1

Medisupply – A Review of Stockholding Policy

Ian Black
Cranfield University, UK

1. Introduction
Following a radical review of the UK National Health Service (NHS) in 1988 the govern-
ment introduced an internal market with the intention of injecting into the framework of a
public service the stimulus of competition. The introduction of an internal market separated
the purchase of healthcare from its provision, by making hospital and other community ser-
vices dependent on patient choice for funds. An important component of the reorganization
that accompanied this change was the opportunity for major providers of healthcare services
— including the hospitals, to become autonomous trusts (NHS Trusts) with more freedom to pay
staff, dispose of assets and purchase supplies as they saw fit. Whilst being providers of
healthcare the NHS Trusts, general practitioners and community services are also purchasers of
supplies necessary for their services. Following the introduction of the internal market for
healthcare and critical reports by the Audit Commission and the National Audit Office, there was
a reorganization of the various fragmented supplies organizations in the NHS. In October 1991
the NHS Supplies Authority was set up to provide a total supplies service for the NHS with
responsibility to not only manage the supply, storage and distribution of goods for the
purchasers in the NHS but, if requested, also to negotiate contracts on their behalf. In the
financial year 1992—3 the potential market for NHS Supplies was almost £3000 million. This
market included such items as stationery, cars and energy, but the major components were
medical equipment (£900 million) and drugs (£500 million). Of the former, about £670 million
was provided by NHS Supplies. The remainder was supplied by direct purchase or in-dependent
wholesalers, who were usually closely connected to manufacturers and had always played a
small but significant part in the market. One such company was Medisupply with a turnover of
£25 million through five warehouses in 1993. With the introduction of the in-ternal market the
NHS trusts were not required to use NHS Supplies, they could choose how and where to spend
their money on supplies and how much of the supply chain they wanted to manage. This
apparent opportunity for the independent wholesalers was at the same time threatened by a
radical reorganization in structure and, according to management, the philosophy of NHS
Supplies. ’Putting the customer first’, ’proactive and flexible rather than reactive and restrictive’,
’a reliable, responsive and forward looking service’ were phrases that were accompanied by a
streamlining of the warehousing and logistics operation into a more efficient and integrated
system. Savings in operating costs of over £50 million were claimed

1
This case is based on an actual company but the company name and some of the data have been
disguised for reasons of commercial confidentiality.
in the first two years. The changes in the market and the opportunities available prompted a
wide interest in the market for supplying medical equipment and a number of take-over attempts
were initiated. A successful one in 1994 was for Medisupply by a large multinational company
with strong interests in the medical and surgical equipment market. Following the takeover a
major review of the Medisupply’s operating practices was initiated. One of the key elements in
this review focused on the companyś stockholding policy which on cursory examination was
considered by the new owner to be ... ’naive, lacking any appreciation of fundamental inventory
control methods and, most important, excessively costly’.

2. Medisupply’s products
The company’s total list of products was 20,000 supplied from 300 European manufac-
turers. A maximum of 5000 of these products was held in stock at any one time. From this long
list of products the main categories sand their contribution to total sales were sutures (35%),
gloves (20%), needles and syringes (9%) )and dressings (6%). Each of these categories
contained within it a large number of individual products. These individual products were
classified by the frequency of recent orders into four bands; A: fast movers ordered at least 24
times in the last three months; B: medium movers ordered at least six times and less than 24
times; C: slow movers ordered less than six times; and Z: no order in the last three months The
number of products at that time in categories A, B and C was 752, 687 and 1240, re-spectively.
Category A accounted for 13% of sales by value. The main customers were Trust hospitals
which generated approximately 55% of the company s revenue the second and third largest
customers were NHS Supplies (25%) and private hospitals (15%).

3. The initial review

In order to assess the current strength of the stockholding policy and provide a guide to
the implications of any change in policy an analysis of current costs was undertaken,
accompanied by an examination of the methods used to determine orders for products. The
review focused on one of the company’s warehouses where data were collected on the ten
products that contributed most to sales. In the previous year these products had contributed
11.1% of total case throughput. These data, it was thought, could then provide an illustration
of the impact of different policies and by extrapolation some tentative estimates of the
overall impact on the company’s costs and resource requirements. A list of the products and
the sales over the last 24 months is given in Table 1. A longer data series was not possible
(or only at excessive cost) owing to a changeover in the computer system used. The units of
demand used (in Table 1) were ’cases’ or ’cartons’. The weight and volume of these cases
for different products are rather different but this is taken into account when calculating
storage requirements and costs.

