Hardy Hospital Case Study Chapter 12 OM5 What are good estimates of order cost and inventory holding cost? State all assumptions and show all computations.

Hardy Hospital Case Study

Caroline Highgrove, Hardy’s director of Materials Management, glanced at the papers spread across her desk. She wondered where the week had gone. On Monday, the director of University Operations, Drew Paris, had asked Caroline to look into the purchasing and supplies systems for the hospital. Drew specifically wanted Caroline to evaluate the current materials-management system, identify ways to reduce costs, and recommend a final plan of action. Drew explained that the university was under pressure to cut expenses, and hospital inventory did not seem to be under control.

As Caroline reviewed her notes, she was struck by the variations in order sizes and order frequencies for the hospital’s stock-keeping units (SKUs). For some SKUs, inventory ran out before new orders came in, whereas for other SKUs, excessively high stock levels were being carried. The university and hospital’s computerized materials-management system was about a decade old and generally worked well; however, employees often ignored or did not update key information. Thus, data integrity was a major problem in this information system.

Hospital and university supply orders were classified as either regular stock or special order. The hospital was the originator of almost all special orders. Regular stock items, such as bed sheets, uniforms, and syringes, were characterized by their long-standing and frequent use throughout the university and hospital, and by a low risk of obsolescence. When a department needed a regular stock item, that department generally ordered (requisitioned) the item. If the item was in stock, it would be delivered to the department by the next delivery date.

When the university did not normally stock an item, individual hospital departments could special-order them. Special-order items were supposed to be those of an experimental nature or critical to patient health care, but not used frequently. Hospital departments requiring these special items bypassed the university purchasing system. Once a special order Hardy Hospital Case Study was placed, the hospital department informed university purchasing so that it could eventually authorize payment on the vendor’s invoice. Hospital department coordinators, doctors, or head nurses were responsible for initiating and/or authorizing special orders. In total, these special orders required a significant amount of work that took department coordinators and head nurses away from their duties. University purchasing kept no records on the hospital’s special-order inventories or for the 215 secondary hospital stocking points such as exam rooms and moveable carts.

One department’s head nurse explained that many departments were afraid of running out of regular stock items. University purchasing didn’t understand the importance and nature of hospital inventory, and they were slow to respond. The nurse cited the months-long period university purchasing process needed to place new items on the regular stock list, and the long lead times sometimes involved in receiving orders requisitioned from the university’s approved vendor list.

Because the university was a state institution, strict bidding and purchasing procedures had to be followed for both regular stock and special orders. For example, three written bids were required for an individual order of $2,000 or more. The processing of these bids often took up to two months. For orders between $800 and $1,999, three telephone bids were necessary. In these situations, purchases could be made only from the lowest bidder. Orders under $800, or items on the state contract list, could be ordered over the phone, without any bids. State contract list items were those for which statewide needs had been combined and one contract left to cover all of them.

Caroline had gathered information on the costs of ordering and storing hospital supplies. For order costs, she estimated that, on average, the purchasing, account payables, and receiving personnel spent three hours processing a single purchase order. A single purchase order typically included four SKUs (i.e., each SKU on a purchase order was called a line item). The average hospital storeroom’s wage was $16 an hour; with employee benefits and associated overhead, the cost of one worker-hour came to $20.

For inventory-holding costs, the university warehouse and hospital storeroom used 36,750 square feet of storage space. The university stored an average of $4.15 million in hospital supplies in this space. Records indicated that the average annual variable and semivariable cost for storage space this year would be $4.60 per square foot. Five warehouse workers and storeroom associates were required to handle the hospital’s supplies. These individuals each earned $32,000 a year; benefits and overhead rates for these employees were the same as for other personnel, about 20 percent. Other warehouse costs, including obsolescence and taxes, were expected to reach $200,000 this year. The hospital operated 52 weeks per year. Also, the state recently had floated a bond issue at 8.9 percent, and Caroline thought that might be a good estimate of the cost of money to finance inventory, but she wasn’t sure what other costs to include in inventory-holding cost.

After reviewing her notes on the hospital’s materials-management situation, Caroline decided to take a closer look at some individual regular stock items. She sorted through the papers on her desk and found 30 SKUs of interest. She wanted to analyze all 30 SKUs but decided to begin with one SKU widely used in the hospital—Strike Disinfectant. Data on this SKU are shown in Exhibits 12.16 and 12.17.

Hardy Hospital Strike Disinfectant Data

Hardy Hospital Aggregate Strike Disinfectant Weekly Demand as Measured by Hospital Requisitions

Exhibit 12.17Hardy Hospital Aggregate Strike Disinfectant Weekly Demand as Measured by Hospital Requisitions

Hardy Hospital Aggregate Strike Disinfectant Weekly Demand as Measured by Hospital Requisitions

Discussion Questions

1.Who approves what in this materials management system?

2. What are good estimates of order cost and inventory-holding cost? (State all assumptions and show all computations.)
3. What is the EOQ and reorder point for Strike Disinfectant given your answer to question 1?

4. Compute the total order and inventory-holding costs for a fixed-quantity system (FQS) and compare to the current order Q’s. Can you save money by adopting an FQS?
5. What are your final recommendations, including what you would recommend regarding regular and special orders, the state bidding system, and overall control of the university materials-management system? Explain the reasoning for your recommendations.