3M HEALTH CARE

Richard Ivey School of Business

The University of Western Ontario

Viola Hco prepared this case under the suwvision of Professor P. Fraser Johnson solely to provide material

for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a

managerial situation. The authors may have disguised certain names and other identifying information to

protect confidentiality.

Richard Ivey SchtN)l of Business Foundation prohibits any form of reproduction, storage or transmission without

its written permission Reproduction of this material is not covered under authorization by any reprcxluction

rights organization. To order copies or request to reproduce materials, contact Ivey Publishing,

Richard Ivey Scm)l of Business Foundation, The University of Westem Ontario, London, Ontario, Canada,

N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail c..s@ivey.uwo.ca.

Copyright @ 2005, Richard Ivey of Business Foundation

Version: 2011-01-04

On August 6, 2003, Viola Hoo, summer intern student at 3M Health Care, was

preparing for her meeting with Kevin Higgins, vice president of 3M Health Care

Markets. Kevin had asked Viola to spend her summer internship analysing the

health care division's logistics system and to prepare a report on her findings.

Viola was returning to the Richard Ivey of Business to complete the second

year of her MBA at the end of the month, and Kevin was expecting to review the

final report in approximately two weeks time. He was particularly interested in

Viola's recommendations regarding proposed changes to the existing method of

distributing products to Canadian hospitals.

delivering and co-ordinating 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 (see Exhibit 2). In addition,

healthcare professionals were developing innovative practices that allowed the

aging population to Stay in homecare rather than long-term care institutions (see

Exhibit 3).

Other actions included the formation Of larger group purchasing organizations and

the consolidation Of warehouse operations. These new organizations targeted

supplier price reductions and lower total costs Of ownership through prcxluct and

service standardization. Warehouse consolidation provided improved control Of

inventories, invoicing and product handling. Wherever hospital

purchasing groups were attempting to reduce costs by negotiating Contracts

directly with manufacturers, as opposed to dealing with distributors.

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 successfully established itself as a leading developer, manufacturer and

distributor of consumer and industrial prcxlucts.

In 3M had $17 billion in revenues with more than 40 business units

organized into seven big businesses: consumer and office, display and graphics,

electronics and telecommunications, health care, industrial, safety and security,

and transportation. Headquartered in St. Paul, Minnesota, the company had

operations in more than 60 countries and served customers in nearly 2(H) countries.

Thirty-two Of 3M's international companies had laboratories that provided

technical service, manufacturing support, product modification, prcxluct

development and technology development. Its research and development spending

in 2002 was more than S 1 billion. Some Of 3M's most widely recognized brands

included Scotchbrand Magic Tape, Post-it Notes, Thinsulate, 3M Brand Filtrete

Filters and Scotchgard Brand Stain Protector.

3M CANADA COMPANY

Based in London, Ontario, 3M Canada business units were grouped into the seven

' 'Big Businesses" and had added another business group that focused on Canada's

resource industries. There were a number Of individual business units within these

businesses, aligned according to products and markets. While the business units

operated with autonomy, they also benefited from close involvement in the

marketing strategies Of the more than 40 business units within these sectors in the

U nited States.

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 IXsitioned

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.

The majority Of Canadian laboratory efforts were designed to existing

product lines and to Create new products based On expressed Or perceived Customer

needs. In addition, longer-range research was carried out in some niche disciplines,

Often in partnership with customers and educational institutions.

3M Health Care was committed to supplying innovative and reliable prcxlucts and

services that made a difference in the practice, delivery and outcomes of health

care. The business units within the health care division served the medical, dental,

pharmaceutical, veterinarian and personal care markets. The "Big Business" had

more than medical, surgical, consumer, dental, orthodontic, pharmaceutical

and animal care products in its catalogues (see Exhibit 4). Products in the medical

market division included a spectrum of items, such as surgical drapes, bandages,

sterilization equipment, wound-care materials, casting, stethoscopes and

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 health 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 hospital and physician services, provinces and territories provided a

range of additional health care support 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 2003, 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

government fiscal constraints and rising costs. Total health care

expenditures, in current dollars, was S97.4 billion in and was forecasted to

reach S 105.6 billion in 2001 and Sl 12.2 billion in From 1991 to 1996, total

spending on health care had declined by 0.8 per cent and increased by 5.2 per cent

in the 1996 to period. Government sources expected real growth in health

care spending to be 6.6 per cent in 2001 and 3.3 per cent in 2002 (see Exhibit l). 1

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. Between 1995

and 275 hospitals closed, merged, or changed to provide Other types Of care.2

In most provinces, RHAs were created with responsibility for organizing,

respirators. Each business unit 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 hew] them gain credibility with customer user

groups. Like all 3M Canada businesses, the health care division drew its logistical

supE%jrt from the company's shared services organization. Products were

manufactured globally, and Canadian materials management staff ordered products

that were then shipped to 3M' s Toronto distribution centre.

3M CANADA COMPANY LOGISTICS NETWORK

Sales to Canadian hospitals were approximately $3.9 million per month, or 70 per

cent Of the medical markets division's revenue, while the remainder went to the

growing Out Of hospital market. Sales to hospitals were channeled through

specialized distributors called value-added resellers (VARs). There were eight

VARs selling 3M health care products to approximately 350 hospital customers in

Canada. In only 10 per cent Of the medical market division's sales to

hospitals were sold on a direct basis.

The out-of-hospital market, which comprised approximately organizations

across the country, such as 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).

Pl-ICs responded to the unique needs Of the various sub-segments Of the Out-Of-

hospital market.