4. The current ordering method

For categories A, B and C the system in operation at the time used the sales data for the
previous six months. Average demand for this period was calculated and the second highest
peak identified. The ’minimum balance’ was defined as the estimated demand in the lead

2
 Table 1: Total sales for two years – ten major products (units 3 cases)
Products
month SU15 GP07 GP09 NS42 NS44 SU09 SU05 NS22 SU17 NS08
Jan 92 43 207 68 169 198 78 190 227 20
Feb 101 41 201 101 120 161 89 164 202 20
Mar 94 38 177 131 132 169 76 269 216 17
Apr 100 49 176 94 70 139 80 162 187 39
May 97 32 197 51 113 125 79 253 214 50
Jun 105 42 185 115 140 132 74 198 222 33
Jul 100 39 176 99 117 87 141 311 234 47
Aug 98 52 171 139 152 94 99 387 217 57
Sep 104 42 191 65 148 112 94 234 221 64
Oct 96 87 177 116 190 130 65 339 212 56
Nov 93 74 185 105 155 132 133 157 198 54
Dec 90 66 175 106 175 167 82 244 235 33
Jan 103 75 174 118 139 130 90 129 231 52
Feb 103 61 167 91 193 162 101 175 226 70
Mar 95 60 165 91 210 168 89 46 233 77
Apr 104 70 134 105 173 124 102 176 236 56
May 97 66 142 104 134 124 102 184 236 68
Jun 102 71 164 122 131 111 110 231 243 59
Jul 102 64 157 148 273 62 145 233 232 66
Aug 91 74 150 93 182 30 87 310 230 65
Sep 107 64 132 103 215 64 104 210 216 57
Oct 105 71 129 112 210 118 104 331 244 53
Nov 91 63 137 89 214 117 103 185 231 76
Dec 90 53 127 60 145 137 113 149 252 77

time for the order plus the difference between the average demand and the second-
highest peak. Mathematically this is given by

minimum balance = L D + (Dh D)

where D is the average demand, Dh is the demand at the second highest peak and L is the
average lead time all defined in terms of monthly units. This minimum balance provided the
trigger fora new order. The order size was one month’s demand based on the average sales
over the last six months. This ordering policy was heavily criticized by some members of the
review panel. The forecast of demand implicit in the calculation of average demand was thought
to be too limited in the number of factors taken into account. The relevant demand, it was
argued, was the expected demand in the immediate future and estimates should take into
account any trend in sales and seasonal patterns that might occur. It was suggested that the
company should use one of the. numerous computer packages available for forecasting using
techniques such as exponential weighting. The existing method was defended on the

3
basis of its simplicity, its modest requirement in terms of data and its good track record in
keeping the number of orders that could not he met immediately at an acceptable level. The
percentage of unfilled orders was generally below 1% except for four products, two of which
experienced quite exceptional changes in demand (Table 2). These large jumps in demand
appear to have been due to changes in a competitor’s marketing practices and could not
have been forecast with any method based on analysis of trends in sales.

Table 2: Unfulfilled orders for two years – ten major products (percentage of total orders)
Product SU15 GP07 GP09 NS42 NS44 SU09 SU05 NS22 SU17 NS08
Percent 0.12 2.04 0.01 0.54 1.73 0.62 1.92 0.62 1,88 0.17

