Owens and Minor Inc Case

Case III:  Owens and Minor, Inc. (A)

Q1: What is the value added by O&M?

A1: O&M is one of the largest distributors of medical and surgical supplies. It adds values to its manufacturers and customers alike.

Value addition to Manufacturers:

• O&M owns and manages inventory for the manufacturers.
• O&M monitors agreements between end users (health care providers) and manufacturers.
• Manufacturers depend on O&M for information on Product flow.
• O&M breaks down the large quantities of product sent by the manufacturers and deliver it to the customers.
• O&M supplies customer usage and sales number back to the manufacturers.
• O&M handle the risk of product returns and product expirations.
• They carry the burden of receivables which can take up to 90 days creating cash flow issues.

Value addition to Customers:

• O&M acts as a “One stop shop” for hospitals by carrying and managing inventory for the hospital.
• O&M accommodates JIT ordering and also caters to stockless method for some health care facilities.
• They monitor and maintain pricing contracts which the manufacturer has negotiated with the customer and alleviate the burden of price rebates from the customers.
• Based on customer demands, O&M sometimes packaged the product in smaller units so that they could go directly to the nursing and surgical units, bypassing the “stop at” loading dock/storeroom process.

These value-adds are highlighted in Red on the Supply Chain Flow Chart of Owens and Minor, Inc.

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Q2: Evaluate the impact cost-plus pricing has on distributors, customers and suppliers.

A2: Cost-plus meant that the customer paid a base manufacturer price plus a mark-up added on by the distributor. Impact of cost-plus pricing on distributors, customers and suppliers is shown below:

• It led to a creation of a committed contract which meant that the member hospitals agreed to commit all their traditionally distributed business to one distributor. This helped the distributor since he could get orders in bulk but that only translated to 60% of the volume. This was again at the discretion of the customer since they had an option to buy from elsewhere.
• There was a single fee of 7% for all products. This limited the profit O&M could make on an order unless the order was a large size for less cost product or a low order of high cost product.
• It allowed customers to “cherry pick” the products that they wanted to buy from distributor which led them to buy low-inexpensive supplies from the distributor while buying the more expensive product from the manufacturer directly.
• Separate product prices were negotiated by the customer and distributor with the manufacturer.
• Distributors were only allowed to add their cost-plus fee to the product prices arrived by the manufacturer and the customer.
• Manufacturers offered distributor discounts which encouraged distributors to buy in bulk to increase profitability. This was advantageous to the manufacturers since they didn’t have to worry about finished product carrying costs but the distributor ended up with the inventory.
• Customers had the option of making off-contract purchases for a different product or from a different manufacturer.
• Payment terms were set for 30 days but sometimes the customers took up to 90 days to pay.
• Since Cost-Plus was concerned at product level, minimum purchase orders were not needed hence customers started ordering low quantities, just in time and stockless.
• Distributors that were a part of a manufacturing company which sold private labels combined the product price and distribution fee making cost distinction between them a near impossibility.

Based on the above analysis, there are three key factors that can impact profitability at O&M. They are Overhead compared to profits, Average collection period of receivable and Days in Inventory. Financial impact from these factors have been calculated below:

• OverHead expenses as a ratio of Gross Operating Profit and PBT(OH Ratio)= (SGA Exp+Dep&Amor)/(Gross Operating Profit+Profit before tax)
• Receivables Turnover = (Sales)/(Ending Receivable of Prev Year + Ending Receivable of Current Year)/2. Please note: For 1990, we have used the ending Inventory as the average inventory.
• Average Collection Period = 365/Receivables Turnover
• Inventory Ratio = COGS/Merchandise Inventory
• Days Inventory = 365/Inventory Ratio

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As you can see, the overhead for providing the same level of service to customer has increased by huge margin in 1995. This can be attributed to an increase in SGA expenses while profit margin has remained relatively same. Similarly, the days in inventory has seen an increase in 1994 and 1995 as compared to 1993 and 1992. The average collection period has improved since 1990s but it is still at 34 days instead of 30 days for 1995.