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Hospital Survival Through Smart Purchasing

The following article was written by Greg Charleston and Chris Good and published in the American Bankruptcy Institute Journal.

On Dec. 17, 2013, Time published the “Top 10 Google Searches of 2013.”1 It should come as no surprise that the top search question was, “What is twerking?” Rounding out the list was a concept that will surely test our notion of currency and will likely be a topic of future articles: “What is bitcoin?” Of particular interest — and the question at the foundation of this article — is list item number seven: “What is Obamacare?” The better question is: “What will be the impact of the Affordable Care Act on the nation?”

The primary goals of Obamacare, or more formally, The Patient Protection and Affordable Care Act (ACA), include the following mandates:

  1. give Americans greater access to health care;
  2. add more consumer benefits and protections that are related to health insurance; and
  3. rein in (and ideally reduce) the cost of health care. In other words, the ACA’s goals are to provide more coverage for more people at a lower cost.

Providing more for less typically involves taking advantage of scale, volume and a substantial decrease in the per-unit cost. Therefore, for the ACA to work, health care provider costs must come down.

Industries that do not produce a profit do not survive; entities that do not meet the public’s needs fail, except when government intervenes. The microeconomic supply-and-demand model has four “laws,” the first being that if demand increases and supply remains unchanged, a shortage occurs, leading to a higher equilibrium price. Demand will certainly increase with the new health care laws by their very nature of providing health care access to a broader cross-section of the population. Larger health systems have a greater advantage over smaller, independent health systems in finding ways to create economies of scale and reducing per-unit costs.

As shown in Table 1, there has been a wave of bankruptcies among smaller, independent hospitals over the past two years. (This list pales in comparison to the number of hospitals that have closed during the same period.) The financial pressure on independent health systems has been growing for years. The ACA will only continue to increase the strain on these health systems. Independent health care organizations are fighting for survival, as they are faced with significant industry changes and decreasing reimbursement rates. Hospitals in particular are desperately searching for new cost efficiencies to maintain financial stability.

Bill George published an article in The Wall Street Journal titled “Seven Lessons for Leading in Crisis,”2 with lesson number six being, “Never waste a good crisis.” He credits this piece of advice as coming from Benjamin Netanyahu, prime minister of Israel. This crisis-management concept has also recently been cited in Charles Duhigg’s popular book, The Power of Habit. In chapter six, entitled “The Power of a Crisis,” Duhigg illustrates the power of crisis management as a tool in the context of a major crisis. Leaders have learned that they can make significant changes during a crisis because overcoming the inertia of an organization to spark change is much easier. This interesting characteristic of organizations is covered at length by Duhigg, and a crisis is coming for health care, so leaders will need to use this crisis to effect great change. This crisis will see the failure of many health care institutions and will likely cause a complete rework of how we deal with health care in the U.S.

Group purchasing organizations (GPOs) are entities that aggregate the purchasing volume of its members and utilize that leverage to reduce supply chain costs. It is important to realize that GPOs typically do not actually buy anything; instead, GPOs generally only negotiate contracts for their members for the purpose of the procurement of goods and services. It still remains incumbent upon the GPO’s membership to select the products that they deem appropriate based on quality, delivery and price.

GPOs date back to around 1909 with the creation of the Hospital Bureau of New York.3 The roots of GPOs are in health care, and more than 105 years later, health care GPOs are some of the largest. In 2012, the largest GPOs were ranked by annual purchasing volume (see Table 2).

GPOs are clearly a significant presence in the health care field, and as such, you would expect that their value is without question. However, there are numerous studies that argue against the value of GPOs. This article will not go into details on this debate except to state that GPOs simply aggregate volume. Purchasing larger volumes can tend to reduce the overall system per-unit costs. However, for many independent hospitals, the traditional GPO approach is simply not enough. Just being a member of a GPO does not ensure procurement success for health care providers. For independent organizations that wish to maintain their independence and survive, it will be critical to develop a supply-chain approach that involves both purchasing managers and clinicians to develop a safe, strategic and cost-efficient purchasing-specification process. The GPO relationship must be managed to achieve the greatest benefit.

The new and improved procurement and GPO approach must become much more strategic and comprehensive. Hospitals must begin to face the ongoing purchasing dilemma that is related to specifying what supplies are needed and necessary rather than continuing to acquire supplies that are driven by what the clinicians would “like to have.” This article identifies nine strategic initiatives that must be incorporated into a hospital’s procurement system to enable future survival for independent hospitals.

