Healthcare Supply Chain Costs: A Tough Pill to Swallow 

Tags: Supply Chain Management, Health Care Logistics

illustration of hand holding very large pill

Organizations all along the healthcare supply chain are taking a dose of smarter procurement and logistics practices to cure high costs and treat ailments in other areas of the business.

Talk with anyone in the healthcare industry, and before long you'll hear the same four-letter word: cost. Governments, insurance firms, and patients all are clamoring to bring prices for medical services under control. Squeezed by changes such as lower Medicare and Medicaid reimbursements, healthcare providers are looking for every possible way to cut expenditures. Key among those efforts is the drive to save money on procurement.

Three major groups comprise the healthcare supply chain:

  1. Producers: companies that make pharmaceuticals, medical devices, and healthcare supplies.
  2. Intermediaries: wholesale distributors and group purchasing organizations (GPOs), which help bring healthcare products to the marketplace.
  3. Providers: hospitals, medical practices, and large integrated delivery networks (IDNs).

Leaders in each segment are grappling with how to take costs out of the healthcare supply chain. They're also running up against other challenges, such as the need to comply with complex government regulations and find sources of revenue as products and markets mature. All this is forcing industry players to devise new ways of doing business.

Here's a look at some major issues confronting each segment of the healthcare supply chain today, and the strategies that organizations are using to negotiate this new terrain.

Pain for Producers

Healthcare manufacturers face a range of supply chain concerns, according to the 2011 Pain in the (Supply) Chain Survey (see chart below). Published by Atlanta-based supply chain solutions provider UPS, the survey polled senior executives at 250 pharmaceutical, biotech, and medical device manufacturers in the United States, Europe, and Asia.

U.S. Healthcare Manufacturers' Greatest Supply Chain Challenges

Top executives at 250 pharmaceutical, biotech, and medical device manufacturers report that regulatory compliance—with its potential fines and lawsuits—is the supply chain challenge that sends their blood pressure soaring. But they are almost as anxious about achieving cost reductions, with 64 percent expressing concern about the issue.

Source: 2011 Pain in the (Supply) Chain Survey, UPS

One big issue emerges from the fact that makers of branded pharmaceuticals will soon see patents expire on many of their most successful products. Facing losses as competitors rush in with generic equivalents, pharma companies are looking for alternative ways to boost their earnings, says John Menna, director of strategy for healthcare at UPS.

"Healthcare manufacturers are reinventing themselves," Menna says. This transformation involves entering new lines of business, such as animal health and over-the-counter medication, and moving into biopharmaceuticals—large-molecule products such as hormones, derived largely from humans and animals rather than compounded from chemicals.

Market pressures, too, are pushing healthcare manufacturers to devise new strategies. Along with competition, pressure from government and private insurance programs is forcing manufacturers to charge less than they used to for their products. Also, patients these days are more discriminating. They expect more choice, demand evidence that treatments really work and, to some extent, also demand lower prices. Ever-more-complex government regulations add further pressure.

As healthcare manufacturers find it harder to thrive at home, they're seeking opportunities in other regions of the world. "They're looking at the emerging global middle class, primarily in Asia," Menna says.

Diversification into new product lines and markets generates fresh supply chain challenges. A pharma company expanding into biotech, for instance, may find that those products require special handling, such as temperature regulation during transport. Not only must shippers keep the product within the required range, but they must prove to regulators that they have done so.

A Western company targeting markets such as China and India must rethink its global logistics network. "It has to extend into geographies that the company hasn't served in the past," Menna says. "And each new geography has different regulatory requirements and regulating bodies."

One way to address those concerns is to work with a third-party logistics (3PL) company that offers a global network, including facilities designed specifically for healthcare products.

Seeking Efficiency

While many healthcare manufacturers are working to diversify their product lines and target markets, cost pressures are also forcing those companies to operate more efficiently. For Cook Medical, a producer of healthcare devices based in Bloomington, Ind., the key to efficiency is centralization.

Cook manufactures its devices and runs distribution centers (DCs) in the United States, Europe, China, Japan, and Australia. It also uses a third-party DC in South Korea. In the past, several employees at each DC worked full-time to analyze demand in the region and determine how much of each product to stock.

As part of a recent drive to consolidate its operations, Cook has developed a software solution, the Inventory Ordering Priority System (IOPS), to manage those replenishment decisions automatically and globally. "Now one person at our North American distribution center orders product for all the distribution centers every day in less than one hour," says Rusty Burns, Cook's vice president of global logistics and purchasing.

Cook's factories still source many of their materials regionally, but the company plans to centralize that function as well. "Part of our supply chain initiative is writing a global software package for everything from procuring raw materials to distributing the finished product," Burns says.