3M's sales representatives spent all their efforts working with the hospital

customers. The company's sales Strategy was to Offer premium prcxlucts with

innovative features that improved the health and healing processes Of the patients.

The local sales representatives and regional managers worked with clinicians and

educated nurses and doctors Of the superior benefits Of 3M prcxlucts. Their efforts

were tailored to the needs Of the local RHA and health care delivery model.

The clinicians would be encouraged to specify 3M prcxlucts to hospital purchasing

committees when making contracting decisions. Hospitals were free to choose

their channel to purchase 3M products. The hospitals could elect to buy their

directly from 3M Or through one of the VARs. In either case, the unit price for

prcxlucts remained the same; only the terms and conditions were negotiable.

VARs received an agency fee based on sales to hospital Customers for performing

value-added services such as storage, transportation, product handling, transaction

and order prcwessing, credit management, billing, returns and inventory

management. By contractual agreement, VARs could also tx required to provide

srweial services to 3M such as EDI for order processing and order tracing. 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 (Exhibit 5). 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. 3M

estimated that only one in four hospital deliveries were full cases. Some VARs

also accommodated hospital requirements for specific delivery windows that

cross-dock shipments arrangements. Many VARs were investing in IT

in order to satisfy billing preferences Of the customers.

A third party logistics company (3PL) operated 3M's Canadian distribution center

(DC) in Toronto, Ontario which maintained an average inventory level Of

approximately $4.5 million in medical market Monthly storage costs

were S6,750 per month. The DC handled full case shipments only, with monthly

picking costs Of approximately $30,000. Management expected that moving to

subcarton picking would double this cost. Current volumes at the Toronto DC

were approximately 45 cases per month.

3M Canada had a centralized materials management and customer services team

based in London, Ontario. The team Of customer service staff managed all

electronic and manual orders that were received from all 3M Health Care

customers. On average, 2.25 full-time equivalents (FTEs) were dedicated to

processing the medical market division's Orders. Two materials management staff

monitored inventory levels at the DC for the entire medical market prcxluct line.

They also provided back-up service to the customer service staff.

The orders placed in the medical markets division differed from much Of the Other

health care orders in that orders were primarily received from the large VAR

customers. Viola estimated that, Of the 419 monthly electronic Orders and 654

monthly manual Orders handled by 3M, only 30 per cent were for out-of-hospital

Customers. In addition, each month the 350 hospital Customers generated, in total,

approximately manual Orders and 1,650 monthly electronic Orders for 3M

medical products that were processed by the VARS. She also estimated that a

manual order would cost 3M approximately S8.50 to prcxess, while electronic

Orders would cost 3M approximately S2.15 to process. Fixed costs in the 3M

customer service department were estimated to be $37 month.

THE DIRECT DISTRIBUTION ALTERNATIVE

As part of her project, Viola was asked to evaluate the current method of

distribution for 3M medical markets products and to make appropriate

recommendations to Kevin As part of this assignment, Viola decided to

interview the direct0 of materiel at eight of the largest Canadian hospitals across

the country. These interviews indicated a strong perception by hospital materiel

managers that major cost savings could achieved in the supply chain if hospitals

t%jught directly from 3M, and 3M shipped directly to the hospital as

to through VARs.

As part of her analysis, Viola had also been able to collect information from the

VARs concerning their transportation costs. Exhibit 6 summarizes the current

warehouse handling costs incurred by 3M Canada under the existing distribution

model. Exhibit 7 gives estimates Of the additional transportation volumes and costs

from the 3M Toronto DC to hospital customers under a direct-sell model. Viola

also estimated that inventories would need to be increased by approximately 25 per

cent to support direct distribution.

Although direct distribution had several advantages, Viola was concerned about

the ability Of 3M to transition from a distribution network that relied on VARs to a

ship-direct model. If 3M medical markets went direct, it would pull away from the

distribution model that was used by most Other 3M Canada businesses. As part Of

her report to Kevin, Viola 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. Viola identified five areas that she believed would have to be addressed

in her assessment Of direct distribution with respect to logistics: storage,

fulfillment, warehouse handling and customer service.

Other major competitors in Canada, such as Johnson & Johnson, maintained a

direct distribution supply chain and Viola felt she should carefully evaluate

the opportunities associated with such a system. She felt the direct model would be

considered if variable expenses could be limited to less than 10 cent Of sales.

Viola looked at her calendar and recognized that she had only two weeks to

complete her report. She wondered what value did the VARs provide to the

hospitals, and were they actually acting in the best interest Of 3M Canada? While

3M Canada was responsible for the entire prcxluct and pricing support, VARs were

paid a commission in the form Of an agency fee. Several VARs claimed there was

not enough profit to Supm)rt the services they supplied. Meanwhile, the staff in the

3M Canada logistics group warned Viola Of the major challenges that would be

presented by using a direct Viola wanted to make Sure she had considered

all vxssible ramifications and cost implications as part of her report to Kevin.

Questions:

Assignment Questions

1.Evaluate the costs of the current distribution systems and a direct-to-hospital supply chain in the following areas: warehouse storage, transportation, fulfillment, warehouse handling and customer service.

2.Besides costs, what other factors should be taken into consideration as part of the analysis?

3.If you were in the position of Viola Hoo, what recommendations would you make to Kevin Higgins and why?

4.What value do VARs provide in the health care supply chain? How much money can be saved by adopting a direct distribution model?

5.Does it make sense for 3M to adopt direct distribution model?

6.What are the long-term trends in the health care industry? How will our VAR relationships be affected in other areas of our business?

7.Should 3M hire a 3PL to handle distribution?

8.How does 3M's distribution network help position the company against the competition?