Outsourcing
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| Any time a decision is made to outsource, an organization is taking an inherent risk. But the risk is mitigated with thorough research and by assessing an organization’s needs. There are several models represented in the article, all of which relay the potential benefits, costs and risks associated with each. Even though the potential for problems exist when making the decision to outsource, the risk of escalating costs and failing operations is greater than if nothing is done to combat existing inefficiencies in the supply chain. |
Supply costs and the associated direct and indirect labor involved in ordering, moving, storing and using products can account for up to
45 percent of a hospital’s operating expenses. When a typical CEO thinks of the supply chain, he or she may equate it with materials management. For most systems, this is too narrow of a view because clinical areas and pharmacy continue to operate supply chains separately from materials management, thus creating multiple and potentially duplicate processes for ordering, inventory and replenishment.
Couple these processes with the complexity of multiple distributors, suppliers and service companies and you can see why most organizations have inefficient and outdated supply chains. One approach to connecting all of these “dots” that has gained recent exposure in health care is the concept of business process outsourcing (BPO). Outsourcing most commonly has been associated with information technology. Some organizations have benefited greatly from these arrangements because staying on the forefront of technology has become more complicated and also stretches internal resources to the breaking point. BPO, however, is a much broader and much more visible change. BPO can be simply defined as completely handing over the management, assets, data and control for acquiring the supplies needed to provide quality patient care. I particularly like the definition in Wikipedia:
“Outsourcing (or contracting out) is often defined as the delegation of noncore operations or jobs from internal production within a business to an external entity (such as a subcontractor) that specializes in that operation. Outsourcing is a business decision that is often made to lower costs or focus on competencies.”
In some cases, this includes transferring individuals from a hospital’s payroll to that of a third-party employer.
Due to the inherent risks of transferring control of key and interrelated processes within an organization, most such agreements are only considered by large organizations.
However attractive this may appear, there is much more to this concept at a strategic level that needs to be considered. Systems need a supply chain strategy that addresses both performance and structure. Simply handing off problems to a third party may not fit with an organization’s culture or overall market strategy, and in some cases the appropriate strategy may be a completely opposite approach to outsourcing.
Informed decisions
This decision is not a simple one, nor does it have a one-size-fits-all decision model. However, there are some commonalities that can be examined to begin shaping the strategic decision. As a hospital CEO told me recently, “There is a huge opportunity for us in the supply chain, but I just don’t know where to start at a board strategy level.”
Strategy development is simply a process of making choices about where to spend time and money to achieve the highest performance at the lowest operating cost.
When determining whether outsourcing is a viable strategy, an organization needs to take a clear and objective look at its current abilities, infrastructure and supply chain resources. A comprehensive and long-term strategy must be developed to ensure it is in alignment with the overall direction and culture of a health care system.
While there are multiple ways of looking at supply chain operations, the following are definitions of three macro options. These represent a substantial change from traditional or typical supply chain operations for a health care system.
Outsourcing: All business processes—from contracting/sourcing through order management and distribution—are managed and “owned” by a third party. Staff is provided on-site (and in some cases existing hospital resources are transferred to the vendor’s payroll) and supply contracts are owned by the third party.
Potential benefits:
- Move to a variable-cost model, shifting fixed costs to the vendor
- Access to updated technology and information
- Access to specialized skills and competencies
- Relatively fast reduction in costs and improvement in performance for those facilities in financial difficulties
- Significant cost reduction.
Potential costs:
- Combination of fixed and variable service fees as well as continued payment for supplies (system maintains ownership of inventory in most cases)
- Some performance-based agreements
- Opportunity costs should performance levels not be met
- Higher costs may exist in outsource vendor’s agreement with distribution partners that must continue to be maintained.
Risks/trade-offs:
- Loss of control of product selection, inventory management and potentially key supply expense information
- Significant attention must be paid to the vendor’s performance and clear nonperformance criteria must be managed
- Due to the visibility and criticality to supplies in a hospital, an us-versus-them mentality may take place, thus hampering change
- Vendor does not meet service level agreements or overall expense targets.
Integrated shared services: Supply chain operations and business processes, including distribution and contracting are owned, staffed and managed by the system. Contracts with the system (or self-GPO) are negotiated and owned by the system. A self-distribution model is maintained with warehouse and transportation assets owned by the system.
Potential benefits:
- Complete control of performance for the system’s supply costs
- Ownership of information on spend, inventory and order performance
- Revenue streams from contract administrative fees and distribution fees from manufacturers
- Ability to negotiate favorable pricing directly with vendors due to direct ability to influence compliance and market share commitments
- Ability to customize distribution needs (e.g., delivery frequency, packaging, etc.) without additional markups or up-charges
- Partnership credibility with physicians, clinicians and administration.