A level of less than 1% was considered acceptable as some unfulfilled orders were not
canceled but merely delivered a few days later. The net revenue loss of an unfilled order
was also examined. The ratio of net profit to sales for the previous financial year was 1.7%.
It was argued, however, that when considering whether to hold additional stock to avoid
potential lost sales then the profit margin was much higher because the marginal, or
additional cost, of holding a unit of stock was much lower than the average cost. If just the
handling cost of the stock was taken into account (i.e. excluding fixed costs such as
depreciation and rates) then the profit margin was estimated to increase to 5.1%. These
estimates of profit provided a basis on which it was possible to examine whether the costs of
extra stockholding might outweigh the revenue loss from not having items in stock. The
member of the review panel closely concerned with marketing argued that with a more
competitive market emerging, there was an increasing danger that lack of availability of
products or late delivery of orders may lead to customers moving the entire order to another
distributor. Another technical concern with the formula used to calculate the minimum
balance was the role of lead time. The formula used to estimate minimum balance did not
take account of any variance in the lead times which in some cases was quite significant.
The estimates of variance were highest (see Table 3 for figures rounded to the nearest day)
where deliveries were only on one specified day a week. The main conclusion by members
of the review panel critical of the existing policy was that stock levels should be increased in
order to improve the service offered by the company.

Table 3: Costs and lead times – ten major products

Product SU15 GP07 GP09 NS42 NS44 SU09 SU05 NS22 SU17 NS08
Storage cost
(£/case/month) 0.7 0.7 0.7 1.5 1.5 1,1 1.2 0.4 1.1 0.9
Lead Time (days)
Mean 5 7 8 5 5 8 15 10 20 5
Std. Dev. 2 2 2 1 1 2 4 1 4 1
Purchase cost
per case (£) 71 101 613 211 29 43 129 50 21 179

The issue of the order size was also subject to some criticism. The practice of making all
orders equal to one month’s demand failed to take account of the di fference between

4
products. Furthermore it could lead to significantly higher stocks being held than necessary,
The level of stocks was critical, as another purpose of the review was to examine the
warehouse space needed for future operations; the intention being to use any spare
capacity as a storage location for products of the parent company. The existing policy was
defended on the grounds of its administrative simplicity and the absence of the
computations and data necessary for such formulae as the economic order quantity.

5. Costs
An examination of the costs of holding stock and the costs of ordering posed considerable
problems given the breakdown of expenditure included in the accounting framework. Exam-
ination of the all the. administrative costs of placing orders, Checking orders, queries and
payment amounted to £25 per order. This included all office related costs and labour costs. A
study of the time and resources used for a small sample of orders (50) handled in one week
tentatively suggested that of the total figure of £25, about £17 was constant regardless of order
size. When it came to the issue of the cost of holding stock the allocation of costs attempted to
identify those cost elements that were dependent on the level of stock held and whether they
would vary in the short or long term. The calculation of long-run warehouse holding costs
included the depreciation of part of the warehouse and part of the office space (Table 4). Only
80% of the warehouse and 20% of the office space was included as the re-mainder was
assumed to be used for handling orders rather than the storage function. The same percentages
were used to allocate the cost of maintenance, and heating of the warehouse and offices. The
cost of materials handling equipment and nearly all the warehouse labour force was assumed to
be related to the consolidation of orders and the movement of stock into and out of the
warehouse rather than its storage. The (modest) cost of pilferage was included with
maintenance of the warehouse. Any difference in the storage volume used by a product was
taken into account in estimating the per case storage costs which are shown in Table 4. Given
the difficulties of allocating certain costs it was reckoned that these costs were accurate to
within 20% of the true figure. Turning to short-run storage costs it appeared that none of the
warehouse and office costs was very sensitive to the level of stocks held.
Examination of the financial accounts also showed that the company had quite high
current liabilities and was running an overdraft facility with the bank, paying an average
rate of interest over the last year of 15%.

6. Outcome of the initial review

The initial review posed more problems than it answered. Strong arguments were put
forward by one side to adopt an approach that was based on Classic stock control methods.
The other Viewpoint was that a change of policy would be costly, requiring more data
collection and a resort to methods heavy in computational complexity and based in many
cases on dubious estimates of cost. The need to decide on the appropriate size of
warehouse for the future gave considerable urgency to the next phase of decision making.

