Reducing healthcare costs through supply chain management

March 17, 2010

In the national debate over how to make U.S. healthcare more efficient, one promising area for reform is often overlooked: supplies. Whether the products are knee implants, pacemakers, or expensive medications, hospitals have long purchased whatever doctors desired with little discussion among the parties involved about cost.

Researchers at the W. P. Carey School Business are trying to unravel the tangled supply relationships that drive up the cost of healthcare, burdening hospitals and frustrating efforts to expand coverage among the uninsured.

"We look very strategically at purchasing, distribution, and the other related areas," says Eugene Schneller, professor at the School of Health Management and Policy and co-director of the Health Sector Supply Chain Research Consortium. "We consider how they affect efficiency and effectiveness, as well as the possibilities for improving clinical care."

Co-director Natalia Wilson says, "The cost of supplies is second only to the cost of labor for hospitals. To take care of a patient in a hospital, there are all kinds of products involved, from cotton balls to bandages to hip implants."

Aligning interests and saving money

Supplies are an important and growing part of hospital budgets. According to the Association for Healthcare Resource and Materials Management, the cost of supplies jumped nearly 40 percent between 2003 and 2005 and now represents as much as 31 percent of a hospital's expenses on a per case basis.

Jonathan Ketcham, assistant professor at the School of Health Management and Policy, has found in his research that the runaway cost of supplies is due, to a large extent, to the fact that doctors and hospitals are not in a position to cooperate. In areas of medicine with highest supply costs -- notably cardiology and orthopedics -- physicians determine what devices and drugs are used, but hospitals pay for them.

"You have misaligned incentives between hospitals and physicians," Ketcham says

Ketcham has been studying the practice of "gainsharing," in which hospitals reward doctors when efficiencies bring down costs. In gainsharing, hospitals and doctors divide savings from improved efficiencies.

Ketcham recently received a two-year, $500,000 federal grant to study gainsharing experiments and other issues related to supply costs.

Supply chain lessons for healthcare

Supply chain management -- the coordination of businesses and processes involved in producing and delivering a product or service -- has been widely used in other industries for decades. Many businesses, retailers in particular, have attributed their success to effective supply chain management.

But supply chain management in healthcare has lagged. In part, this is because healthcare deals with finished products, according to Schneller. Unlike an auto manufacturer, which can ask suppliers to design a specific kind of brake for a vehicle, hospitals usually have to take what suppliers have off the shelf.

"It's also an industry where supplies have not been seen as assets, and if you don't see something as an asset, you probably don't manage it," Schneller says.

The consortium has been working to build the research base that will help healthcare leverage supply management. Much of the consortium's attention has been focused on what are known as "supply-intensive admissions," cases in which supplies represent between 50 and 80 percent of the cost of the procedures. Joint replacements and cardiac implants typically fall into this category.

"The reason we've worked in that area is that from a policy perspective, it's one of the highest costs areas in American medicine and one of the fastest growing," Schneller says. He points out that it is the ability for suppliers, physicians and hospitals to mutually find value in their transactions that will allow the health care industry to take advantages of the efficiencies associated with strategic supply chain management. As long as it is a "zero-sum game" it will be a contentious set of relationships.

One approach that has promise, according to researchers, is standardization of products. If physicians can agree on common products, such as for joint replacement, then costs can be brought down considerably, researchers at the consortium have found.

"A Chevy and a Ferrari will both get you to the grocery store," says Schneller. "Are they the same car? No. Are they equivalent in terms of doing something? Probably."

Sharing the benefits of efficiency

Ketcham is investigating whether gainsharing is an effective approach to improving the value of spending on supplies. "There is a wide spectrum of approaches hospitals can use to align incentives. Gainsharing is one of the few where cash can actually change hands," he says.

The practice has faced legal barriers. The Inspector General of the U.S. Department of Health and Human Services has found gainsharing to violate anti-kickback and other federal regulations. Hospitals that wish to use gainsharing must get exemptions from the inspector general, but with the federal government increasingly interested in cutting costs, exemptions have not been extremely difficult to obtain. The U.S. Medicare program has authorized experimental gainsharing programs.

