3m canada industrial business division

W15359

3M CANADA: THE HEALTH CARE SUPPLY CHAIN Professor P. Fraser Johnson wrote this case solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a managerial situation. The author may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright © 2015, Richard Ivey School of Business Foundation Version: 2018-11-07 On Monday January 12, 2015, Scott Davis, national manager of key accounts and channel markets, Medical Division at 3M Canada (3M) Health Care, was preparing for his meeting at the end of the month with Matt Pepe, vice president of 3M Canada’s Health Care Business Group. The Medical Division currently relied on value-added resellers (VARs) to distribute its products to Canadian hospitals. Recently, however, these customers were pressuring 3M to ship products directly to the hospitals as opposed to using VARs. Hospital strategic sourcing managers believed that major cost savings could be achieved in the supply chain through a “direct distribution” model. Matt had asked Scott to prepare an analysis of the Medical Division’s distribution system and to make recommendations by the end of the month regarding potential changes to its existing method of distributing products to Canadian hospitals. THE CANADIAN HEALTH CARE SYSTEM Health care services in Canada were government-funded and delivered through a variety of organizations such as Regional Health Authorities (RHAs), hospitals, physician practices and medical clinics. While the provinces held the primary responsibility for delivery of health care services, the federal government maintained regulatory authority through the Canada Health Act. In addition to providing hospital and physician services, provinces and territories delivered a range of additional health care support services including prescription drug plans, homecare, continuing care and long-term care. The nature and scope of these services could vary depending on the province and territory, and were influenced by changing health care demands and demographics. In 2015, the Canadian health care system was under significant financial strain as a result of a number of factors, including the aging baby boomer segment of the population, government fiscal constraints and rising costs. Total health care expenditures were estimated at $215 billion in 2014. Government spending on health care had more than doubled since 2000 and represented approximately 11 per cent of Canadian gross domestic product (GDP), compared to 7.0 per cent of GDP in 1975.1

1 Canadian Institute for Health Information, National Health Expenditure Trends, 1975 to 2014, CIHI October 2014, www.cihi.ca/en/nhex_2014_report_en.pdf, accessed December 15, 2014.

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The major categories of health care spending in Canada from 1975 to 2014 included hospitals, drugs and physicians. Hospitals had traditionally represented a prominent place in health care provision and the single largest cost in the system; however, the share of health care spending on specific categories had shifted during the past four decades. Spending on hospitals had declined from 47 per cent of the total in 1975 to 31 per cent in 2014, while spending on “other” health care costs (e.g., public health, nursing homes, residential care facilities and other health care professions) increased from 28 to 37 per cent during the same period. Drugs accounted for approximately 16 per cent of total health care spending, while physicians constituted approximately 16 per cent (see Exhibit 1).2 As a result of the fiscal pressures faced by government policy makers, a number of initiatives were introduced with the objective of changing business practices in order to improve speed and efficiency of service. One outcome was the closure of hospital beds and sites and the consolidation of hospital operations. As a result, hospital spending as a percentage of total government spending shrunk significantly, although spending on hospitals, in current dollars increased twelvefold between 1975 and 2014 (see Exhibit 1).3 In most provinces, RHAs were created with responsibility for organizing, delivering and coordinating public health programs, hospital services, community care and long-term or continuing care services. These efforts resulted in changes in the delivery of health care in Canada. For example, day surgeries were on the rise and fewer patients were staying overnight in hospital. Overall, out-of-hospital health care was increasing and health care professionals were developing innovative practices that allowed the aging population to stay in homecare rather than long-term care institutions or hospitals. Other cost reduction actions included the formation of larger centralized procurement organizations and the consolidation of hospital supply chain operations. New centralized strategic sourcing organizations targeted supplier price reductions and lower total costs of ownership through product and service standardization. Supply chain operations consolidation provided improved control of inventories, invoicing and product handling. Wherever possible, hospital procurement groups were attempting to reduce costs by negotiating contracts directly with manufacturers, as opposed to dealing with distributors. Most provinces had initiatives underway to restructure their health care supply chain organizations with the objective of reducing costs. One example was in British Columbia, where the Health Shared Services BC (HSSBC) was launched in February 2009 to provide services to the province’s six health authorities in the areas of accounts receivable, accounts payable, payroll services, employee records and benefits, technology services, and supply chain, which included purchasing and strategic sourcing, inventory management, warehousing and in-hospital replenishment.4 The supply chain group had approximately 1,000 employees located across six health authorities, and managed more than $1.9 billion in total annual spending. The hybrid organizational model balanced the needs of the local regions with the need for centralization by allowing each health authority to have a regional branch office that was responsible for that particular health authority’s requirements. HSSBC supply chain estimated that it had achieved more than $230 million in savings since its inception.5