5
 Table 4: Warehouse costs in last financial year
Costs £ (thousands)
Hates 23.5
Utilities 14.7
Labour 135.4
Administration 9.1
Maintenance 8.7
General expenses 7.2
Depreciation 57.7
Insurance 1.5
257.8
inventory value 423.0
Finance 0.15 63.5
Throughput (cases/veer) 143,158
Cases in stock 15,747
 6

1
Medisupply – A Review of Stockholding Policy
Ian Black
Cranfield University, UK

1. Introduction
Following a radical review of the UK National Health Service (NHS) in 1988 the govern-
ment introduced an internal market with the intention of injecting into the framework of a
public service the stimulus of competition. The introduction of an internal market separated
the purchase of healthcare from its provision, by making hospital and other community ser-
vices dependent on patient choice for funds. An important component of the reorganization
that accompanied this change was the opportunity for major providers of healthcare services
— including the hospitals, to become autonomous trusts (NHS Trusts) with more freedom to pay
staff, dispose of assets and purchase supplies as they saw fit. Whilst being providers of
healthcare the NHS Trusts, general practitioners and community services are also purchasers of
supplies necessary for their services. Following the introduction of the internal market for
healthcare and critical reports by the Audit Commission and the National Audit Office, there was
a reorganization of the various fragmented supplies organizations in the NHS. In October 1991
the NHS Supplies Authority was set up to provide a total supplies service for the NHS with
responsibility to not only manage the supply, storage and distribution of goods for the
purchasers in the NHS but, if requested, also to negotiate contracts on their behalf. In the
financial year 1992—3 the potential market for NHS Supplies was almost £3000 million. This
market included such items as stationery, cars and energy, but the major components were
medical equipment (£900 million) and drugs (£500 million). Of the former, about £670 million
was provided by NHS Supplies. The remainder was supplied by direct purchase or in-dependent
wholesalers, who were usually closely connected to manufacturers and had always played a
small but significant part in the market. One such company was Medisupply with a turnover of
£25 million through five warehouses in 1993. With the introduction of the in-ternal market the
NHS trusts were not required to use NHS Supplies, they could choose how and where to spend
their money on supplies and how much of the supply chain they wanted to manage. This
apparent opportunity for the independent wholesalers was at the same time threatened by a
radical reorganization in structure and, according to management, the philosophy of NHS
Supplies. ’Putting the customer first’, ’proactive and flexible rather than reactive and restrictive’,
’a reliable, responsive and forward looking service’ were phrases that were accompanied by a
streamlining of the warehousing and logistics operation into a more efficient and integrated
system. Savings in operating costs of over £50 million were claimed

1
This case is based on an actual company but the company name and some of the data have been
disguised for reasons of commercial confidentiality.
in the first two years. The changes in the market and the opportunities available prompted a
wide interest in the market for supplying medical equipment and a number of take-over attempts
were initiated. A successful one in 1994 was for Medisupply by a large multinational company
with strong interests in the medical and surgical equipment market. Following the takeover a
major review of the Medisupply’s operating practices was initiated. One of the key elements in
this review focused on the companyś stockholding policy which on cursory examination was
considered by the new owner to be ... ’naive, lacking any appreciation of fundamental inventory
control methods and, most important, excessively costly’.

2. Medisupply’s products
The company’s total list of products was 20,000 supplied from 300 European manufac-
turers. A maximum of 5000 of these products was held in stock at any one time. From this long
list of products the main categories sand their contribution to total sales were sutures (35%),
gloves (20%), needles and syringes (9%) )and dressings (6%). Each of these categories
contained within it a large number of individual products. These individual products were
classified by the frequency of recent orders into four bands; A: fast movers ordered at least 24
times in the last three months; B: medium movers ordered at least six times and less than 24
times; C: slow movers ordered less than six times; and Z: no order in the last three months The
number of products at that time in categories A, B and C was 752, 687 and 1240, re-spectively.
Category A accounted for 13% of sales by value. The main customers were Trust hospitals
which generated approximately 55% of the company s revenue the second and third largest
customers were NHS Supplies (25%) and private hospitals (15%).

3. The initial review

In order to assess the current strength of the stockholding policy and provide a guide to
the implications of any change in policy an analysis of current costs was undertaken,
accompanied by an examination of the methods used to determine orders for products. The
review focused on one of the company’s warehouses where data were collected on the ten
products that contributed most to sales. In the previous year these products had contributed
11.1% of total case throughput. These data, it was thought, could then provide an illustration
of the impact of different policies and by extrapolation some tentative estimates of the
overall impact on the company’s costs and resource requirements. A list of the products and
the sales over the last 24 months is given in Table 1. A longer data series was not possible
(or only at excessive cost) owing to a changeover in the computer system used. The units of
demand used (in Table 1) were ’cases’ or ’cartons’. The weight and volume of these cases
for different products are rather different but this is taken into account when calculating
storage requirements and costs.