Nine Strategic Initiatives

Rebid the GPO Agreement as Often as Allowed
While there will be thousands of stock keeping units (SKUs) and a significant investment of time and talent, contracts must be tested to ensure that they are competitive within the market. Many factors change over time, and many of these are not easily detected without a significant market test. A market-basket approach is a tool that will reduce the workload to a manageable level. Choosing the market basket of items to test is the real challenge for the procurement team, which might already be light on resources, as the GPO is serving as the surrogate sourcing and negotiating entity.

Drive Compliance Rebates are volume-driven.
If hospital employees are ordering products from non-GPO contracts when a GPO contract is available, rebate money is lost.

Understand and Validate Rebates Being Paid to the Hospital
Blindly accepting rebate checks from suppliers is a lost opportunity. The volume of goods that are purchased and the level of the rebate should be validated. The rebate has been negotiated and the compliance with the contract met, so not validating the rebate check is easy money that is left on the table.

Develop Purchasing Selection Committees
These committees are comprised of clinicians and material management professionals who select products and manage physician preference items. Procurement in the health care field is largely driven by clinicians; no one wants their health put in jeopardy or the perception of jeopardy from a front office bureaucrat telling the highly skilled and trained surgeon that the gloves that he/she prefers are too expensive. The only way to drive down costs is to work collaboratively as a team. The clinicians need to have regular updates on the financial condition of the hospital so that they can see the need for cost controls being put into place and participate in selecting the best options for cost reduction.

Develop Sourcing Criteria to Weight Sourcing Factors
Cost is not the only factor that should be considered in sourcing. A weighted matrix should be developed for use by the selection committee to objectively evaluate products for sourcing.

Seek Substitute Products at Lower Costs for High-Volume and Higher-Priced SKUs
Using the pareto principle (aka the 80/20 rule), seek out alternatives for the items with the highest volume and highest cost. Try to find items that clinicians have greater flexibility to change.

Control Medical Device Sales Representative Access to Facility and Health Care Personnel
Medical supply company sales representatives are great at selling, and they have an army of research and development staff behind them designing items that may or may not provide greater value for the customer. A sales representative knows how to get doctors excited about a product. Therefore, it is important to control the access and procurement process in order to avoid clinicians ordering a product impulsively before the sourcing committee has had the ability to fairly analyze the new offering.

Regularly Meet with GPOs to Review Cost Trends and Options for Alternate Manufacturers and Products
Seek to understand price increases passed along by the GPO. The GPO is negotiating with representatives for thousands of items with hundreds of manufacturers. Make sure that needs are known, and meet on a regular basis to understand cost changes and seek alternatives.

Maintain In-House Sourcing Expertise
An additional benefit to employing a GPO is lower direct personnel costs. Hospitals and other health care entities would be able to staff fewer procurement employees as the GPO would handle a great deal of this function. Hospital internal material management professionals typically serve more of an order-fulfillment and replenishment role. They spend a large portion of their time ensuring that orders go through and are placed under the proper contract, that deliveries occur as planned, and that price mismatches are corrected.

As the GPO serves as the sourcing expert, in-house procurement becomes less practiced at sourcing, which can be a significant challenge for the management of the procurement team that is utilizing a GPO. Sourcing expertise and product knowledge must be maintained to continuously evaluate sourcing decisions, and in-house expertise must be maintained to rebid the GPO contract as often as permitted. In addition, deep product knowledge should be developed on high-volume and high-cost products, as they can serve to provide great savings when sourced properly.

Conclusion

Leaders can effect important changes during difficult times. The health care industry has not been kind to independent hospitals over the past several years, and there is no indication that the ACA and reduced reimbursement rates will make the industry any less cruel on these organizations over the next few years. Survival in this world will take decisive and creative action. Procurement cost savings remains an area of opportunity, despite many of these hospitals being under the false belief that purchasing has already been optimized through its arrangement with a GPO. The nine initiatives described herein can provide additional and meaningful cost savings at a time when every dollar is important and can mean all the difference in the world.

 1 Nick Carbone, “Paging Alex Trebek: The Top 10 ‘What Is’ Google Searches of 2013,” Time, Dec. 17, 2013, available at http://newsfeed.time.com/2013/12/17/google-what-is-searches/.
2 Bill George, “Seven Lessons for Leading in Crisis,” The Wall Street Journal, March 5, 2009, available at http://online.wsj.com/news/articles/SB123551729786163925.
3 “A Primer on Group Purchasing Organizations: Questions and Answers,” Healthcare Supply Chain Association, available at www.supplychainassociation.org/resource/resmgr/research/gpo_primer.pdf.