Curing Health Care's Ills

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SYMPTOMS: hemorrhaging costs, swollen inventory, impaired visibility & tracking, technological paralysis. DIAGNOSIS: unhealthy supply chain management and related complications. RECOMMENDED TREATMENT: take control of costs, exercise better visibility, optimize infrastructure...and call me in the morning.

Rising health care costs, already threatening many basic industries, now consume 16 percent of the nation's economic output—the highest proportion ever.

The nation's health care bill continued to grow substantially faster than inflation and wages.

The overall cost of health care—everything from hospital and doctor bills to the cost of pharmaceuticals, medical equipment, insurance, and nursing home and home health care—doubled from 1993 to 2004.

In 2004, the nation spent almost $140 billion more for health care than the year before. The health care increase of 7.9 percent in 2004 was almost three times the overall national inflation rate, which was 2.7 percent.

These are among the sobering findings of a newly released report from the Centers for Medicare and Medicaid Services. While the numbers are high, they come as no surprise. Every corporation and individual in the United States feels the effects of this cost escalation.

"Health care costs are spiraling out of control," says Chris Holt, vice president of consulting for UPS Supply Chain Solutions. "They're pushing many companies toward bankruptcy. We all have a responsibility to cure the health care industry; to take control of these wildly escalating costs."

Healthier supply chain management, Holt believes, plays an important role in this endeavor.

Improving supply chain performance, however, is no simple matter. The health care industry is tremendously complex, made up of health care providers, device and implant manufacturers, pharmaceutical companies, distributors, and a host of other service and product suppliers.

"The health care industry has always searched for supply chain nirvana—perfect visibility of supply and demand, a well balanced and coordinated supply chain, and optimized infrastructure with the right kind, number, and location of facilities across the industry," says Jamie Hintlian, a consultant with Accenture. "At this point, however, the industry is a long way from reaching that state.

"Many manufacturers in the sector have improved internal integration—streamlining supply chain demand planning within the enterprise," Hintlian says. (See the sidebar, below, for one example.) "But there is still room for improvement in both internal and external supply chain operations."

The unique characteristics and issues of hospitals and device/implant manufacturers make them interesting subsets to examine. What are their chief supply chain challenges? And what is the recommended treatment?

Hospitals: Lagging Behind

Supply chain costs represent the second-largest expense for hospitals after labor costs. According to a whitepaper written by Tim Bremer and Jim Reiner, principals with UPS Supply Chain Solutions, Atlanta, those costs break down as follows:

  • Managing materials and supplies consumes 15 to 30 percent of net patient revenues. Hospital supply expenses alone represent 25 to 30 percent of spend.
  • Hospitals overpay suppliers for contracted medical and surgical products from 2 to 7 percent of the available contract price.
  • Purchasers and accounts payable workers spend approximately 40 percent and 60 percent of their time, respectively, processing transactions manually.
  • Approximately 35 to 40 percent of hospital supply costs are devoted to handling, moving, and processing materials and supplies, compared to less than 10 percent in other industries.
  • A 5- to 15-percent savings in supply chain costs would equate to a 1- to 3-percent improvement in a hospital's operating margin.
  • A single paper-based purchase order may cost between $75 and $140 to process. When processed online, however, it can cost as little as $6 to $10.
  • Current use of EDI within hospitals only covers 30 to 40 percent of transactions available for automated processing.

Departmental inventories at an average 300-bed hospital could represent $4.5 million in on-hand value, with an inventory turn rate of only three to four times per year, reports health care manufacturer/distributor Cardinal Health Inc. Clinical staff can spend up to 25 percent of their time on supply chain activities.

These are compelling reasons for hospitals to reevaluate how their supply chain operations impact the bottom line and consider ways to improve. For many hospitals, however, focusing on the supply chain remains a low priority.

"Hospitals have tough decisions to make when committing resources to visible areas such as clinical technology versus less-visible areas such as the supply chain," say Bremer and Reiner.

The priority improvements are usually highly visible—a new MRI machine, for example, has a direct impact on patient wellness and receives a high vote of confidence from physicians and the medical community.

In most hospital organizations, the materials manager, who is closely linked to activities focused around procurement, leads supply chain management efforts.

"Rarely does this supply chain authority report directly to the CEO, who could elevate the supply chain's visibility and provide the attention required," Bremer and Reiner say.

As a result, supply chain management's importance often goes unrecognized either for its current contributions or its potential ability to reduce costs, improve margins, and add value to the bottom line.

Procurement constitutes a particularly troublesome area for hospitals.

"The typical hospital is information poor," explains John Walko, Accenture. "It doesn't have accurate data on what it buys. In fact, hospitals lag behind most industries in managing procurement."

Hospitals struggle with sourcing issues for several reasons. "First, manufacturers are constantly introducing new technology," Walko notes, "so the product mix is always changing."

