José Valderas as the Divisional Vice President of Owens & Minor, Inc. has been keenly attached to the problem of decreasing profitability and sales figures due to competition and changing market dynamics. As a matter of fact, the company lost nearly $ 11 million due to decrease in operating profits and swelled expenses. The changing market dynamics and competition have given such a position to the manufacturers and hospitals that they require more services on lowest costs incurred in their income statements. Hence, profitable customers are the need in time for company’s survival; where Ideal Health System is going to offer tenders for a $ 30 million supplies for medical and surgical equipment. Valderas is looking to get this contract; since it will help companies to overcome are its losses and inject a sense of motivation in their employees about the business. But the main problem is of quoting the right price in such competitive environment and giving value added services to the hospital. Atlantic Healthcare is the main competitor of Owens and Minor, Inc. and a right set of value added services are to be offered to win the contract. In this regard, O&M value addition to its customers is the brand-neutral aspect of business. The business also offers a lot more flexibility than the competitors are offering. Hence, in the case of Atlantic Healthcare, they cannot offer low and flexible price like O&M can do. In this regard, the company has the policy to provide excellent logistics and inventorial services to hospitals and manufacturers. Also, a revamp in the cost structure from Cost-plus percentage to Activity Based costing is also a noble step by the company. Since, the hospitals try to bypass distribution centers in order to avoid excessive cost. In this situation, distributors are on the losing side but the hospitals also have to purchase in bulk which swells their purchasing figure. As a Stand-alone distributor, such a step would allow the company to set up a balance for all the stakeholders involve, also an enhanced system to reduce internal costs and provide low cost products and services to customers.
- Evaluate the impact cost-plus pricing has on distributors, customers, and suppliers.
The industry is largely dominated by cost-plus pricing method. In this method, the customer had to pay the manufacturer a price and a markup in addition to the manufacturing price by the distributor. As a matter of fact, this percentage addition was not justified in terms of logistics in which moving, storing and shipping the product was included. The markup was set to be 7 percent. In this regard, Valderas has serious reservations. It has a severe impact when transportation and freight costs are in question. Moving a small consignment if compared to larger wooden boxes has different transportation modes and costs. Hence, a straight rate of seven percent in not justified in this situation. On the other hand, this pricing method has created many problems for accounting and budget structure. This costing system increased the value of the product; not the value of the services provided to the manufacturers and hospitals by O & M Inc. So, customers have to buy directly from the manufacturers in order to save costs; but the customers have to buy in bulk no matter their requirement is not that much. Therefore, a significant higher price has to be paid by customers in this manner. Also, handling such huge inventory, transportation, and mishandling, damaging and storing costs also impacts such customers who choose to buy directly. Also, the hospitals and manufacturers have to pay additional seven percent costs which does not make sense. So, cost-plus pricing hits all the stakeholders in terms of higher prices to be paid..
- What effect will ABP have on customer behavior?
The company officials realized the fact that the pricing mechanism needs to get revamped. Valderas, Petrella and Stefanic started joint working for introducing activity based pricing from activity based costing. The administration also realized the fact that the cost attached with the activity would give an opportunity to customers to become more efficient as they will get the knowledge of their costs which are affected by the activity levels. In this regard, better efficiency on the customer’s part would help O & M Inc. to save costs related to delivery, processing, transitioning and product handling. It was also believed that such a pricing system would also support right fee structure according to the services provided to the customer. This also supports the fact the O & M would not be dealing with unprofitable customers. The customers on the other hand were not happy with this new idea. One of the reasons for such strong resentment was the existing method of working in the industry with cost plus pricing method. For example, Ideal Health care’s entire internal system including budgeting, incentive programs, accounts, etc were based on cost – plus system and they were not ready to refurbish their structure. Also, such a modification was complex and time consuming. Transfer fees were another issue, since many of the hospitals using cost – plus to allocate transfer prices to distributors. Although the finance management at Ideal Health care realized that advantages of such a system but there was another problem of the employees who might not be giving full support for the new pricing mechanism. As a matter of fact, Ideal health care had to pit their management processes at risk if they have to accept O & M’s bid; as purchasing, sourcing, storing, and all the relevant processes are to be modified. On technological grounds, such an ABP system also raised questions to be implemented. Since and Electronic Data Interchange (EDI) has to be established between Ideal and O & M for better information sharing. Again, the process seems to be difficult in implementation stages. In these situations, where winning the contract from Ideal Health care is the way which can let Owens and Minor Inc. from its financial problems and inject a sense of motivation in their employees, such a pricing mechanism will not make the hospitals and manufacturers happy. Infact, they will avoid working with the company due to their complex costing and transactional processes with the new ABP system.
- What are the obstacles to successful implementation of ABP at Ideal? How would you address these obstacles?
The new ABP system is no matter would be in favor of Ideal Healthcare but there are many problems and limitations which would be faced by the nonprofit organization. The industry in general and Ideal in particular also follow cost-plus pricing method. Introducing the new ABP method would no doubt support the hospital to have an efficient costing mechanism but requires a complete restructuring in the managerial processes being followed. As a matter of fact, the entire processes of procuring, storing, supply, budgeting, etc. are based of cost-plus system and such a transformation of processes would be hectic, complex and time consuming which is a constraint in the implementation if ABP. Also, there is a probability that the workers at Ideal do not show their willingness for the new pricing system; since they have been adapted to the older cost plus pricing mechanism. Also, the appraisal and compensation system at Idea is also dependent on the industrial system of pricing. Deployment of Electronic Data Interchange is another requirement in order to have ABP system successfully implemented in the system for win-win strategy. All of these obstacles need space, capital, and time and organization willingness; in this case all are not present. Therefore ABP system implementation seems difficult until certain problems are not addressed robustly. The problems can be addressed by taking the management into sheer confidence that such a costing system would not create any problem in their working pattern, infact it will reduce their work burden also increase their productivity. Also, in the presence of electronic data interchange, the pooled data and resources will let both parties to take timely decisions also work effectively. It will also decrease the operational and transactional costs dramatically; hence both parties would be better off. So, such an analysis should be made in order to motivate the upper management as well as the lower staff to adopt the new pricing mechanism. Having proper trainings and education to the resistive workers would also be helpful to serve the purpose. If O & M agrees to be jointly investing with Ideal out of their earned revenues from Idea for their restructuring in business process, it will also tempt Ideal health care to inject the new system proposed by O & M Inc.