Reference no: EM13953221

Case 29: Clarinda Community Hospital

           Clarinda Community Hospital is a 230-bed, not-for-profit, acute care hospital located in Clarinda, Iowa. The city is a typical Mid-western county seat/farming community best known as the birthplace of Glenn Miller, the famous big band leader of the late 1930s and early 1940s.

            The hospital carries more than 10,000 different items of inventory that vary widely in price, order lead times, and stockout costs. (Stock-out costs are the total costs that result from running out of stock of a particular inventory item, including higher costs of service caused by scheduling delays or emergency replenishments as well as the costs associated with negative patient outcomes and potential lawsuits.)

            Clarinda uses the ABC method of inventory classification, also called selective inventory control, along with a variety of inventory-control methods, to manage its different inventory items. The ABC classification system works in this way: Clarinda maintains data on the average annual usage and unit cost of each inventory item, which typically is called a stock-keeping unit (SKU). Then, the dollar usage (Average annual usage × Unit cost) is calculated for each SKU. Next, these amounts are con-verted into percentages of total dollar usage and the SKUs are arrayed from highest to lowest percentage. The SKUs are then divided into three groups (or classes), labeled A, B, and C, using the general guidelines provided in Exhibit 29.1.

            To better utilize the limited resources available for inventory management, Clarinda's managers focus most of their attention on Class A items. The usage rates, stock positions, and delivery times for SKUs in this class are reviewed on a biweekly basis, with control and ordering system data adjusted as necessary. Class B items are reviewed every quarter, while Class C items are reviewed semiannually.

            Even though this process has served Clarinda well, Marco Muñoz, the hospital's newly hired chief financial officer, thinks the hospital is carrying excess inventories. He notes that Clarinda has never come close to having a stockout, even when it has been running near 100 percent occupancy. Marco believes that a thorough review should be undertaken of all Class A items and that it might be possible to increase inventory turnover by 25 percent, and hence lower inventory carrying costs, by trimming current stocks.

            To convince Clarinda's CEO, Marco plans to perform a demonstration inventory analysis that focuses on the forms used by the surgical intensive care unit (SICU). Different forms are required for almost every aspect of SICU operations, including records of patient progress; requests for lab tests, blood products, and medications; nurse and physician notes; and transfer/discharge instructions. Exhibit 29.2 shows inventory usage and cost data on the SICU's 25 forms. To begin his demonstration analysis, Marco plans to conduct a new ABC analysis on the SICU's inventory. (Clarinda is in the process of converting to computerized forms as part of the transition to electronic medical records, but the paper forms will still be used for several years.)

            As part of its commitment to supporting the local economy, Clarinda currently uses a single local source for all of the SICU's forms:  Atwood Printing and Office Supplies (Supplier A). Supplier A requires a $25 set-up fee on each order, in addition to the cost per unit. Clarinda is considering using a national supplier, Bateman Medical Office Products (Supplier B), which charges no set-up fee but does charge $50 to cover postage and handling. Supplier B takes three days to deliver the forms, versus only one day for Supplier A. Processing each order will cost Clarinda another $25, regardless of which supplier is used. Thus, the total order cost is $50 for Supplier A and $75 for Supplier B.

            Marco's ultimate goal is to use economic ordering quantity (EOQ) concepts to select the supplier for all forms used by the SICU. His primary areas of concern are (1) the number of orders placed each year, (2) reorder points (in units), and (3) total inventory costs. As part of the demonstration analysis, Marco will focus on the form used to order blood products from the hospital's blood bank (SKU number 53104 in Exhibit 29.2). The data associated with Suppliers A and B, as well as inventory carrying costs and other data, are summarized in Exhibit 29.3.

            In addition to an analysis without safety stocks, Marco is concerned about the impact of safety stocks on the decision. Clarinda currently carries a safety stock of two units of SKU 53104 to protect itself against stockouts as a result of delivery delays and/or an increase in the usage rate. When asked how that amount was arrived at, the manager of the SICU stated that she didn't know and that they had always done it that way. However, if the hospital decides to switch to Supplier B, the manager stated that it seems logical to increase the safety stock to six units to reflect Supplier B's three-times-as-long lead time. Of particular interest are the impact of safety stocks on inventory costs, the safety margins that such stocks would provide against higher-than-expected usage and shipping delays, and whether or not the current lead time for Supplier A and the estimate for Supplier B make any sense.             Also, Marco has heard a rumor that Supplier B is about to offer a 10 percent discount if the entire year's demand (92 units) is ordered at once. He wants to know what the impact of this discount would be on the decision about which supplier to use. Also, it would be useful to know how high a discount is needed to make Supplier B less costly than Supplier A.

            Furthermore, Marco knows that it is unlikely that the forms would be ordered exactly as prescribed by the EOQ model, so he would like to know the impact of ordering variations on total inventory costs. Finally, Marco knows that Clarinda's CEO has expressed some doubt about the value of the EOQ model in making real-world inventory decisions. "If I'm right in my concerns," he asked, "what other inventory control methods are available to us?"

            Place yourself in Marco's shoes and see if you can conduct the demonstration analysis that he has in mind.