2 CIHI, National Health Expenditure Trends, 1975 to 2014, Canadian Institute for Health Information, October 2014, www.cihi.ca/en/nhex_2014_report_en.pdf, accessed December 15, 2014. 3 Ibid. 4 Health Shared Services BC, “About Us—Health Shared Services BC,” HSSBC, www.hssbc.ca/AboutUs/default.htm, accessed December 15, 2014. 5 Health Shared Services BC, “Services—Supply Chain,” HSSBC, www.hssbc.ca/Services/Supply-Chain/default.htm, accessed December 15, 2014.

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This document is authorized for use only by Grant Williams in SCM 4301 Logistics Mgmt Fall 2020 - Tibodeau taught by DALE TIBODEAU, University of Houston from Aug 2020 to Feb 2021.

http://www.hssbc.ca/Services/Supply-Chain/default.htm
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3M COMPANY The Minnesota, Mining and Manufacturing Company, now called 3M, was founded in 1902. After an initial mining venture proved to be unsuccessful, the company established itself as a leading developer, manufacturer and distributor of consumer and industrial products. 3M was a Fortune 500 Company with revenues of $31.8 billion in fiscal 2014. The company had more than 30 business units organized into five business groups — consumer, safety and graphics, industrial, health care, and electronics and energy. Headquartered in St. Paul, Minnesota, the company had operations in more than 70 countries and served customers in more than 200 countries.6 Known for innovation and problem solving, 3M was a science and technology company with laboratories and manufacturing facilities in more than 38 countries. Its research and development (R&D) spending in 2014 was $1.8 billion, and in 2013, 3M’s CEO Inge Thulin committed to spending six per cent of the company’s sales on R&D aimed at helping the company achieve its targeted four to six per cent organic revenue growth over five years.7 Some of 3M’s most widely recognized brands included ScotchgardTM stain removal and fabric protection, FiltreteTM home filtration products, Post-itTM Notes, ThinsulateTM Insulation, and LittmannTM Stethoscopes. 3M had operated in Canada for more than 60 years from their head office in London, Ontario. 3M Canada was optimized for global alignment (with five business groups) as well as the ability to serve the priority markets relevant to the country’s business landscape — the Priority Markets Division focused on the construction, mining, oil and gas industries in Canada. While the business groups operated with autonomy, they also benefited from involvement in the marketing strategies of the more than 30 business units within these sectors globally. All local business units had their own technical, sales and marketing functions, along with full access to the experience, knowledge, manufacturing capabilities and other valuable assets of the global organization. The exchange was a two- way street, and many new 3M products carried the stamp of knowledge gained through 3M’s global operations, including 3M Canada. This internal synergy positioned 3M Canada as a vital component in the North American market. Unique centres of marketing, sales, administrative and manufacturing excellence within 3M Canada also served some of 3M’s North American customers. 3M CANADA MEDICAL DIVISION 3M Canada Health Care Group was committed to supplying innovative products and solutions for medical, oral care, health information management, drug delivery and food safety. Major product categories included skin and wound care, infection prevention, stethoscopes, medical devices, dental, orthodontics, drug delivery systems, veterinary and animal care, and health information systems (see Exhibit 2). The Medical Division focused on institutional customers, such as hospitals, long term care facilities and home care agencies.

6 3M, “About Us – Who We Are,” 3M, http://solutions.3m.com/wps/portal/3M/en_US/3M-Company/Information/AboutUs/ WhoWeAre/, accessed August 12, 2014. 7 3M, “Corporate Profile – 3M Performance,” 3M, http://solutions.3m.com/wps/portal/3M/en_US/3M-Company/Information/ Profile/Performance/, accessed August 12, 2014.