4. The current ordering method

For categories A, B and C the system in operation at the time used the sales data for the
previous six months. Average demand for this period was calculated and the second highest
peak identified. The ’minimum balance’ was defined as the estimated demand in the lead

2
 Table 1: Total sales for two years – ten major products (units 3 cases)
Products
month SU15 GP07 GP09 NS42 NS44 SU09 SU05 NS22 SU17 NS08
Jan 92 43 207 68 169 198 78 190 227 20
Feb 101 41 201 101 120 161 89 164 202 20
Mar 94 38 177 131 132 169 76 269 216 17
Apr 100 49 176 94 70 139 80 162 187 39
May 97 32 197 51 113 125 79 253 214 50
Jun 105 42 185 115 140 132 74 198 222 33
Jul 100 39 176 99 117 87 141 311 234 47
Aug 98 52 171 139 152 94 99 387 217 57
Sep 104 42 191 65 148 112 94 234 221 64
Oct 96 87 177 116 190 130 65 339 212 56
Nov 93 74 185 105 155 132 133 157 198 54
Dec 90 66 175 106 175 167 82 244 235 33
Jan 103 75 174 118 139 130 90 129 231 52
Feb 103 61 167 91 193 162 101 175 226 70
Mar 95 60 165 91 210 168 89 46 233 77
Apr 104 70 134 105 173 124 102 176 236 56
May 97 66 142 104 134 124 102 184 236 68
Jun 102 71 164 122 131 111 110 231 243 59
Jul 102 64 157 148 273 62 145 233 232 66
Aug 91 74 150 93 182 30 87 310 230 65
Sep 107 64 132 103 215 64 104 210 216 57
Oct 105 71 129 112 210 118 104 331 244 53
Nov 91 63 137 89 214 117 103 185 231 76
Dec 90 53 127 60 145 137 113 149 252 77

time for the order plus the difference between the average demand and the second-
highest peak. Mathematically this is given by

minimum balance = L D + (Dh D)

where D is the average demand, Dh is the demand at the second highest peak and L is the
average lead time all defined in terms of monthly units. This minimum balance provided the
trigger fora new order. The order size was one month’s demand based on the average sales
over the last six months. This ordering policy was heavily criticized by some members of the
review panel. The forecast of demand implicit in the calculation of average demand was thought
to be too limited in the number of factors taken into account. The relevant demand, it was
argued, was the expected demand in the immediate future and estimates should take into
account any trend in sales and seasonal patterns that might occur. It was suggested that the
company should use one of the. numerous computer packages available for forecasting using
techniques such as exponential weighting. The existing method was defended on the

3
basis of its simplicity, its modest requirement in terms of data and its good track record in
keeping the number of orders that could not he met immediately at an acceptable level. The
percentage of unfilled orders was generally below 1% except for four products, two of which
experienced quite exceptional changes in demand (Table 2). These large jumps in demand
appear to have been due to changes in a competitor’s marketing practices and could not
have been forecast with any method based on analysis of trends in sales.

Table 2: Unfulfilled orders for two years – ten major products (percentage of total orders)
Product SU15 GP07 GP09 NS42 NS44 SU09 SU05 NS22 SU17 NS08
Percent 0.12 2.04 0.01 0.54 1.73 0.62 1.92 0.62 1,88 0.17

