What health care supply chain can learn from other industries

December 11, 2012
By Tony Benedict

Utilizing best practices from other industries

Utilizing best practices for health care based on experiences from other industries is probably one of the most relevant topics for the health care supply chain today in light of the imminent changes scheduled in 2013. The increase of Medicare dependent Baby Boomers over the next 10 years, coupled with the 2 to 3 percent cuts Medicare will impose each year for the next 10 years will strain the health care system beyond anything imaginable in prior decades. The cuts in Medicare most likely will be followed by cuts in reimbursement from private payers. Accountable Care Organizations and bundled payments are two other changes that providers have needed to adjust to starting Oct. 1 of this year.

Most supply chain professionals are focused on reducing product related costs through volume-based contracting and utilization related costs through value analysis efforts. The question going forward is how does one take an additional 30 to 40 percent of cost out of the delivery of care while still addressing the challenge of product cost being either the first or second highest cost related to care delivery? How much of the care delivered is waste?

For anyone working as part of the health care supply chain, the answers to those questions are incredibly important. So what are the best practices to help reduce the cost associated with delivery of care? The answers can be found by looking at several industries that have managed to be innovative and deliver their products and services to customers in a more efficient and cost effective manner.

Upon first entering the supply chain sector of the health care industry, the first thing one will notice is that there are no real standards, at least not like those found in the retail, high tech, or consumer packaged goods industries. Standards are essential because they enable interoperability – or the ability for disparate things to work together in an integrated fashion. For example, the standards developed for USB enables any computer peripheral to connect to any computer and work. The hardware and software are based on those standards and not only simplify things, but also reduce costs involved in the manufacturing. It’s difficult to name a corollary in health care. Interoperability of capital equipment providers is an example – not all are compatible with competitors’ equipment. Hardware providers in health care want you to buy just their products so they don’t want theirs to work with anyone else’s. If you’ve been in the industry for a decent amount of time, you know who these providers are and this helps explain why costs are so high to switch equipment and platforms. Software is another example. There are just a handful of EMR providers and even fewer clinical application providers. Since interoperability can be a concern, hospitals often must make a choice and stick with it, especially to meet meaningful use requirements for government reimbursement. Bar coding and RFID systems are relatively inexpensive and work well in many other industries, but have yet to take hold in health care at a price point that makes it attractive to most facilities. But by looking at how other industries work and how companies have found success, there’s reason for optimism.

The retail industry offers the first success story to model after. Retail offers several innovations that can help health care, in particular, point of use systems used in retail stores based on a simple, yet powerful bar code technology. The standards used are universal and readily applicable to health care where bar code use can help track consumption of supplies and devices at the point of use. The software standards used for accomplishing this have been around for ages. The hindrance here is that many companies create proprietary software that locks customers into their system. But as costs and efficiency come under greater scrutiny, it may change. Imagine that all inventory locations in a hospital are monitored and items are scanned as they’re being used. They are scanned and an order is sent to the warehouse so that the inventory can be replenished – plus an invoice would be generated and sent to the billing system simultaneously. In other industries, especially in manufacturing, it’s standard practice, but in health care, we are manually tracking par levels or using a basic technology that doesn’t link well into our ERP or materials management system let alone the charge master. The purpose of standards is to simplify, improve efficiency and reduce costs – all major goals for the health care system.

Product Design
There is a term in manufacturing called “design for cost” which considers the design of a product based on a market cost target that must be met in order for that product to be viable. The market demand must be enough to hit the volumes necessary for breakeven and ultimately, profit. The computer technology sector is a good example of a working “design for cost” model.

In the late 1980s and early 1990s, the PC revolution began and desktop PCs were expensive, around $3,000 to $4,000 and laptops didn’t even exist. Then, technology development and design for cost were applied to make computers more affordable for the average consumer. Now, you see desktops and laptops for around $350 and the technology is such that it far surpasses the performance of computers produced two decades ago. Memory, CPU, HD monitors and other associated technologies are all more powerful, yet less expensive and affordable to the point where many families have multiple computers in their homes. The design for cost concept is based on a target price point to give the product mass appeal. Cell phones followed a similar pattern. How would this be applied in health care? Medical device implants would be a good area to start with in terms of identifying a target price point, except that it wouldn’t be based on the price a consumer would be willing to pay, but rather what the reimbursement rates would deliver. Obviously Medicare reimbursements would be an ideal starting point to crunch the numbers. The design for cost concept applied to health care would look like a Profit and Loss for a hospital provider for a given procedure, except that there would be a cap on what each component would cost based on the reimbursement. For example, with a reimbursement amount of $10,000, there would be a variable cost (operating room, labor) and supply cost, plus implant cost. If supply cost was 2 percent of reimbursement, implant cost was 50 percent and variable cost was 40 percent, then you would have $9,200 in costs against a $10,000 reimbursement yielding a contribution margin of $800 – this would not include bad debt or charity, which would bring down overall net income.

So the point would be to establish a cost target for the medical device that allowed for a reasonable contribution margin for the provider and the manufacturer so that both win. In high-tech manufacturing, this is done all the time. In health care, it would require strategic partnerships at a level where device manufacturers partner and plan a product roadmap based on projected reimbursement (cost for manufacturer) and an agreed upon margin for provider and manufacturer. The effort required changing the thinking of manufacturers and (probably) group purchasing organizations cannot be overstated, but would be essential for this next step in the innovation necessary for the health care supply chain.

About the author:
Tony Benedict is Vice President of Supply Chain for Vanguard Health Systems at Abrazo Health Care in Arizona. He is currently serving as President and Director of Board of Directors for the Association of Business Process Management Professionals International. Most recently Benedict was Senior Manager of Supply Chain Strategy at Tata Consultancy Services where he was brought on board as one of 10 consultants in the U.S. to develop opportunities in the manufacturing, health care, and high tech industries for the company’s newly formed global consulting practice.