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The Medical Division was staffed with dedicated sales, marketing and technical personnel. Many of the sales and technical staff were health care professionals who had left the hospital system to work at 3M. Their highly specialized health care knowledge helped them gain credibility with customer user groups. Medical Division sales to Canadian hospitals were approximately $9 million per month, or 65 per cent of the Medical Division’s revenue, while the remainder went to the out of hospital market. Sales to hospitals were channeled through specialized distributors called value-added resellers (VARs). There were five VARs distributing 3M health care products to approximately 350 hospital customers in Canada. Only approximately 5 per cent of the Medical Division’s sales to hospitals were sold on a direct basis. The out-of-hospital market, which comprised approximately 5,000 organizations across the country, such as home care agencies, surgical centres, long-term care facilities, walk-in clinics and private physician offices, was serviced by both VARs and another distribution channel identified as the Professional Health Care Dealers (PHC). PHCs responded to the unique needs of the various sub-segments of the out-of- hospital market. 3M Canada Medical Division sales representatives spent almost all their efforts working with the hospital customers. The company’s sales strategy was to offer premium products with innovative features that improved the health and healing processes of the patients. The sales representatives and regional managers worked with clinicians and educated nurses and doctors of the superior benefits of 3M products. Their efforts were tailored to the needs of the local RHA and health care delivery model. Clinicians would be encouraged to specify 3M products to hospital strategic sourcing committees when making contracting decisions. Hospitals were free to choose their channels to purchase 3M products. The hospitals could elect to buy their goods directly from 3M (for full case shipments only) or through one of the VARs. In either case, the unit price for products remained the same; only the terms and conditions were negotiable. VARs received an agency fee, which averaged 8 per cent, based on sales to hospital customers for performing value-added services such as storage, transportation, product handling, transaction and order processing, credit management, billing, returns and inventory management. By contractual agreement, VARs could also be required to provide special services, such as EDI (electronic data interchange) for order processing and sales tracings, to 3M. Some VARs serviced only certain parts of Canada, such as a province or region, while others operated nationally. 3M Canada was usually indifferent as to which VAR serviced its hospital customers since contracts were between 3M and the hospitals, and the VAR acted as an intermediary or agent (see Exhibit 3). VARs competed for the award of 3M hospital contracts by providing value-added services to the hospital. For example, some VARs offered small lot shipment quantities and just-in-time (JIT) deliveries. Scott estimated that one in four hospital deliveries from VARs were full case shipments. Some VARs also accommodated hospital requirements for specific delivery windows that supported JIT delivery arrangements. Many VARs had invested in information systems that supported the billing preferences of the customers.

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This document is authorized for use only by Grant Williams in SCM 4301 Logistics Mgmt Fall 2020 - Tibodeau taught by DALE TIBODEAU, University of Houston from Aug 2020 to Feb 2021.

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3M CANADA COMPANY LOGISTICS NETWORK Like all 3M Canada businesses, the Health Care Group drew its logistical support from the company’s shared services organization. Products were manufactured globally, and Canadian materials management staff ordered products that were shipped to 3M’s distribution centre (DC) in Milton, Ontario (approximately 50 kilometers west of Toronto) from 3M’s Forest City, Iowa DC. Approximately 7.5 per cent of the Milton DC capacity was dedicated to Medical Division products. A third party logistics company operated the Milton DC, which had monthly facility costs of approximately $250,000. The DC handled only full case shipments and current volumes for the Medical Division were approximately 76,000 cases per month. The associated monthly picking costs were approximately $12,000, of which the hospital portion was approximately 65 per cent. The company targeted inventory turns of 12 times in all of its distribution centres, and the Milton DC maintained an average inventory level of approximately $5.5 million in Medical Division products, including $3.575 million for the hospital market. The distribution centre manager indicated to Scott that moving to subcarton picking to support direct distribution would require significant changes to the warehouse configuration and picking processes, which would be much more labour-intensive. He indicated that picking costs for hospital products would increase by approximately tenfold under direct distribution. 3M Canada had a centralized materials management and customer service team based in London, Ontario. A team of customer service staff managed all orders that were received from 3M customers, including the Medical Division. The orders placed for the hospital market differed from much of the other health care group orders in that orders were primarily received from the five VARs, who ordered in large volumes. Scott estimated that, of the approximately 500 orders 3M currently received each month, more than 80 per cent were electronic orders and the balance were manual orders. Moving to a direct-distribution model would result in a significant increase in the number of Medical Division orders processed each month and the percentage of manual orders was expected to increase dramatically because many hospitals did not have systems to support electronic orders. Scott estimated that the customer service team would need to add additional staff and resources to handle the increased workload at a total cost of approximately $550,000 per year. THE DIRECT-DISTRIBUTION ALTERNATIVE Matt Pepe expected Scott to evaluate the existing method of distribution for the Medical Division and to make appropriate recommendations. As part of this assignment, Scott decided to interview several directors of strategic sourcing at 3M’s largest hospital customers. These interviews indicated a strong perception that major cost savings could be achieved in the supply chain if hospitals bought product directly from 3M as opposed to using VARs. As part of initiatives to restructure provincial health care supply chain organizations, most hospitals were members of regional supply chain service organizations, such as HSSBC and Health Care Materials Management, located in London, Ontario. These organizations, although not a substitute for the VARs, provided some of the logistical services offered by the VARs, such as consolidation, inventory management, replenishment and small lot shipments. Contracts with VARs compensated hospitals for services by regional supply chain service organizations through reductions in the agency fee. Scott also investigated how direct distribution would affect supply chain costs in the areas of warehouse handling and transportation. Exhibit 4 summarizes the warehouse handling costs incurred by 3M Canada

