Can you help sustain change in your hospital or IDN?

Insights from James R. Francis, Chair, Supply Chain Management, a division of the Finance Department at Mayo Clinic; and David S. Loeb, M.D., Chair, Office of Expense Management and physician leader for Supply Chain Management at Mayo Clinic

Healthcare executives face a significant, permanent mandate – to provide affordable patient care that is of consistently high quality. Shifting from today’s volume-based environment to one that focuses on outcomes won’t be easy, but a comprehensive supply chain strategy will assist in the transformational requirements to tactically reduce cost and become more efficient.

Post-reform environment
A study of 71 health systems by Citigroup found that healthcare organizations (HCOs) with larger scale and higher degrees of integration were more profitable than others.1 Increasingly, HCOs that operate as a single organization will realize greater value, higher quality and a safer, more consistent approach to patient care. Integrated healthcare systems often have increased levels of standardized supplies, equipment and processes; more appropriate utilization management; and collaboration among all supply chain participants.
Despite some progress, many healthcare supply chains are still ill-equipped to adapt to the realities of a post-reform environment. The Council of Supply Chain Management Professionals defines supply chain management as “encompassing the planning and management of all activities involved in sourcing and procurement, conversion and all logistics management activities. It also includes coordination and collaboration with channel partners, which can be suppliers, distributors, third party service partners and customers. In essence, supply chain management integrates supply and demand management within and across companies.”2 However, very few healthcare organizations take such a broad view of supply chain management. Even fewer recognize the need to manage the supply chain from a complete end-to-end or life-cycle perspective. As a result, supply chain responsibilities are highly variable in healthcare and often unique to a locale.
Deficiencies also often exist in terms of investments in infrastructure, technology and personnel, despite growing expectations for supply chain executives to deliver increasing value without diminishing the primary mission of promoting patient health.

The challenge
Industry estimates suggest that healthcare organizations will have to reduce their operating expenses by 10 percent to 30 percent, as a result of the Patient Protection and Affordable Care Act of 20103 and market forces, including:

1. A growing Medicare-eligible population, which means more patients with fixed reimbursement.
2. Anticipated declines in commercial reimbursement, which has traditionally borne some of the costs of caring for Medicare and Medicaid patients; and the shift of patients into healthcare exchanges, where reimbursement is anticipated to be at or below Medicare levels.
3. The need to reduce the federal deficit, resulting in reductions or declining updates to Medicare reimbursement.
4. Increasing accountability by healthcare providers for the quality, safety, service and cost of healthcare.

Traditional non-labor expense management has focused on price reductions from suppliers. But increasingly, supply chain executives are focusing on standardizing the supply and services formulary and implementing utilization management programs. A recent article by Rauh, Wadsworth, Weeks and Weinstein concluded that most healthcare costs are insensitive to changes in volume and utilization, so clinical quality improvements typically create additional capacity rather than bottom line savings. Examination of the different components of cost highlights the distinction between variable costs – such as supplies and medications, where reduced use produces true savings – and fixed costs, such as facilities and ancillary services, where the costs persist despite reduced use. 4

Time’s right for change
In addition to market forces, several trends are making the climate more favorable to implementing changes in the supply chain. These include:

