Vendor Issues

By John Cunningham

Former movie mogul Samuel Goldwyn once remarked that, “A verbal contract isn’t worth the paper it’s written on.” But when it comes to prices for hospital products and supplies, even a written contract can be worth much less than it seems. As materials managers know all too well, what you see on a contract is frequently not what you get on the invoice.

Studies have shown that as much as 60 percent of invoices have errors or are missing information; and that erroneous data can increase supply costs from 3 percent to 5 percent. These and similar findings underscore the need for materials management departments to focus greater attention on price management.

Broadly defined, price management can encompass everything from up-front vendor negotiations on market share and tier discounts to strategies to maximize savings and rebates from purchasing commitment programs. Following are five simple but effective steps to improve your price management capabilities and start your hospital on the path toward what-you-see-is-what-you-get purchasing.

In the beginning

Price management has many complex components, but it all starts with the contract. The first and obvious step to better price management is negotiating advantageous discounts and terms with your supplier. Make sure you know your suppliers’ margins and break-even points—especially for high-price, high-volume items—which will give you a better idea of how hard you can push for a better deal. When negotiating these items, be aware of their reimbursement rates and how much you can afford to spend and remain profitable.

Consider and weigh different options such as consignment pricing, loaner pricing or equity pricing. In some cases, it is not always best to rely on vendor supported inventory. Be open to adopting more innovative contracting strategies such as procedure pricing programs. I have seen savings between 10 percent to 15 percent in these product categories through procedure pricing strategies such as capitated pricing for all implantable devices associated with a procedure such as total joints.

These strategies require balance as they are most successful when there is physician alignment, commitment to the strategy, and a large degree of single- and dual-supplier market share within the organization. Another strategy would be segmenting devices used in the treatment of a disease. By identifying the group of devices used to treat the disease state (e.g., devices for a cardiac catheterization procedure), organizations have successfully shifted market share from multiple suppliers to fewer or even one for the same products. For example, if a procedure requires different types of devices such as catheters, balloons, stents and guide wires, organizations that shift market share on even a portion of those items can achieve 5 percent to 8 percent savings in the overall treatment.

Also, take into account all the elements comprising your total costs such as freight costs, handling fees, rebates, free goods, administrative fee returns, etc. Ideally, your total delivered cost should be built into your prices since this eliminates unexpected charges and allows you to do relevant benchmarking.

Finally, be careful about contract language, especially with regard to agreement disputes or unforeseen events. For example, your contract language should protect your price if a vendor “fails to supply” and you must source a substitute from a competitor.

Taking control

A common mistake among materials managers is to rely on suppliers to provide them with accurate cost of goods information for the organization. Instead of having to validate and reconcile supplier data, it’s much better when you can be proactive in managing price. To do so, you need to evaluate the systems and processes used to capture, organize and analyze this information. Your checklist can include such activities as:

• Make certain all contract information is electronically linked to your organization’s purchasing system.
• Understand the purchasing/payment processes in the major departments and cost centers.
• Review systems for comparing and reconciling supplier invoices with both contracted prices and purchase orders.
• Identify and chart those individuals with the authority to make orders, enter data and approve invoices.

You should expect your GPO to be able to synchronize your pricing file with current pricing information based on the GPO agreement and your purchase activity. Check on the pricing algorithms in your contracts to ensure that they are programmable in your materials management price file.

If these algorithms (i.e., the metrics by which price is derived such as market share, unit volume, dollar volume, standardization levels, etc.) are not programmable, they cannot be managed.

Pay careful attention to how contract pricing changes are entered into the item master system, whether electronically or manually, to find and fix the areas where omissions or breakdowns occur.

Materials managers should look for and address “loopholes” in this process such as departments or personnel buying items off-contract without a purchase order. These front-line actions can minimize the high error rates at the back end of the process when purchase orders are matched with invoice prices.

Don’t assume suppliers have superior systems that always deliver reliable information. To confirm market share data, for example, you might want to count  the number of procedures performed in a given period and compare this with your OR or cath lab implant log to validate the kinds of contracted implants used in each procedure. While such a hands-on method may seem outdated in this age of  perpetual inventories and supply utilization tracking systems, I guarantee that many of your suppliers are doing the same thing.   

Find and fix price discrepancies

The golden rule of price management is imperative: Make certain that all payments are based on the prices stipulated in purchasing contracts. To accomplish this, you must identify the mismatches, correct the errors and, most importantly, prevent them from reoccurring by addressing their root causes.

It sounds fairly simple, until you stop to consider how many supplier invoices a materials management department processes each year. 

Given the high volume of purchasing, the complexity of contracts, the decentralized nature of hospitals and the sophisticated analysis required, it’s more surprising that mispricing doesn’t occur more often.

Some hospitals are meeting this formidable challenge head-on. For example, the UAB Health System in Birmingham, Ala., which includes the 908-bed University Hospital and nine other health care member and affiliate organizations, uses a price parity report to identify and address pricing discrepancies.

Although the UAB system plans to become an IDN, it has different MMISs within each entity that do not interface with each other. The price parity report looks for and compares like items purchased by more than one entity and calculates the potential savings to be had if all entities paid the lowest price. UAB has garnered more than $56,000 of $181,000 in systemwide savings opportunities.

Others have taken advantage of spend analytics tools, which help hospitals compare line item data for thousands of products with what they should be paying based on their contracted prices and volume discounts.

This basic function provides insights into whether suppliers’ invoices based on contract information that is current, complete and accurate, which often can instantly lead to significant savings opportunities.

At the Santa Clara (Calif.) Valley Medical Center, for example, the use of this tool revealed that one distributor was accidentally overcharging for catheterization kits. By correcting this one error, the medical center saved $80,000.

Price benchmarking

Materials managers should have a good idea of the acceptable price range for high-ticket items, then monitor and manage cost information regularly to ensure that these charges are competitively priced.

The key to effective benchmarking is to make sure you’re making apples-to-apples comparisons for equivalent products at institutions with similar characteristics (e.g., size, geographic location, care level, etc.).

Keep in mind that you may not be able to achieve the best price in the market due to factors such as your organization’s level of standardization, market share and purchasing volumes. Ask your GPO or a reputable third party to provide guidance on setting up a benchmark group and determining which price metrics are best suited to your organization.

Again, this type of analysis is most useful when hospitals compare themselves with others that have similar spends in the product category. For example, eight Midwest academic health centers formed a regional collaborative to conduct focused price benchmarking assessments on physician preference items in orthopedics and cardiology.

Their collective data provided detailed information on savings opportunities based on price-tier discounts, market share and best market prices. As a result of these assessments, the organizations found that, for most orthopedic products, having three to four suppliers increased price competition and that they could achieve the greatest cost savings by giving the majority of the market share to one supplier.

Maintain data quality

A critical component of price management is having a three-level matching system (e.g., contract, purchase order and invoice) that checks and matches the purchase order with the receipt and the invoice. Because system outputs depend on the quality of the inputs, materials managers should take steps to ensure that the data is clean and accurate.

Be aware of all the people who can access your materials management price file, and limit the number who can change or add a price. Also develop strict protocols for how new pricing is reviewed and approved before being accepted and/or imported into your price file.

I strongly recommend that someone on your staff regularly audit all three aspects of the price continuum.

Expect to find errors and weaknesses, which will give you the opportunity to demonstrate your skills in recouping unwarranted charges and improving internal processes. 

John Cunningham is Vice President, Supply Chain, for University HealthSystem Consortium, Oak brook, Ill.

This article first appeared in the October 2007 issue of Materials Management in Health Care.

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