Name: Ram Mohan Thakur , MSCM18

Major Individual Assignment TO-624

[15] Owens and Minor, Inc. (A). HBS 9-100-055. While most of the discussion thus far has been from a
buyers perspective, this case allows us to look at sourcing contracts from a suppliers perspective. O&M
currently uses a cost-plus pricing contract but is looking to move to activity-based pricing (ABP)
contract. For your assignment, consider the following questions (you may submit your
assignment as a Q&A):
1. Qualitatively, evaluate the impact O&Ms cost-plus pricing has on distributors, customers, and
suppliers.

Supplier
Suppliers: In a cost-plus pricing model Suppliers shares the price of goods with customers and
distributors gets a margin above the cost quoted by suppliers. In many cases, private label
suppliers/manufacturers directly sell goods to the customer.

Power to play with cost price: Depending on market condition, competition, cost drivers a supplier can
change the quoted cost to customer and distributors to win customers.

Focus on manufacturing: Supplier gets demand data and forecast data from distributors.In this
manufacturers can focus on core activity.

Avoiding waste,expiry product, unused industry cost: Supplier has transferred the responsibility of
handling excess inventory, damaged inventory to distributors and customers.So this helps in reducing
the uncertainty in cost because of market, specification and demand change.

Distributor
The simplicity of calculation: It is straightforward to maintain cost plus transaction details. The supplier
will provide the cost and distributor will add cost plus percentage, and the customer will provide that.

Challenging to compete on services: As the final price is fixed distributor does not have any advantage
of providing extra services. Cost plus model works well with standard terms of the delivery model. As
the customer became, more demanding distributor started losing out on margin. Distributors do not
have any advantage by providing better service to customers.

Price to the customer not based on actual cost: Distributor were getting the margin over product cost
and not over actual cost service provided by the distributor. This made distributor to calculate the
benefit of providing extra services

Close to the customer: Distributor was nearest to the customer, and this led to better understanding
the customer demand. Supplier depends on distributors to provide customer demand data. Using this
information distributor can develop a new product, services or solution for the customer.

Customers
Simple Accounting system: For the customer, it was simple to calculate the cost of purchasing items
from distributors and manufacturers.
High Customer Power: Customers by getting together can demand low margin plus cost from
distributors and manufacturers

Flexibility: Customer has the flexibility to buy different goods from different distributors and
manufacturers. In this way, customer can purchase high quantity goods directly from manufacturer and
low cost from distributors

Not able to discover actual cost: While buying from directly or indirectly from manufacturers, the
customer did not have landed cost of delivery. This limited negotiation power and the customer can only
negotiate on lowest cost and cost-plus percentage. In addition to this customer does not have any
visibility on what will be the impact of different services requested by them on distributors and
manufacturers. The customer does not have visibility to decide based on which type of service to
choose.

Customers were losing money in damage, excess inventory, expiry but they did not have any mechanism
to optimize this loss in the current cost-plus model.

2. What effect will ABP have on customer behavior? Would you expect different responses by
customers? To focus your thoughts, download the spreadsheet titled O&M Data and Numerical
Exercise. Consider the example listed in the sheet named Numerical Exercise that asks you to
compare the impact of ABP on two customers. To solve the numerical exercise, you may use the
template provided in the sheet named Solution Template. Would Alpha & Beta hospital respond
differently to ABP and why?

Cost Driver Rate Alpha Beta Alpha 1 Beta 1

Volume Volume Volume Volume

EDI Orders 4.5 187.5 316.35 380 627

Non-EDI Orders 9.01 562.5 16.65 20 33
Lines 0.66 15,000 10,000 11,000 20,000
Deliveries 457.58 12 10 7 10
Days Sales Outstanding 8.64% 300,000 $75,000 $75,000 $150,000
Emergency Orders 25 20 10 6 6
Shipping and Handling 130 12 10 7 10
Product Sales $150,000 $150,000 150000 $300,000
Cost Plus Margin 22,500 22,500
ABP Fees 19,187 28,659
Total Revenue 172,500 172,500 169,187 328,659
COGS 150,000 $150,000 150,000 300,000
Vendor Discounts 4,035 4,035 4,035 8,070
Gross Margin 26,535 $26,535 4,035 8,070
EDI Order Costs 844 1423.575 1,710 2,822
NonEDI Order Costs 5,068 150.0165 180 297
Line Costs 9,900 6600 7,260 13,200
Shipping and Handling 1,560 1300 910 1,300
Delivery Cost 5,491 4575.8 3,203 4,576
Emergency Orders 500 250 150 150
Interest 2,160 $540.00 540 1,080
 Procurement 1,486 1486 1,486 1,486
Labeling 1,000 1000 1,000 1,000
Account Management 991 991 991 991
Occupancy 1,007 1007 1,007 1,007
Group Fees 750 750 750 750
Net Operating Profit -4,222 $6,462 4,035 8,070
Cost Plus/Equivalent Cost Plus 15% 15% 13% 10%

Alpha and Beta both will respond to ABP costing positively as the Cost-Plus margin equivalent is lower in
ABP case.It is more profitable for Beta1, and this may be because of higher volume. Among Alpha and
Beta, Beta will be more inclined to change to ABP.Customer will behave differently in case of ABP
costing as the margin now will depend on services they need. As customer will have more visibility in the
cost of services asked so the customer can change their ordering strategy (quantity, lead time, lot size,
etc.) to fulfill the need.

3. What are the risks associated with ABP for Owens and Minor?

1. Complicated to calculate: ABP involves multiple activities from picking goods from manufacturer to
delivering to the customer. These activities again increase based on the type of services demanded by
the customer. It is cumbersome and complicated to keep account of cost of all the activities

2. Increase in workforce requirement: If right type of automated system not used than manpower
requirement may increase to track ABP.

3. Adoption problem: Customer, Supplier, and Distributor all have to implement Activity Based Costing
to make this change successful. There is a risk of non-adoption as it is complicated to implement.

4. Increase in overall cost: ABP requirement may require sophisticated system and this may increase in
implementation cost. For small customer cost-benefit analysis of this change may not be profitable.