1. An overall increase in the transparency of product acquisition cost through the development of business intelligence and analytic tools. These tools enable providers to benchmark in order to achieve more favorable pricing, terms and conditions from suppliers. As technology improves and healthcare providers begin to collaborate and operate globally, further pricing disparity will be disclosed. The demonstration of functional equivalency of products through evidence-based outcomes research will begin to impact product decisions and standardization efforts.
2. Significant consolidation at all levels of healthcare delivery. Supply chains will grow in size and complexity, and rival those of other industries in their importance to financial and operational performance.
3. Increased fiduciary alignment of healthcare providers. Physicians are increasingly being employed, streamlining decision-making processes, and aligning the interests of the healthcare delivery system. As a result, there is increased ability to guide individual preference for products and services.
4. Growing use of information technology, resulting in efficiencies and productivity gains. More advanced supply chain operations have made investments in enterprise resource planning systems, auto replenishment technology, e-commerce, warehouse management systems, contract administration, business analytics, and travel and expense reimbursement systems, to name a few.
5. Price reductions from suppliers as a result of aggregation contracting on the part of like-minded entities. Regional networks, frequently part of a large group purchasing organization, have been realizing average incremental savings in excess of 9 percent, with some reporting higher results.5
6. Increasing constraints on capital. While many healthcare organizations are investing in infrastructure, clinical equipment and facility expansion, future capital expansion will be limited.
7. Increasing accountability on the part of supply chain executives for overall supply chain security and reliability, including product safety, quality and availability. Increased regulations require a focused effort on minimizing risk associated with operating a multi-faceted supply organization. These risks include drug shortages, counterfeit products, product recalls and failures, and disaster recovery; and have led to the need to validate supplier authenticity through credentialing.

Given such trends and market forces, the three key participants in the supply chain will need to transform themselves: supply chain executives in healthcare organizations, group purchasing organizations, and suppliers.

Sustainability matters
Supply chain executives need the support of senior leadership, who must endorse non-labor expense management initiatives. Leadership must endorse a business case that describes the scope of the initiative, sets targets and outlines recommendations. The support of physician leaders is needed as well.

Sustainability is what differentiates cost containment from true expense management. Only when expense reductions are sustained does the cost curve begin to “bend” or move downward. Sustained expense reductions require increased accountability of individuals and groups to manage to a plan and/or a specific expense target. Absent a burning platform (e.g., loss from operations), a compelling vision of the future and its challenges must be crafted and shared with all key stakeholders in order to facilitate change management.
Investments in supply chain infrastructure (people, processes and technology) are necessary in order to facilitate the transformation. Moving from a decentralized operation to a consolidated operation is mandatory. Such moves serve as an example for other administrative integration possibilities or multi-function shared services.

With these practices in place, successful healthcare organizations can focus on balancing clinical, operational and financial needs. Providers at all levels are devising new models of care delivery with the goal of treating patients in a setting that is best from a quality, safety and cost perspective. Understanding the actual cost of caring for patients will be integral to the transformation. Executives will employ activity-based or exact costing to determine the total costs of caring for patients, where waste exists, and how processes may be redesigned to eliminate such waste, increase capacity and produce more effective outcomes.

Accountable care organizations – which can align the care of patient populations with the costs to manage that population – may stimulate greater collaboration between supply chain executives and physicians. Healthcare organizations that employ physicians should strive to create departments that span multiple entities or committees to work on practice improvement, care redesign, and new models of care. Such work should include standardization of supplies, capital medical equipment and purchased services. A team of multi-disciplinary members and subject matter experts could facilitate product/service improvements across the organization. Such groups must represent at least the five major spend areas within healthcare – pharmacy, surgery, laboratory, radiology and cardiology.
A common approach to capital medical equipment, service and maintenance, information technology, facility operations, construction, and purchased services is vital. Healthcare organizations will need to optimize sourcing by developing self-service tools to assist in understanding spend and suggest where future opportunities exist.

These system-wide departments or committees must be guided by a uniform charter if a more systematic approach to the management of supply and purchased services expenditures is to be adopted.

The future will also require different sourcing and contracting strategies. Increasingly, commodities and some purchased services are being sole-sourced. Clinical preference items may be sole- or dual-sourced; while physician-preference items most likely will continue to be dual- or multi-sourced, given the risks associated with recalls and other manufacturing/supply availability issues. Even multi-sourced awards for physician-preference items and capital medical equipment should be considered for improvements in standardization.
As more reimbursement becomes fixed and declines, healthcare organizations simply won’t have the ability to recoup any inflationary price increases from payors. That’s why standardization of products and monitoring individual utilization is so important. Other strategies include procedural pricing capped as a percentage of DRG payment, and tying product pricing to decreases in reimbursement. Suppliers must share the risk associated with product safety, quality, and longevity.