One reason Cook is trying so hard to reduce supply chain costs is a provision in the Affordable Care Act—the U.S. healthcare reform legislation—that imposes a 2.3-percent excise tax on medical devices. Cook estimates that this tax will take a $17-million bite from its revenues. Better efficiency in the supply chain can help to compensate for that loss.

Alternative Treatments

Besides centralizing, Cook is working with vendors and customers to define further opportunities to economize. For example, it's identifying customers who will agree to take deliveries via one-day ground service rather than overnight air.

"We've had a lot of success with that strategy in the United States," Burns says. The switch saves millions of dollars, and Cook shares the savings with customers. The company is also developing more efficient packaging, and consolidating shipments to cut transportation costs.

In addition, Cook's supply chain team hopes to make the company more efficient by working with a smaller vendor pool. "In the past, we had a lot of suppliers doing the same thing," Burns says. "We've tried to consolidate and use only the ones that offer the best service and resources."

But the myriad regulatory protocols that Cook must follow make vendor consolidation a challenge. For example, in one country, Cook must report every manufacturer that contributes materials to a product. In another country, any time Cook makes a change to a product—including a switch to a different vendor for a material—it must report that alteration.

Cook can't sell a device until it has jumped all these regulatory hurdles. So if company officials decide to start buying the tubing in a stent from Vendor B instead of Vendor A, Cook might have to wait a long time for some governments to green-light the change.

If Cook gains approval in one country, it might use a new bill of materials for the product in that market, while using the old bill in countries where approval is pending. "If it's a big cost savings, we'll entertain that approach," Burns says. "If not, we'll just wait."

Along with the pressure to reduce costs, another big change for Cook involves the way it promotes products to healthcare providers.

"In the past, the sales relationship with our customer was typically a rep reaching out to a physician," Burns says. Today, Cook's sales reps increasingly find themselves discussing their wares with supply chain managers who work for the providers or for middlemen—distributors and GPOs.

To make those relationships more productive, Cook has added a team called Healthcare Business Solutions to its sales organization. "We're working with customers on the initiatives we can take to save money and create efficiencies throughout the supply chain," Burns says. "And it's paying off."

United We Save

The intermediaries that entered the picture for companies such as Cook perform several roles in the healthcare supply chain. GPOs—organizations that are usually owned by groups of hospitals and IDNs—negotiate contracts with vendors on behalf of their members. By aggregating the buying power of many healthcare organizations, they negotiate lower prices than one provider—especially a small one—could get on its own.

GPOs do not buy products themselves; they simply issue catalogs that their members use to order from vendors. By contrast, healthcare distributors, like their counterparts in other industries, buy wholesale and sell at retail to end users.

These days, though, both kinds of middlemen offer more, including supply chain services. GPOs, for example, collect data to help healthcare providers make sound sourcing decisions. "They play an integrated role with the hospital to make sure the right product is delivered to the right place at the right time," says Curtis Rooney, president of the Health Industry Group Purchasing Association (HIGPA), a Washington, D.C., trade organization.

Because GPOs are owned by their members, they share many of the supply chain concerns that keep healthcare administrators up at night, Rooney says. Cost is first among them.

GPOs serve as advisors, helping to disseminate best practices. "They provide various ways to make healthcare departments more safe and effective, reduce the number of errors, and promote patient safety efforts," Rooney says.

They also help providers save money not just by delivering lower prices, but also by identifying products that produce better outcomes. Switching from one product to another might help a hospital cut its patient infection rate, for example. That can save the hospital far more than a simple switch from a more expensive product to a cheaper one.

GPOs also help healthcare providers save money by extending the life of large capital items. "Instead of spending $1 million on the latest CT scan, facilities are starting to spend $200,000 to refurbish their existing equipment," Rooney says. GPOs help providers negotiate service contracts on such equipment.

"Price counts in this business," says Todd Ebert, president and chief executive officer of St. Louis-based GPO Amerinet. "A GPO needs to negotiate the best prices it can for its members, but there are a number of other ways organizations can help their customers."

The first is to offer at least two sources for any given product, so there's always a sound, but less expensive, alternative.

Another way Amerinet helps members save money is through its auditing service, which ensures the prices on vendor invoices match the prices on their contracts. "Before the invoice is received at the facility, we run it through our databases and identify any errors," Ebert says. "Usually we can correct errors before the product hits the account the next morning."

The search for savings has also spurred GPOs such as Amerinet to deal in a kind of product that they used to avoid: "physician preference items" (PPIs)—high-end products such as orthopedic implants, heart valves, pacemakers, and other items that physicians traditionally have chosen on their own.

To make a case for a more cost-effective product in this category, Amerinet gathers a C-level hospital executive, the head of the clinical practice in question, a nursing leader, and other key players to walk through the data and examine the alternatives. "We'll guarantee an 18- to 24-percent savings on orthopedic implants, cardiology implants, and spinal implants," Ebert says.