Potential costs:
- Information system and supply chain data needs to be standardized and homogenized.
- Substantial skills must exist on the supply chain team, including analytical, vendor experience, clinical knowledge and advanced supply chain knowledge
- Distribution assets such as warehousing, transportation and warehouse resources must be acquired and maintained
- Substantial increase in fixed costs, investment and labor costs.
Risks/trade-offs:
- Substantial investments must be financed to build distribution and contracting capabilities
- Distributors or GPOs may attempt to influence direction through relationships at single hospitals within a system
- Significant executive leadership support must exist at corporate and individual hospitals
- Operating revenues may not exceed operating costs for several years.
Hybrid: In this model, a combination of system-owned assets (such as focused local contracts and a robust ERP system) are combined with selected strategic partners in a customized solution.
GPOs and distributors are potential partners that contribute resources and technology in exchange for volume commitments and fee-for-service solutions.
Potential benefits:
- Move to a more variable cost model
- Additional information and technology without significant implementation investment
- Additional contracting and supply chain resources to complement.
Potential costs:
- Combination of markups and service fees
- Opportunity costs for short-term price differences from competing (nonstrategic partner) organizations.
Risks/trade-offs:
- Increased need to manage multiple organizations
- Potential for competing priorities among partners
- Inability of parties to meet commitments or performance agreements
- Increased costs for additional services without complete solution control.
Five decision criteria
A decision of this strategic magnitude is difficult to simplify. However, five key questions can be asked to determine the framework for decision-making and the development of a cohesive supply chain operations strategy.
1. What is the overall performance of the supply chain?
For systems operating with minimal to negative margins, accessing investment capital will be more than a challenge and any major investments in supply chain technology or resources will likely fall behind in priority with visible patient treatment technologies. For systems in need of dramatic improvements and relatively quick returns in supply chain, outsourcing may be a strong and viable option. For those systems that are managing average or above-average margins, a look into more centralized control of the supply chain can move an organization to a new level of supply chain performance and an opportunity to add a low-cost provider to their strategy.
2. What is the state of your supply chain technology and data?
Health care continues to underinvest in operations technology and supply chain is the poster-child for this statement. For processes that perform requisitioning, ordering, receiving and inventory functions manually, or for those that still have green screens and green-bar paper reports, the time for an upgrade is long overdue. However, this goes hand-in-hand with the ability to invest in technology.
For systems that are financially healthy, but unable to invest in technology, outsourcing is a feasible choice. And for those that see significant value in implementing or have implemented a more flexible ERP or MMIS, this provides the first major step toward building a shared services organization.
3. How capable is your supply chain organization?
While it is unpopular to say, many materials management resources need to upgrade their skills. Analytical skills, best- practice knowledge in inventory concepts and replenishment methods, and an understanding of logistics is no longer optional. Rather, these are minimum skill sets for those working with the supply chain. System executives need to evaluate the leadership capabilities of those in the supply chain to determine if they can accept increased accountability and manage a supply chain.
Systems that struggle in this area may find substantial value in transferring ownership to individuals who specialize and excel in supply chain management and analytical skills.
4. What is the role of the supply chain in the organization?
An organization that views supply chain management as a support function, with a limited strategic role in patient quality care and financial performance may want to consider holding a third party accountable for tactical and operational performance. However, centralizing under a comprehensive, shared services model requires a board-level seat that reports to either the CEO or at a minimum, the CFO with accountability to the CEO. If an organization has no VP of supply chain, one should be appointed while consolidating all supply expenses under a single structure. Without the commitment to elevate supply chain management, organizations will not be able to drive significant and sustainable improvements, especially in the areas that are most politically charged such as cardiac and orthopedic service lines.
5. What is the executive vision and enterprise aspiration for its market?
For those systems that want to dominate a market, they can differentiate themselves through high-tech procedure offerings and outstanding and visible patient outcomes, all offered to its own and third-party payers at cost-transparent prices. Simply stated: Without control over supply expenses, this cannot be done at profitable and sustainable levels. Large, complex systems have a significant decision to make to determine the best approach to supply chain management and it will often come down to the culture of an organization. For some, it is their nature to take control of an entire supply chain while others prefer a hands-off approach to nonpatient care processes.
Assessing priorities
There are no black-and-white criteria to drive the decision about whether to outsource. But, without doing your homework, a movement to either model has inherent risks. However, doing nothing will result in a far worse outcome over time—as supply chain expenses continue to rise, technology becomes further outdated and vendors continue to exert influence over the second largest (and within 10 years, potentially the largest) expense line for health care providers.
Lane Adams is a senior manager in the provider strategy and operations practice of Deloitte Consulting, St. Louis.
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