items, with 120 customers. They serve an area with nearly 12 million people within one hour *

* The sector is growing, but more and more cost pressures; led to customers demanding reduction in supply costs and improving of inventory management. Customers forced distributors to carry more of the inventory and make more delivers in lower quantities. Distributors were being squeezed from both sides to reduce margins: customers/hospitals one side, and manufacturers the other side. * Medical supply industry competitive, with fewer customers (as consolidations have occurred, leading to large contracts but fewer in number) * Pricing currently done on a cost-plus model, which is based solely on the cost of the product and does not factor in the costs of distribution; there is only a % distributor mark-up on the base manufacturer price of the product *

* By 1995, SG&A costs were increasing again above 7% of sales, and interest expense had increased by over 100% from previous year; inventory costs in 1994 and 1995 were almost triple that in 1993, and A/R around double * To address the cost reduction initiatives of their suppliers and customers, O&M shifted to a ABC structure * Focus in 1996 was to improve service quality and control inventory costs; as well increase gross margin by putting higher prices to services that demanded more resources * They are preparing a proposal to a potential new client, Ideal Health system (which purchases $30million annually for medical/surgical supplies) * O&M created a matrix that was based on two major cost drivers: number of purchase orders per month and the number of lines per purchase order in a pursuit to get Ideal to use ABP

Challenges:
* Challenge within the industry is that many of the competitors are subsidiaries of manufacturers, thereby allowing them to offset their distribution costs to customers with their high margin from sales of manufactured products. However, what this meant was that these competitors didn’t offer the variety of products that O&M could provide (as only sold self-manufactured products) * Cost plus system tied the fee to the distributor to the value of the product rather than the value of the service; Cost Plus was entrenched throughout the industry * The pricing structure within the industry was exceptionally complex and made it difficult to track actual product costs...
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