Second, most hospitals have difficulty managing purchasing costs because physicians decide what products to buy and vendors to use. Doctors may order multiple sizes of an item—screws for an orthopedic device, for instance—but only find out which size they need during the actual surgery.

"Imagine the challenge this creates from a supply perspective," Walko notes. "Doctors need supplies in many different sizes and options. They may pull items out of inventory for a procedure and not use them. This means someone has to figure out how to get the items back either into inventory or to the manufacturers.

"Returning a small number of high-cost products can greatly increase inventory value," Walko says.

Devices implanted in a traditional cardiac catheterization, for instance, can run anywhere from $2,100 to $29,000 each. Hip or knee implants, and the screws and components that accompany them, can cost between $3,000 and $11,000 each.

"Lose a few of these, or let them become obsolete, and you're wasting significant dollars," Walko says.

Better inventory tracking is certainly worth the effort. But where to start?

First, hospitals can rationalize and standardize their supplier base. "Clinicians frequently use similar supplies that could be standardized to leverage better prices from suppliers," Bremer and Reiner say.

Does a hospital need five orthopedic implant providers, for example, when the price of a hip replacement may cost between $4,000 and $7,000 depending on the vendor and type of hip? Hospitals can significantly reduce their operating costs by critically evaluating suppliers, and finding opportunities to pare down the number of similar or redundant supplies.

Similarly, hospitals that use multiple group purchasing organizations (GPOs) should concentrate their business with a primary GPO to leverage their buying power for better pricing, says Hintlian.

Second, hospitals should assume control of their inbound supply chains. Historically, hospital materials managers focused on getting the lowest product price, and had little understanding of inbound transportation and other supply chain costs. Buying on price alone results in too much of the wrong inventory, no visibility into inbound flows, maverick spending, and, in the case of a large group of hospitals, a high level of facility-to-facility transfers.

"Hospitals need to break out logistics costs from the total cost of goods," says Walko. "Rather than have product just show up at the door, they can manage inbound freight, anticipate deliveries, and have visibility into what's coming."

Third, health care providers should explore the option of a multi-channel distribution strategy and evaluate whether it makes financial and operational sense to source select products directly from the manufacturer, Bremer and Reiner advise.

This requires setting up a distribution center or using a third-party logistics provider (3PL) to handle manufacturer goods. Naturally, a hospital group must be large enough to justify the expense of setting up a centralized DC.

Pennsylvania-based Crozer-Keystone Health System, for example, had operating and storage locations at four hospitals and four nursing homes. The health system established an off-site distribution center and saved approximately $1.5 million annually. It reduced inventory by more than $300,000, saved $400,000 by consolidating contracts among the facilities, and saved another $500,000 through item standardization.

Finally, health care providers typically have not implemented the most up-to-date technology in the materials management functions, and still perform many tasks manually. This results in data-entry errors and inaccurate information about order status and actual inventories. A point-of-use inventory tracking system could greatly improve the replenishment process.

Medical Devices: Floating Inventory

The supply chains of medical devices and "implantables"—hips and knees, for example—act more like traditional manufacturing supply chains, but also pose certain unique challenges. Some products are federally regulated while others aren't.

"The art is figuring out how to run the supply chain as efficiently as possible, while dealing with both types of products," says Holt. "Are all products treated as regulated material? Or is there a separate supply chain built for non-regulated goods? Are all products stored in high-quality, pharmaceutical-grade space or split to reduce costs?"

Inventory management is a tricky issue, particularly with implantables.

"Hip replacements come in multiple sizes, shapes, and materials," Hintlian explains. "Hip replacement suppliers have to keep large inventories at surgery clinics. A doctor may go into a surgery thinking the patient needs a size 8 hip, but ends up using a size 6. The doctor wants to make sure every size, and multiple units of every size, are in stock. This means the manufacturer has a bundle of forward inventory scattered throughout the field."

Additionally, during an operation, a physician uses 25 percent or less of the products in an implant surgical kit. "The products that aren't used must be sent back to a stocking point, cleansed and sanitized," Holt says. "And missing components must be replaced."

These returns can incur high transportation and handling costs. In many cases, implantables and medical device manufacturers own inventory in the field, but have no control over its use, and no visibility into the doctor's office. They pay all the returns transportation, handling, and re-kitting costs.

"Device-makers use free logistics as a way to compete," Holt notes. "The down side is that doctors, because they are not paying, have no incentive to manage inventory tightly."

Manufacturers are testing the use of RFID tags to track these items. And some companies are experimenting with special supply closets that scan products as they move in and out of a doctor's office.

"These supply closets are expensive," Holt says, "and all they do is provide more information about what's being done to product already in stock. They don't solve the inventory problem."

Medical device manufacturers have to contend with another thorny inventory issue: trunk stock.