Ketcham has studied the effectiveness of gainsharing at 13 different hospitals where cardiology departments used stents for clogged arteries. In those experiments, gainsharing functioned as it was designed, according to Ketcham.

"It led to cost reductions of just over 7 percent per stent patient, and we didn't find evidence that it worsens quality of care or access to care," he says.

Working together to save money and serve patients

Getting hospitals, doctors, and other interests in healthcare to coordinate their efforts is a key to improving supply chains and saving money, according to researchers.

"There are a number of players so it makes it complex," says Wilson, a research associate at the School of Health Management and Policy and physician. "Traditionally, they have functioned in separate silos. Improving efficiency and collaboration is very important."

In a paper published in the journal Clinical Orthopaedics and Related Research, Schneller and Wilson detail the mistrust and misunderstanding that have characterized relationships between hospitals and orthopedic surgeons. Dependencies have developed by both physicians and hospitals on suppliers of products used in surgery. Doctors may need to reevaluate their roles, according to the researchers.

"The challenge for the profession is to redefine professionalism, accountability, and autonomy in the face of these changes and challenges," Schneller and Wilson write. What is ideal, of course, is for suppliers to want to compete on the basis of the value they bring through various support efforts as well as demonstrated quality of their product.

Schneller maintains that hospitals could benefit by reaching out to physicians, inviting them to become partners in improving healthcare supply chains. Doctors are responsive to well-presented, reliable information about products, he says.

Up from the basement

The recession has created both challenges and opportunities for those overseeing supply chains in healthcare, according to researchers. With budgets tight, hospitals must monitor closely where savings can be achieved and are increasingly looking to supply chain.

With more medical records becoming electronic, some paper materials are redundant, the researchers say. And some items used in medical procedures can be reused, saving hospitals up to a million dollars a year and reducing waste going to landfills, according to Wilson and Schneller.

"It has been said that the recession is the hospital administrator's best friend -- or the supply chain manager's best friend," Schneller says.

According to Wilson and Schneller, supply chain management in healthcare is finally coming out of the hospital basement, where it has been relegated for years. In many hospitals, the manager of supply chain is being given the title of vice president, Schneller notes. Wilson says that people throughout the healthcare field are recognizing the benefits of managing supply chains efficiently and effectively.

"This is a critically important area because it highly impacts patient care," Wilson says. "High quality care is the number one goal for everyone."

Bottom Line:

  • Supplies are the second leading cost to hospitals after labor in providing patient care. Managing supply chains in healthcare is been a neglected area in efforts to improve efficiency and save costs.
  • Researchers at the W. P. Carey School of Business, working in collaboration with key players in the industry, are exploring ways to improve the efficiency of supply chain management in healthcare.
  • The Health Sector Supply Chain Research Consortium is the only structured academic program in the United States focused on healthcare supply chains.
  • Some of the leading companies in U.S. and regional healthcare are members of the consortium. They include Catholic Health Initiatives, Hospital Corporation of America, Ministry Health Care, Premier and Scottsdale Healthcare; as well as group purchasing organizations GHX, Novation, Owens & Minor and Yankee Alliance; and software and business intelligence company Craneware.  
  • As the consortium expands its collaboration with the supplier community, a greater emphasis will be on the ability of supply channel partners to craft "win-win" solutions.
  • The biggest supply costs to hospitals flow from so-called "supply-intensive admissions," typically orthopedic or cardiac procedures involving artificial joints, implants and stents. Standardizing some of these supplies could bring hospitals substantial savings.
  • Gainsharing is a way of aligning the interests of hospitals and doctors. In gainsharing, hospitals reward doctors for efficiencies by sharing some of the money saved.
  • Improving health sector supply chains requires physicians, hospitals, and others in the healthcare field to reassess the roles and collaborative efforts.