The Strategic National Stockpile, a supply of life-saving pharmaceuticals and medical supplies for use in a public emergency, has received substantial scrutiny over the past couple of weeks. In particular, the shortage of personal protective equipment (PPE) in general and the critically important N95 mask in particular have emerged as subjects for heated political debates. Why is it, one wonders, that the richest nation on earth is unable to have sufficient face masks that can, during normal times, be purchased for less than $0.60 per mask?
For most executives, be it in healthcare or in other industries, the idea of holding a national stockpile of anything immediately raises two red flags. Why would the government managing something on a national basis be better than private enterprises operating in a free market? And, why would we want to hold a stockpile of inventory at a time when global supply chains have become lean and are operated just in time?
To begin, consider the term “stockpile," a word that is diametrically opposed to the idea of a lean supply chain. The term “lean” comes from the automotive industry and was coined after a global benchmarking study in the 1980s, which revealed that, at that time, final assembly plants in the U.S. would had one or two weeks of components in inventory while their counterparts in Japan only held inventory for a couple of hours. Rapidly turning over inventory became the mantra of modern supply chain management, accomplished by shipping the needed supplies just-in-time. This keeps inventory levels low, economizing on storage space, and freeing up working capital.
Lean systems work great – except when they don’t. During normal times, PPE procurement is a routine exercise of obtaining supplies at the lowest possible price from reliable suppliers. Hospital administrators simply place replenishment orders for materials consumed in the recent past. At a typical hospital in our system, we typically have enough N95 masks for about 10 days of normal consumption. During the COVID-19 crisis, our demand for N95 masks skyrocketed such that the safety buffer would have lasted only for couple of days. Suddenly, the concept of lean was not so attractive as we were forced to restrict use of masks by front-line workers and require reuse and sterilization.
“Buffer or suffer” is an old saying among purchasing managers. Facing uncertainty, decision makers either have to be willing to hold what may appear to be unnecessary inventory or suffer severe shortages in case of exceptionally high demand. The current PPE shortage is by no means the first break down of a lean supply chain. Lean supply chains are vulnerable to random shocks such as pandemics.
Next, consider the need for the government to step in. Every stockpiling decision is based on balancing the costs of having too much with the costs of having too little. For a hospital system, the cost of having too little PPE corresponds to the price premium it needs to pay when ordering the item during a crisis. But, this does not take into account the externality that a stock-out has on the safety of healthcare workers and the health of patients. These benefits are public goods, which should be paid for by taxes rather than by private capital.
Having the federal government manage PPE supplies has three further advantages.
Centralized inventories are more efficient than distributed inventories. Given the uncertainty of which location will require how much of an item, it is better to pool the associated risk and hold the inventory in a central distribution center as opposed to locally. Amazon’s fulfillment model with regional distribution centers uses inventory more efficiently than brick-and-mortar retailers who hold inventory in local stores.
Only the federal government has the constitutional power to use the Defense Production Act and to arrange for emergency capacity for more production. It thereby can act as a lender of last resort. It therefore makes sense to put the decision of how much PPE to stockpile in the hands of the same organization that can require private enterprises to cease their current production and change over to producing PPE.
Delegating the PPE procurement to the federal government avoids the problem of price gouging. During the pandemic, the price for N95 masks increased by more than 1000% from $0.60 to over $7. Hospitals and states are in a bidding war trying to secure scarce PPE. The outcome is an inequitable distribution of PPE with the masks ending up not in hospitals who need them most but in those who can pay the highest price.
Many leaders around the world have used military rhetoric when referring to the COVID-19 pandemic. Supporting our front-line troops with strategically procured amounts of PPE is the least we as a nation can do in their support.
Christian Terwiesch is the Andrew M Heller Professor at the Wharton School with a secondary appointment at the Perelman School of Medicine. Kevin Mahoney is the Chief Executive Officer at University of Pennsylvania Health System. Kevin Volpp is the Founders Presidential Distinguished Professor at the Perelman School of Medicine and Wharton School