Vendor Issues

By John Cunningham

Materials managers today realize that contracts are not just about negotiated discounts and price breaks for volume purchasing. Yet while they understand the importance of protecting their prices as well as other interests of their health care organizations, they typically count on their legal departments to handle this. Of course, hospital lawyers should carefully review all substantive contracts as well as the templates used for most purchasing agreements. Materials managers, however, also can be effective watchdogs by paying more attention to contract terms and conditions. I remind and encourage my colleagues to start the contracting process with their own standard contract as the default rather than a supplier’s template, which is always to the organization’s advantage. If your contracting department does not have a template contract for goods, purchased services and information technology (hardware and software), you should meet with your legal department to develop these as quickly as possible. And if you do have these templates, review them to determine if they need to be updated or improved.

Many materials managers have a general understanding of the basic information found in the fine print of most purchasing contracts. Certain details, however, deserve a closer look. Here are some things you should know about 10 key contract terms and conditions.

Confidentiality—This provision prohibits a supplier from disclosing to third parties confidential information that typically includes everything relating to the contract terms, the prices and use of the products and all related documents. When appropriate, be sure your contracts include a HIPAA confidentiality clause to safeguard patient information.

Also, public health care organizations should modify their contracts to include language that permits them to release information for public record requests without penalty unless a supplier can prove that this information is confidential, proprietary and/or a trade secret. Last, some suppliers include confidentiality language that limits a hospital’s right to consult with third-party advisors to compare pricing for contracted supplies. Such clauses should be deleted, as hospitals should be allowed to share their pricing data without limitations.

Payment terms—Many vendors offer discounts to health care organizations that agree to prepay or promptly pay within a short time period (e.g., 10 or 15 days). Because timely payments improve vendors’ cash flow and reduce their administrative costs, materials managers should get a share of these savings by negotiating such discounts into their contracts.

It is important, however, to discuss with your finance department the current “cost of cash” to determine whether these price breaks are beneficial. For example, if interest rates are high, a health care organization might be able to earn more by leaving the money in the bank for an additional 30 or 60 days. In all situations, extending payment terms is always in your best interest provided you do not incur penalties for the extended terms.

“Evergreen” clauses—These clauses provide for an automatic extension of the contract (usually on an annual basis) if a vendor is not notified by a certain time. They often include pricing increases, penalties for early cancellation and other provisions that reduce a contract’s value. Busy materials managers can easily lose track of the deadlines for renegotiations and get locked into contract extensions they do not want. Because “evergreen” clauses provide no benefits to materials managers, they should be removed from your contracts.

Termination and “out” clauses—These provisions are critically important to give you the flexibility to exit an agreement in the best interest of patients and your organization. Not surprisingly, vendors’ contracts often contain “out clauses” that penalize providers for switching to other suppliers. Whenever possible, include provisions in your contract that allow you to terminate contracts with minimal or no penalties. These clauses can cover:

1. Failure to supply: This gives you the right to purchase equivalent products from other sources while the contracted supplier is liable to your organization for reasonable costs it may incur in excess of the contracted cost.

2. Failure to perform: Service contracts often include performance metrics (e.g., patient satisfaction scores for a food service provider). Materials managers can play a key role in identifying and evaluating these measures.

3. Termination without cause: Make sure the notification period is not longer than 60 to 90 days so as not to prevent your access to innovative technology.

4. Other causes: These can include supplier breach of contract, financial insolvency, a change in ownership, regulatory noncompliance or criminal acts. For these provisions, limit the time given to suppliers to remedy the situation (usually 30 days) so you can quickly find an alternative solution. If you cannot reach an agreement with the supplier on the terms of a voluntary out clause, your contract at the very least should include language that protects your right to exit the agreement for patient care and safety.

Options and renewals—The optimal length of a contract depends on the product or service, pricing incentives and other factors. In general, however, avoid long-term agreements, especially for technology products. Although this can give you some price protection, it places your organization at risk of being contractually bound to use a product or service that is no longer competitive or in the best interest of patient care. The best length of a contract is usually three years with the option for two one-year extensions, which gives you both flexibility and long-term price protection. For purchases that require up-front investments, a longer-term contract might be appropriate. Also, keep in mind that too many shorter term contracts have a downside; it could result in a contracting process that drains staff resources and becomes prohibitively expensive.

Pricing options—In almost all instances, fixed pricing is your best choice because it ensures your organization will not incur any unforeseen price increases during the length of the contract. If fixed pricing is not possible, be certain that all price changes are tied to a specific index, such as the Consumer Price Index. Pricing terms tied to “list costs” provide very little pricing stability and should be avoided.

In fact, “list price” can be an elusive, moving target since it can refer to a specific year, an equity price list (in which a health care organization owns the goods), a consignment price list (in which a supplier owns the goods, manages the inventory at the provider’s site and bills an organization upon use), or a loaner price list (in which a supplier owns the goods and provides them as needed).

Freight charges, FOB—Freight charges should be the responsibility of the supplier, not your organization because they can significantly increase your overall costs. Freight should always be freight on board (FOB) destination (or FOB destination PPA, where applicable), which means that the supplier incurs all freight charges, owns the goods in transit, and has to replace goods damaged during shipping. Never agree to FOB origin because many materials managers may find it difficult to proactively manage inbound freight charges. You might want to consider working with an inbound freight management firm such as HLS MedFreight or Cardinal Health’s OptiFreight program. Both offer significant guarantees for inbound freight expense reduction.

Hidden charges—Review contracts carefully and remove any language that holds your organization responsible for fuel, commodity surcharges or other hidden fees. In market share contracts, price reductions are often linked to the increased use of a related product or technology. In the IV product category, for example, market share agreements for solutions are contingent upon increased use of the suppliers’ related delivery systems, including products (tubing) and technology (large volume infusion pumps).

Governing laws—By default, most contracts are subject to the governing law in the state where a supplier resides. Instead, aim to always have this governing law be based on where your organization is located or, if that’s not possible, where the product or service was purchased. If some of your agreements do not require legal review before execution, you should know your health care organization’s position on governing law.

 “New technology” clauses—For agreements in certain product categories (e.g., orthopedic and cardiology implants and devices) in which technological advances are commonplace, these clauses can provide invaluable protection. I have often seen health care organizations with seemingly solid contracts suddenly discover that their costs for such products had gone sky high because their physicians and/or clinicians were using a “next generation” technology not covered in the agreement. Inserting language that will protect a health care organization’s pricing on both existing and new technology is a critical point.

Many organizations will sign a contract for existing technology only to learn, the next day, that a new generation of the technology is coming, that it is not on contract and the organization will be vulnerable to paying list price. Should an organization find itself in this situation, with no “new technology” language to protect it, it should move quickly to add an amendment that provides protection (price and terms) to the existing agreement or use the introduction of the new technology to open overall contract negotiations.

Even if the legal department reviews all contracts, don’t assume the lawyers will be knowledgeable about all the details. Their expertise is the law, not the business issues and performance-related metrics that can greatly impact a contract’s value. By understanding and paying attention to the terms and conditions, you will be better prepared to help negotiate and execute better contracts.

John Cunningham is Vice President, Supply Chain, for University HealthSystem Consortium, Oak Brook, IlL.

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

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