"The higher the device's value, the more competitive the market, and the more likely it is that the sales rep plays an important role in product sales and distribution," explains Holt. "Sales reps typically deliver these devices in person to the doctor. They want to make sure they have enough inventory on hand to do so, which means carrying products around in the trunk of the car or keeping it in the garage.

"Sales reps may have a few hundred thousand dollars of product sitting in the garage, in a poorly controlled environment," he adds. "Multiply that figure by hundreds of sales reps and the numbers mount up quickly."

Some companies try to gain better control of this inventory by using their sales offices as regional distribution hubs. "But this forces reps to drive back and forth to the regional office to get the products they need, pulling them out of the field and hurting sales productivity," Holt notes.

How can manufacturers address the trunk inventory issue?

"They could establish forward stocking locations, and treat these products much the same as service parts," Holt suggests. "Companies in the high-tech sector, for example, set up service parts logistics processes to get customers up and running within four hours if computers go down. Medical parts manufacturers could design the same kind of network to handle their products."

Setting up a network to provide four-hour service to every field installation site would be prohibitively expensive for a single company. "Some companies turn to 3PLs, who already have the locations and a shared network model that spreads the cost across many companies," Holt says.

Overall, medical device companies need to take a supply chain-wide view of their business.

"Companies cannot make a difference if they look at the problem as just sales rep-to-doctor, or parts supplier-into-production," Holt says. "But if they understand it from a product flow view, they can build a demand-driven supply chain. The doctor becomes the demand signal."

Ultimately, Holt says, device/implantables manufacturers will have to change their commercial practices—and stop giving doctors unlimited inventory for "free."

Manufacturers can change that paradigm by charging doctors a restocking fee if they ship back half of what they ordered. "That will force the doctor to adopt better business practices," he says.

Clear Opportunities

The health care supply chain is filled with clear and substantial opportunities for supply chain improvement. "Controlling costs requires a greater level of collaboration among the channel players," says Hintlian.

Health care providers must do a better job of managing procurement, inventory, and inbound logistics flows. They and their suppliers must work as a team to establish supply chain practices and processes that reduce costs throughout the channel and build the kind of supply certainty that eliminates the need for padded inventories.

That's the prescription for a healthy supply chain.

A Healthy Approach: Gambro Renal Products Unit

When global companies such as medical technology firm Gambro Group grow through mergers and acquisitions, they invariably encounter business integration challenges. Products and supply chains often overlap, as was the case with one of Gambro's operating units, Gambro Renal Products.

Several other issues were also a concern to the division's management:

  • Falling profit margins were stemming products from maturing and/or becoming commodities.
  • Its 52 warehouses were burning up capital, bloating inventory, and extending lead times.
  • Localized replenishment approaches and more than 25 separate systems at Gambro's regional DCs made it difficult for the company to capture supply chain information at the enterprise level.
  • Independent pull signals at each stage of the supply chain undermined its production planning efficiency.

With the help of Accenture, Gambro Renal Products restructured its European logistics network and implemented new, global processes for forecasting and finished goods supply chain planning.

Gambro started its supply chain reengineering by rationalizing its DC network. It reduced the number of stocking points from 52 smaller warehouses and storage points in Europe to four distribution centers in Germany, Sweden, France, and Italy, and two satellite warehouses in England and Spain.

The division developed a single, enterprise-wide supply chain model that mapped out new roles, processes, and supply chain agreements for all locations and all products. It rolled out the new supply chain model globally, initially using manual tools and existing IT support.

Gambro subsequently implemented a new global demand planning and supply chain planning solution from i2, a Dallas-based software provider. The new solution covers 100 percent of Gambro's demand and about 80 percent of its finished products stock. The supply chain model now addresses the needs, capabilities, and information-management requirements of all products and sites.

In the past, Gambro Renal Products' sales, market, and regional forecasts were handled independently. Today, the process is coordinated globally. Based on historical sales, i2's demand planner generates initial forecasts. Then sales planners make necessary adjustments and consolidation occurs automatically. Sales and marketing organizations also have instant access to global sales histories and forecast figures across all product lines, making it possible to manage holistically and respond adroitly to unplanned shortages.

Gambro also improved its replenishment process. Traditionally, each distribution center and satellite facility conducted its own local replenishment planning, with sporadically compiled sales forecasts and stock figures fed into master-planning tools. Now, local systems provide information on stock levels, in-transit inventories, customer orders, and fixed production plans to the centralized supply chain planner system on a weekly basis.

The system then calculates production requirements and replenishment quantities. Global planning staff can enforce agreed-upon coverage targets because local and regional demand/supply information is available across the enterprise. In the pilot for the new supply chain planning system, Gambro reduced inventory by 30 percent in 12 weeks.

Gambro realized significant benefits from its supply chain overhaul. The company cut delivery lead times from several weeks to between 24 and 72 hours, reduced logistics costs by 30 percent, and improved customer delivery accuracy by 30 percent.

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