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This document is authorized for use only by Grant Williams in SCM 4301 Logistics Mgmt Fall 2020 - Tibodeau taught by DALE TIBODEAU, University of Houston from Aug 2020 to Feb 2021.

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under the existing distribution model for both the hospital and out-of-hospital markets. Based on conversations with the manager of the Milton DC, Scott expected that these costs for the hospital portion would triple under direct distribution. He also estimated that hospital inventories at the Milton DC would need to be increased by approximately 25 per cent to support a direct-distribution model. Working with the transportation manager, Scott had also been able to collect information from the VARs concerning their transportation costs. Exhibit 5 provides estimates of the additional transportation volumes and costs from the 3M Milton DC to hospital customers under direct distribution. PREPARING FOR THE MEETING WITH MATT PEPE Although direct distribution had several advantages, Scott was concerned about the ability of 3M to transition from a distribution network that relied on VARs to a direct-distribution model. If 3M Medical Division adopted the direct-distribution model, it would pull away from the existing distribution model that was used by most other 3M Canada businesses. As part of his report to Matt, Scott would have to identify the specific changes that 3M would have to make to its supply chain organization and the accompanying changes in areas such as sales and marketing, finance and accounting, sourcing and logistics. Scott identified five areas that he believed would have to be addressed in his assessment of direct distribution with respect to logistics: storage, fulfillment, customer service, transportation and warehouse handling. However, Scott was also acutely aware of perceptions by some customers of the existing distribution model. The Medical Division had recently participated in a benchmarking project managed by a third-party consulting firm. As part of the benchmarking process, the consultants collected data from hospital managers, including representatives from purchasing, finance and clinicians, in seven areas that included business relationship and support, manufacturer personnel, products, business education and support, contract administration, logistics and supply chain management, and customer service and support. Overall, the Medical Division ranked very high among the 15 health care companies that participated in the benchmarking project. However, its poorest rating was in the area of logistics and supply chain management, and each of the companies that ranked above the Medical Division in the benchmarking report used a direct distribution model. As Scott looked at his calendar and recognized that he had only three weeks to complete his analysis and develop recommendations for his meeting with Matt, he wondered what value the VARs provided to the hospitals, and whether the current distribution model provided the best value to the Medical Division and its customers. While 3M Canada was responsible for the entire product and pricing support, VARs were paid a commission in the form of an agency fee. Several VARs claimed there was not enough profit to support the services they provided. Other major competitors in Canada, such as Johnson & Johnson, maintained a direct distribution supply chain model, and Scott felt he should carefully evaluate the opportunities associated with such a system. He felt the direct-distribution model would be considered if variable expenses were less than the prevailing agency fee. Meanwhile, the staff in the 3M Canada logistics group warned Scott of major challenges that would be presented by changing to a direct distribution model. Scott wanted to make sure he had considered all possible ramifications and cost implications as part of his report to Matt.

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This document is authorized for use only by Grant Williams in SCM 4301 Logistics Mgmt Fall 2020 - Tibodeau taught by DALE TIBODEAU, University of Houston from Aug 2020 to Feb 2021.

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EXHIBIT 1: SHIFTING SHARES OF HEALTH CARE SPENDING IN CANADA 1975 – 2014

Source: Canadian Institute for Health Information, National Health Expenditure Trends, 1975 to 2014, CIHI October 2014, www.cihi.ca.