Opportunity in the Millions

While GPOs help their members obtain lower prices for products, another kind of healthcare middleman saves providers money by removing costs from logistics operations.

"The hospital industry's supply chain has been extremely inefficient," says Craig Smith, president and CEO of healthcare distributor Owens & Minor in Mechanicsville, Va. "There are millions of dollars' worth of opportunities to improve efficiency in individual healthcare systems."

Owens & Minor sells brand-name products from 1,200 manufacturers, as well as a private-label product line. Buying from a distributor simplifies procurement; it lets the provider receive many products from many vendors in a single shipment, then pay on a single invoice, says Trudi Allcott, Owens & Minor's director of investor and media relations. Owens & Minor sells directly to providers and through GPO contracts.

Besides selling and delivering healthcare products, Owens & Minor offers supply chain services to healthcare providers. For example, it works with vendors to develop replenishment models that fit providers' needs, which often means making frequent deliveries and breaking large orders into smaller units for distribution throughout the provider's building or campus.

"We put the products in totes and deliver them to the facility," Smith says. "Then they're taken to the floors or departments in small volumes."

Administrators want limited amounts of product to arrive once or twice a day, because healthcare facilities don't have much storage space. "Closets and warehouses don't generate revenue," he notes. Providers prefer to outsource inbound product storage.

Another trend is a greater push toward standardization. As large healthcare systems acquire smaller ones, they want to ensure all their operating units are buying the same products, in a limited range.

"Our customer might say, 'I'm buying nine different types of gloves. Let's standardize on one glove,'" Smith explains. "From 60 stockkeeping units in a glove line, let's standardize on one glove and three sizes."

Besides providing supply chain services to healthcare providers, Owens & Minor has started serving as a 3PL to product manufacturers, particularly to companies selling high-dollar PPIs. Traditionally, manufacturers have sold PPIs directly to hospitals, not through distributors.

Outsourcing to 3PLs saves vendors money, which is important because GPOs, providers, and third-party payers have forced those vendors to reduce their profit margins. Five years ago, a vendor might have sold a certain PPI for $3,000. Today, the price might be $1,500—but it still costs the same $1,000 to make, sell, and deliver that product.

Providing materials handling, warehousing, and transportation services allows Owens & Minor to cut expenses dramatically for some larger vendors.

Changing Old Habits

For healthcare providers today, the hot supply chain topic is cost-effective utilization, according to Ed Smith, chief supply chain officer at the University of Mississippi Medical Center (UMMC) in Jackson.

Campaigns to drive down prices on medical supplies probably have achieved all they can. "The way that supply chain management can affect cost now is to get involved in consumption practices," he says.

UMMC encompasses six health professions schools, four hospitals, a medical group with more than 450 physicians, and a world-renowned research center.

Ed Smith's team procures all supplies except pharmaceuticals for the entire campus. Ninety percent of those procurement dollars are spent on supplies for the hospitals.

To save money on supplies, UMMC needs to change old habits that might waste only pennies in each instance, but add up to serious dollars. "Hospital workers are used to opening a pack of sterile gloves because it's convenient, but it's a non-sterile procedure," Ed Smith explains. Or someone might open a suture tray kit, take out the scissors to use, and discard the rest.

Lack of supply standardization also leads to waste. Supply chain managers need to persuade staff on nursing floors and in procedure rooms to use the most effective products available at the best prices, while maintaining a high standard of care.

Most healthcare organizations approach this challenge through their value analysis departments, which examine the total cost of the products they use. "We evaluate the products and consider how we can influence the surgeons to use something else that will get the same clinical outcome," Ed Smith says. "In a way, we counteract what the sales reps say."

Calling in a Specialist

To give the value analysis department the clout it needs to get physicians' attention, UMMC recruited a registered nurse with both surgical experience and an MBA degree to head the team.

When the value analysis team recommends a product, it doesn't always favor the one that sells at the lowest unit cost. "On several occasions, we have proven that a more expensive product saves money," Ed Smith says.

For example, last year the team advocated for a particular port-a-cath device that cost 30 percent more than the device UMMC was currently using. Other hospitals had found that when they switched to the pricier product, patients recovered faster and could go home sooner.

"If it costs us $1,900 a day to have patients sitting in the hospital, and we can get them out one day earlier, then that product, even though it costs more, saves on the bottom line," Ed Smith says.

The value analysis department always bases its decisions on hard evidence. "We do the research," Ed Smith notes. "We ensure the product supports a standard of care across the healthcare industry, or has been recognized and is becoming the new standard of care."

Along the entire supply chain, participants maintain that their major goal is to give healthcare professionals top-quality products for patient care. Maintaining those high standards while making healthcare more affordable is a tough pill to swallow.