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.
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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 certain products – i. e. for all the different products used in ex-rays while also understanding the revenue generated from those products may influence management decisions. In this way lower-cost, higher-profit products are emphasized. Furthermore, management decisions surrounding expansions, process structuring and goal-setting, among others, also benefit from the increased information TSCC provides.
Overall, the increased information TSCC provides in regards to cost drivers allow VM and OM to understand their costs better, incentivize each other to lower costs in the long run, and gives them the ability to set long-term targets and goals in regards to increasing efficiency. Another aspect that TSCC draws value from is the synergic benefits as a result of its institution alongside that of the Alpha-Vendor program. The Alpha-Vendor program allows VM to order many of its supplies with OM and through these large volume orders generate discounts.
Through TSCC, VM will generate even more cost savings and multiply the effects of the Alpha-Vendor program because it will direct its large volume orders to more cost efficient manufacturers and SKUs. Furthermore, the Alpha-Vendor program sets a precedent of collaboration and mutual assistance that the TSCC will now build upon. TSCC would be much more expensive and difficult to implement if Alpha-Vendor program was not already in place. For example, the Alpha-Vendor program has created cross-organization positions in the form of dock managers and business integration directors who understand both VM and OM.
These cross organization personnel will have a shorter learning curve and will be able to help institute TSCC more quickly and effectively. It is clear that the TSCC program and the Alpha-Vendor program merge well and will produce synergic benefits including lower costs and easier implementation. Finally, the TSCC program has a range of other “side” benefits that add to its value. First and foremost is the industry power that TSCC will help generate for both OM and VM. If you refer to Exhibit 3, it is clear that both OM and VM rely ultimately on the manufacturers.
Furthermore, OM and VM rely on middlemen like GMX (their data processor). But through TSCC these companies combine their strength, data and goals and gain more power over both the manufacturers and the middle-men (the VANs). For example OM may know which manufacturer is better and which is worse but it has no control over purchases because it receives order from providers like VM. But through TSCC it acts as an adviser to VM and as a result VM can make the most efficient purchase choices. This will ultimately force manufacturers to compete more aggressively with each other and drive down their margins.
Furthermore, companies like GMX generally deal with providers and distributors separately. But the combined data and translucency that OM and VM share force middle-men like GMX to deal with them as one unit. This allows OM and VM to control GMX and prevent it from taking advantage of its middle position between the two companies. Ultimately, this gained power from the -manufacturers and middle-men that activity based pricing programs like TSCC allow will result in higher margins and better control of the industry and the direction its heading for both distributors and providers.
Another side benefit that TSCC produces (especially for VM) is the reinforcement it provides to the companies’ values. Both VM and OM seek to cut costs and increase margins. VM has specifically instituted “lean” programs and focused on teamwork and quality in the past. The concentration on these values will be amplified by TSCC’s similar concentration on cost cutting and leanness in the supply chain. Therefore, this program will support the vision of both companies and help them encourage the members of their organization to act according to that vision.
Finally, the last side benefit the TSCC program will produce is the new knowledge created as a result of instituting the TSCC program. Both companies can do several things with this knowledge including use it to improve their own operations independently (i. e. lower errors in supply chain), share this program with other distributors/providers and more effectively manage their long term goals (i. e. set efficiency targets using cost drivers). In sum, the side benefits of TSCC include increased industry power, reinforcement of company values and increased cross applicable knowledge for both OM and VM.
These side benefits add additional value to the TSCC program. Before concluding, a few drawbacks of the TSCC program should be noted. First, the TSCC program decreases the amount of product choice available to VM. OM will hold less SKUs if VM and other providers order less SKUs. Although this will reduce costs and fees, it will also result in fewer products to choose from when providers are ordering. But if TSCC is instituted effectively this decrease in choice should not have an effect on the final product (i. e. he care delivered to the patients) because often many products satisfy needs that just one product/SKU could with the same effect. Another drawback is the other side of the coin of increased industry power; increased reliance. Because both OM and VM will increase their industry power by working together in a more encompassing way (explained above) they will also increase their reliance on one another. Just because the TSCC program’s data is actually kept by GMX does not mean that another distributor/provider could use that data to the same effect (it is tailored data for OM and VM).
If the relationship between VM and OM goes awry it could cause the loss of lots of hard-work and money spent on both sides. Therefore, increased reliance is definitely a cost of TSCC. In conclusion, TSCC provides lots of value for both VM and OM and is a very effective alternative to the current cost-plus program. TSCC provides value in a multitude of ways including increased information resulting in lower costs and better decision-making, synergic benefits with the already existing alpha vendor program and side benefits including increased industry power, vision support and knowledge.
These benefits are long-run in nature – in fact it is even stated in the case by Daniel Borunda (the main person working in this project on VM’s side) that “the cost savings from TSCC are an annuity; they just keep on giving. ” The TSCC program makes continuous, ongoing improvements to the supply chain (as explained above) while the cost-plus program is short-run by nature and looks for discounts now. This is the key difference between the two programs. This will become clear through the explanation of alternative two.
Furthermore, the two main drawbacks of the TSCC program, reduced product choice and increased reliance, are not significant and can be avoided with effective management of the system. It should also be noted that the TSCC is a flexible mechanism and can be manipulated and instituted in other ways; this point will be touched on in the alternative three section of the report.