Consolidated service centers transform hospital purchasing

Hospitals traditionally haven’t given a lot of thought to their supply chains. As one CEO in a major academic health center told Supply Chain Management Professor Eugene Schneller, “Our job is training physicians and giving outstanding patient care.”

But today, forces are combining to turn their attention to supplies and distribution. A trend of mergers and acquisitions in health care is encouraging economies of scale. And new medicare and medicaid outcome-based reimbursement rules are forcing hospitals to find ways to operate both cheaply and efficiently. “There are huge incentives to provide high-quality care and be very cost-effective,” Schneller said.

One solution is the consolidated service center (CSC), an entity set up and owned by hospitals or hospital networks to manage purchasing and distribution. A CSC reduces the number of components in the complex hospital supply chain and gives hospitals better pricing power and distribution control. Each center that Schneller and colleagues — Kuwait University's Yousef Abdulsalam, Associate Professor Mohan Gopalakrishnan, and Associate Professor Arnold Maltz — examined did things a little differently, but all experienced pronounced improvements in efficiency.

Alpha: Simplify to reduce costs

An independent nonprofit CSC in the Southeast serving seven acute care hospitals, the CSC that Schneller christened, “Alpha,” operates on a “membership model” — its hospitals are the members, and the center treats them like customers. This CSC started off by negotiating purchasing contracts. Then it established its own warehouse and logistics operations to supply hospitals more efficiently.

As Alpha evolved, it continued to add services. For example, it developed its own clean room to assemble instruments into surgical packs.

But Alpha’s cost efficiencies didn’t come from contract negotiation and better distribution alone. Like other CSCs, the center created a “value analysis team” composed of doctors, nurses, and purchasing managers representing member hospitals. The team met to choose the best products and limit the number of Stock Keeping Units (SKUs) in the system. That reduced the number of suppliers, giving the center greater bargaining power.

“You can say, ‘We’ll give you 80 percent of our spend if you give us your best price,’” Schneller said. These kinds of commitments, he explains, can lead to strong and trusting relationships between suppliers and their health care customers.

Though it may sound simple, getting physicians to agree on product choice is easier said than done. Doctors develop preferences early, sometimes while still in medical school. Once in practice, they develop close relationships with manufacturers’ representatives, who often sit in on surgeries with them, providing real-time advice on product use and sometimes even managing inventory.

But it’s the relationships more than the products themselves that tie doctors to specific brands, Schneller said. Using data on product effectiveness (when it’s available) and demonstrating product standardization’s dramatic effect on the bottom line, value analysis teams increasingly succeeded in convincing doctors limiting their choices while still obtaining high-quality equipment and services.

By managing distribution and reducing the number of products and suppliers its hospitals deal with, Alpha transformed the supply chain from an unwieldy Rube Goldberg-like contraption to a lean, smooth-functioning machine.

Beta: Pick your battles

Beta, a CSC serving hospitals and clinics in the Southwest, manages purchasing for 14 acute care hospitals. It also operates a warehouse that serves a smaller subset of hospitals. At the warehouse, Beta repackages products into smaller sets, assembling surgical packs and compounding drugs.

When it comes to products, Beta negotiates directly with suppliers for some of them, but for “commodities” — simple supplies like cotton balls, bandages, gauze, and IV solutions — it uses a Group Purchasing Organization (GPO) instead. Many hospitals work with GPOs because their size gives them negotiating power and economies of scale.

Beta’s value analysis team meets regularly to consider alternatives for other types of products, analyzing price, volume, effectiveness, and supplier support. It often reduces SKUs for a certain type of product from 10 to around four or five.

Beta finds it worthwhile to negotiate with some suppliers, but not all of them. Using a GPO frees the CSC from thinking about commodities to focus on larger concerns. Like Alpha, Beta uses a warehouse for more efficient distribution and does some product assembly and packaging itself. Its emphasis on product standardization simplifies the system by reducing the number of entities with which it must negotiate and lowers costs.

Gamma: Why not do it all?