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

19 75

19 77

19 79

19 81

19 83

19 85

19 87

19 89

19 91

19 93

19 95

19 97

19 99

20 01

20 03

20 05

20 07

20 09

20 11

20 13

Pe rc

en ta

ge o

f T ot

al H

ea lth

C ar

e E

xp en

di tu

re s

Hospitals

Other

Physicians

Drugs

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This document is authorized for use only by Grant Williams in SCM 4301 Logistics Mgmt Fall 2020 - Tibodeau taught by DALE TIBODEAU, University of Houston from Aug 2020 to Feb 2021.

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EXHIBIT 2: 3M HEALTH CARE — SELECTED PRODUCT LINES

Dental • Adhesives • Cements • Composites • Curing Lights • Digital Materials and Equipment • Finishing and Polishing

• Glass Ionomer and Liner • Implants • Impression Materials and Equipment • Infection Control • Preventative Care • Provisional/Temporizing • Teeth Whitening

Infection Prevention • Diagnostics • Fabric Drapes • Hand Antiseptic • Hygiene Monitoring • Immobilization • Incise Drapes

• Masks and Respirators • Patient Monitoring • Skin Preparation • Staplers • Sterilization • Surgical Hair Removal • Surgical Scrub

Health Information Systems • Coding and Reimbursement • ICD-10 Solutions and Services • Medical Records Abstracting • Patient Care Planning • Classification and Grouping

• Clinical Documentation Improvement • Coding and Billing compliance • Consulting Services • Health Data Interoperability • Medical Dictation and Transcription

Medical Devices • In Vitro Diagnostic Components • Optical Laboratory Consumables

• Stick to Skin

Skin and Wound Care • Cleaners • Compression Systems • Dressings • Foam Padding • Hydrogel

• I.V. Site Dressings • Medical Tape • Moisture Barriers, Creams and Lotions • Self-Adherent Wraps • Skin Closures

Veterinary and Animal Care • Casting and Splinting • Diagnostic Imaging • Sterilization Assurance

• Stethoscopes and Accessories • Surgical Products • Wound Management

Source: http://solutions.3mcanada.ca/wps/portal/3M/en_CA/Products/ProdServ/Dir/HealthCare/, accessed August 12, 2014.

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This document is authorized for use only by Grant Williams in SCM 4301 Logistics Mgmt Fall 2020 - Tibodeau taught by DALE TIBODEAU, University of Houston from Aug 2020 to Feb 2021.

http://solutions.3mcanada.ca/wps/portal/3M/en_CA/Products/ProdServ/Dir/HealthCare/
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EXHIBIT 3: 3M MEDICAL MARKET DISTRIBUTION STRATEGY

Acute Care/Institutional Markets 3M will conduct its business as required to meet customer expectations including the negotiations for pricing of products and terms. However, we will allow our customers alternatives to how the product is purchased, inventoried, delivered. Customers may select to receive goods directly from 3M or from a select list of value-added resellers. 3M encourages its customers to select a prime distributor to enable a tripartite optimization of the supply chain.

Non-acute Markets 3M will always allow its customers a choice of distributor but will endeavor to leave the setting of prices to the needs of the market and channel that delivers the product.

Intent 3M will seek other ways to control our brands, markets and relationships with customers without becoming a logistics company.

Source: Company records.

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EXHIBIT 4: MONTHLY WAREHOUSE HANDLING COSTS UNDER CURRENT MODEL

Receipts $ 3,732 Put away $ 2,343 Let down $ 919 Movement $ 340 Legislative labeling $ 28 Serial number $ 48 Lot number $ 19,664 Bill 101 relabel $ 41

Source: Company records.

EXHIBIT 5: ESTIMATED TRANSPORTATION COSTS — DIRECT DISTRIBUTION MODEL

Average transportation rate ($)*

Estimated number of shipments per year

Alberta 60.17 3,676 British Columbia 69.76 3,621

Manitoba 41.52 1,372 New Brunswick 58.51 1,097 Newfoundland 64.69 933

Nova Scotia 50.86 1,262 Northwest Territories 91.31 55

Ontario 26.76 33,302 Prince Edward Island 15.84 165

Quebec 31.64 8,559 Saskatchewan 26.61 768

Yukon Territory 114.68 55 * Transportation costs based on three-day standard ground transportation, except Ontario and Quebec — next-day

service and adjusted for typical shipment size (weight and volume). Source: Company records.

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