A level of less than 1% was considered acceptable as some unfulfilled orders were not
canceled but merely delivered a few days later. The net revenue loss of an unfilled order
was also examined. The ratio of net profit to sales for the previous financial year was 1.7%.
It was argued, however, that when considering whether to hold additional stock to avoid
potential lost sales then the profit margin was much higher because the marginal, or
additional cost, of holding a unit of stock was much lower than the average cost. If just the
handling cost of the stock was taken into account (i.e. excluding fixed costs such as
depreciation and rates) then the profit margin was estimated to increase to 5.1%. These
estimates of profit provided a basis on which it was possible to examine whether the costs of
extra stockholding might outweigh the revenue loss from not having items in stock. The
member of the review panel closely concerned with marketing argued that with a more
competitive market emerging, there was an increasing danger that lack of availability of
products or late delivery of orders may lead to customers moving the entire order to another
distributor. Another technical concern with the formula used to calculate the minimum
balance was the role of lead time. The formula used to estimate minimum balance did not
take account of any variance in the lead times which in some cases was quite significant.
The estimates of variance were highest (see Table 3 for figures rounded to the nearest day)
where deliveries were only on one specified day a week. The main conclusion by members
of the review panel critical of the existing policy was that stock levels should be increased in
order to improve the service offered by the company.

Table 3: Costs and lead times – ten major products

Product SU15 GP07 GP09 NS42 NS44 SU09 SU05 NS22 SU17 NS08
Storage cost
(£/case/month) 0.7 0.7 0.7 1.5 1.5 1,1 1.2 0.4 1.1 0.9
Lead Time (days)
Mean 5 7 8 5 5 8 15 10 20 5
Std. Dev. 2 2 2 1 1 2 4 1 4 1
Purchase cost
per case (£) 71 101 613 211 29 43 129 50 21 179

The issue of the order size was also subject to some criticism. The practice of making all
orders equal to one month’s demand failed to take account of the di fference between

4
products. Furthermore it could lead to significantly higher stocks being held than necessary,
The level of stocks was critical, as another purpose of the review was to examine the
warehouse space needed for future operations; the intention being to use any spare
capacity as a storage location for products of the parent company. The existing policy was
defended on the grounds of its administrative simplicity and the absence of the
computations and data necessary for such formulae as the economic order quantity.

5. Costs
An examination of the costs of holding stock and the costs of ordering posed considerable
problems given the breakdown of expenditure included in the accounting framework. Exam-
ination of the all the. administrative costs of placing orders, Checking orders, queries and
payment amounted to £25 per order. This included all office related costs and labour costs. A
study of the time and resources used for a small sample of orders (50) handled in one week
tentatively suggested that of the total figure of £25, about £17 was constant regardless of order
size. When it came to the issue of the cost of holding stock the allocation of costs attempted to
identify those cost elements that were dependent on the level of stock held and whether they
would vary in the short or long term. The calculation of long-run warehouse holding costs
included the depreciation of part of the warehouse and part of the office space (Table 4). Only
80% of the warehouse and 20% of the office space was included as the re-mainder was
assumed to be used for handling orders rather than the storage function. The same percentages
were used to allocate the cost of maintenance, and heating of the warehouse and offices. The
cost of materials handling equipment and nearly all the warehouse labour force was assumed to
be related to the consolidation of orders and the movement of stock into and out of the
warehouse rather than its storage. The (modest) cost of pilferage was included with
maintenance of the warehouse. Any difference in the storage volume used by a product was
taken into account in estimating the per case storage costs which are shown in Table 4. Given
the difficulties of allocating certain costs it was reckoned that these costs were accurate to
within 20% of the true figure. Turning to short-run storage costs it appeared that none of the
warehouse and office costs was very sensitive to the level of stocks held.
Examination of the financial accounts also showed that the company had quite high
current liabilities and was running an overdraft facility with the bank, paying an average
rate of interest over the last year of 15%.

6. Outcome of the initial review

The initial review posed more problems than it answered. Strong arguments were put
forward by one side to adopt an approach that was based on Classic stock control methods.
The other Viewpoint was that a change of policy would be costly, requiring more data
collection and a resort to methods heavy in computational complexity and based in many
cases on dubious estimates of cost. The need to decide on the appropriate size of
warehouse for the future gave considerable urgency to the next phase of decision making.

5
 Table 4: Warehouse costs in last financial year
Costs £ (thousands)
Hates 23.5
Utilities 14.7
Labour 135.4
Administration 9.1
Maintenance 8.7
General expenses 7.2
Depreciation 57.7
Insurance 1.5
257.8
inventory value 423.0
Finance 0.15 63.5
Throughput (cases/veer) 143,158
Cases in stock 15,747