Gamma is a Midwestern CSC that emerged from the restructuring of a large health care system. Before the reorganization, the network had no strategic supply chain focus. Purchasing and inventory management were poorly integrated, and standardization was minimal. Ordering products was such a slow process that the chief operations officer thought the system might have been created as a deliberate attempt to discourage spending. Yet there is great risk when hospitals do not have the appropriate products. Surgeries might need to be postponed and patients may receive alternative products that are not really the best for their medical problem.

The new CSC first focused on integrating supply chain information across hospitals, which revealed many missed cost-saving opportunities. In some cases, identical items were being purchased by member hospitals at different prices.

Standardizing products and purchasing was just the beginning for Gamma. The center eventually moved beyond sourcing its products to working with manufacturers in the United States and China to create its own private-label portfolio, which now contains more than 1,000 SKUs. It started with commodities, moving into designing more sophisticated equipment as it gained confidence.

“We started with garbage bags, and now we are manufacturing medical devices,” a CSC executive said.

Gamma’s foray into manufacturing illustrates another hallmark of CSCs — a spirit of innovation. The CEO of Alpha described his organization as “a supply chain think tank.”

Whether they create a private label or brainstorm new ways of ordering supplies, CSCs have a strong entrepreneurial bent, especially when compared to traditional hospital approaches to their materials management. Interestingly, their leaders often come from outside the health care industry. They’re used to bandying about ideas on insourcing versus outsourcing or making versus buying. This breaks the long-held view that “material managers just fill orders,” Schneller said.

Beyond cost efficiency

Like other enterprises, CSCs create economies of scale. But that’s not all they do.

They also seek products that help them achieve policy goals. Hospitals today are penalized if patients come down with hospital-related infections or, under new reimbursement schemes, have to be readmitted within 30 days of a procedure. “They want to strategically source products that lead to the best outcome,” Schneller said.

Another feature that distinguishes CSCs from other businesses is their approach to expansion. In private industry, scaling up is considered an essential part of growth. At CSCs, scaling is more nuanced. CSCs do grow, but they are cautious about adding new hospitals to their networks.

“Say another hospital wants to join, but it says, ‘Our doctors don’t really like the suppliers you have; we need to add three or four others.’ That would be a huge cost to a CSC, and you’d lose leverage with your own suppliers,” Schneller said. CSCs insist that member hospitals comply with their contracts for products, services, and distribution. If they didn’t, the whole system experiences losses.

Nevertheless, they realize there will be exceptions to the rules, and cut hospitals some slack if a contracted brand’s product isn’t available or if physicians have a strong and justifiable product preference, as long as it doesn’t throw the supply chain out of whack. For example, “I’ve heard of some surgeons saying, ‘This is the only surgical glove I can tie a knot with using one hand,’” Schneller said. If I were a patient, he continued, “I’d want that surgeon to have his preferred glove.”

CSCs aren’t the right solution for all hospitals. The specialized IT, warehousing systems, and advanced robotics that are part of an advanced purchasing and distribution system don’t come cheap. Some health care groups feel it’s easier to outsource the supply chain rather than try to manage it themselves.

But the benefits of CSCs are undeniable, boding well for the model’s future. “Looking into the crystal ball, I think you’re going to see more hospital mergers, and more organizations will want to negotiate contracts with suppliers and payers,” Schneller said. “If you’ve got a large system and the ability to work with physicians on standardizing products, you have a very good strategic advantage.” More importantly, traditional suppliers recognize this trend and are working to develop new ways to provide needed knowledge and technology to support CSCs.

Bottom line

  • Health care CSCs provide hospitals that previously used multiple distribution channels with a methodical, disciplined, and prudent approach to choosing products and suppliers.
  • CSCs create a fully integrated supply chain that brings distribution and logistics, as well as purchasing, under hospital control.
  • By reducing the number of product SKUs and suppliers, CSCs simplify the notoriously complex hospital supply chain, making it faster, more responsive, and more cost-effective.
  • With system-wide value analysis teams, including doctors, nurses, and purchasing managers, CSCs give formerly resistant clinicians an avenue for working closely with their supply chain colleagues for tightening hospital operations. In an environment where both hospitals and clinicians share in savings, they become active participants in the quest to drive down prices while maintaining quality. Innovative, entrepreneurial thinking leads CSCs to manage new processes and participate in a cycle of continuous improvement.