With a Unique Device Identifier (UDI), products can be tracked from supplier through distributor into healthcare organizations, all the way to patients and ultimately, disposal. This type of data trail in conjunction with clinical information allows for the development of best supply practices and increased understanding of which products produce similar outcomes.

GPOs develop new capabilities
GPOs are undergoing change as well. Originally formed to leverage economies of scale by amassing large volumes, they are reorganizing in order to provide strategic programs and services, and they are developing new capabilities to create alternative sources of revenue. Facing continuing margin compression, suppliers will increasingly challenge the value of GPOs, given other activities occurring in the marketplace, such as regional aggregation groups and direct competition.

Traditionally, healthcare organizations have had agreements with multiple GPOs, but this trend is diminishing as more organizations seek higher service levels and look to maximize their return from all sources of value. Some HCOs treat their GPO as a transactional rather than a strategic partner, resulting in lost value creation for the healthcare organization. GPOs have added expertise in revenue cycle, information technology and business intelligence tools. GPOs can offer differentiated value based on volume, commitment and market share. In the future, GPOs will continue to move to a service provider model, where programs and services are purchased rather than funded through traditional means, such as administrative fees.

As the industry consolidates to fewer healthcare systems, and as regional aggregation groups increase their influence and buying power, suppliers are likely to further challenge the value of GPOs. Consequently, GPOs must build alternative sources of revenue, and healthcare organizations must be vigilant about maintaining value derived from administrative fees, most likely through lower product acquisition costs.

New models of distribution
Suppliers and distributors play integral roles in the overall healthcare supply chain. The collaborative relationships they have built with providers are fundamental to the practice of medicine, continuing medical education and research.

Many distributors are evaluating the true cost of handling certain products and supplies. It is likely this will lead to potential disruption in the supply channel, with distributors refusing to handle products from suppliers that refuse to pay for the costs associated with distribution. Suppliers are examining other models to distribute supplies to healthcare organizations, including operating their own distribution centers or outsourcing such responsibilities to 3PL companies. Distributors will also move to more activity-based-costing models in search of strategic relationships with healthcare organizations, where risk and reward associated with the handling and distribution of products are more equally shared.

Near term, the focus will be on reducing the acquisition costs of supplies as the industry moves from a seller- to a buyer-centric model. Increased visibility to pricing disparity in the marketplace will lead healthcare organizations’ efforts to reduce acquisition costs. Supplier competition will increase, and control of market share will become more important. As healthcare organizations improve their analytic capabilities, they will increasingly focus on utilization management and inventory management. As a result, suppliers will see margin erosion if they do not streamline SG&A expense.

Suppliers will also be impacted by the medical device tax beginning in 2013 as part of the Patient Protection and Affordable Care Act. Healthcare organizations must be vigilant in ensuring that such tax is not passed through the supply chain, and must work with suppliers to meet the common challenge of decreased funding.

Healthcare organizations are being held accountable for ensuring a safe and reliable supply chain, and suppliers must participate in solutions. Advancements in the use of global data standards, authenticating legality of suppliers and their sources for product, managing recall and product issues, traceability associated with product movement, etc., must be managed in a comprehensive plan.

Leaders wanted
Healthcare executives are reflecting on the needs of their organizations and abilities of the management team to lead in these tumultuous times. As it relates to the supply chain, they are focusing on investing in the right talent for their organizations. They may outsource operations, partner with GPOs and suppliers, and/or hire or appoint a physician executive to help lead supply chain transformation needs. Given the increased focus on the supply chain operation and the value that it can bring, the supply chain executive of the future will need certain skill sets and capabilities, including:

1. Leadership ability. Does the supply chain executive have the ability to scan the environment, collect and analyze both internal and external data, and use the information to develop solutions? Is he able to envision a future strategy and align individuals with that vision? Is he a critical thinker, thoroughly assessing various scenarios and adapting to change in order to determine appropriate actions? Does he possess a balance of technical skills and abilities along with emotional intelligence? Is he a cultural fit with the organization and able to work with all levels of professionals?
2. Change management. Does the supply chain leader understand and follow principles of change management? Can she motivate staff to accept and embrace change as the organization transforms? Does she understand that staff cares more about the process leading to a change than the decision itself, and as a result, does she collaborate with all staff on the process to successfully implement change?
3. Results orientation. Does the leader inspire others? Can he build highly effective teams? Is he obsessed with metrics and measurement in order to track progress and monitor results? Does he take appropriate risks while paying attention to detail? Is he adequately motivated to perform and deliver results?
4. Relationship management. Does she communicate well at all levels? Does she hand off effectively, and is she able to develop relationships with other professionals? Can she earn and build trust among teammates and other key stakeholders? Is she job-centric rather than egocentric? Is she adequately networked inside and outside of the industry?

Healthcare is entering a period of unprecedented CHANGE, and the pace of change will likely accelerate. Successful supply chain leaders will recognize the challenges as well as opportunities, position their organization appropriately for the healthcare supply chain of the future, and transform the supply chain to deliver even more value. They will deploy non-traditional cost management strategies, fully explore all areas of non-labor spend for opportunities, collaborate fully with physicians and other colleagues, implement technology investments, enhance staff and individual skills, and dramatically challenge historical behaviors and practices. If executed correctly, the transformation will preserve access to the latest clinical advancements for patients and help achieve the overall expense reduction necessary in the new operating environment.

James R. Francis is Chair, Supply Chain Management, a division of the Finance Department at Mayo Clinic. Mayo Clinic spends more than $2.1 billion on supplies and purchased services annually, with an additional $700M in capital expenditures. Gartner has selected Mayo Clinic as one of the Top 25 Supply Chains in Life Sciences and Healthcare for each of the past three years.
David S. Loeb, MD, is Chair, Office of Expense Management and physician leader for Supply Chain Management at Mayo Clinic. He is an assistant professor at the Mayo Clinic College of Medicine. Dr. Loeb is a board-certified gastroenterologist and practices at Mayo Clinic Florida.

1. Warner, L., Cyganowski, D., 2011. Citigroup Study, Examining the Impact of Scale and Integration.
2. Source: Council of Supply Chain Management Professionals at www.cscmp.org/aboutcscmp/definitions
3. An analysis by Mayo Clinic showed a need to reduce from 7-20% of total operating costs in order to offset estimated reimbursement reductions. Through networking with other HCOs, estimates of 10-30% reductions are often mentioned.
4. S. Rauh, E. Wadsworth, W. Weeks, and J. Weinstein. 2011. The Savings-Illusion – Why Clinical Quality Improvement Fails to Deliver Bottom-Line Results. The New England Journal of Medicine, December 14, 2011 at www.nejm.org.
5. Mayo Clinic is a member and service provider to the Upper Midwest Consolidated Services Center, LLC. Since its inception, Mayo Clinic has realized savings greater than 9% per year on contracting initiatives. In 2011, Mayo Clinic realized 15% savings on completed contracting initiatives.

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Sidebar:
Example charter for committees focused on management of supplies and purchased-services expenditures

The physician leaders in specialty areas in conjunction with supply chain and finance colleagues must regularly:

1. Monitor supplies, equipment, and services through standardized metrics and dashboards and understanding reasons for variation.
2. Establish and maintain savings targets / expense budgets.
3. Establish a standardized process for all areas to analyze and evaluate products/services prior to contract awards.
4. Achieve high levels of contract compliance and address non-compliance in a timely manner.
5. Establish a product formulary for high-spend categories based on safety, quality, efficacy, outcomes, cost and reimbursement. Allow no changes to the formulary without a thorough analysis of the impact of a change on safety, quality, service, cost and reimbursement.
6. Adapt best practice utilization on a procedural/cost basis by reducing variation.
7. Assess new technology and determine clinical acceptance on a system-wide basis using evidence-based criteria in order to allow innovation.
8. Segment and partner with suppliers based on their potential to add the greatest value to the healthcare organization.
9. Increase visibility of demand and adopt best inventory management practices.