Suppliers and providers do what they can to avoid price hikes…or to at least minimize them.
Editor’s note: In their dual role as contracting executives and consumers, JHC readers are feeling the heat from rising prices. Their suppliers are too. In the previous issue of JHC, we looked at reasons behind rising prices. In this issue, we look at solutions.
Manufacturers of medical devices and equipment are pretty much locked into the materials they use (e.g., resin, cotton, latex rubber) to make their products. And many times they are also locked into the country or region from which those materials originate. True, they have some flexibility as to where they locate their manufacturing plants. Still, “you can’t just open up a plant and make it cost-efficient,” says Manny Losada, vice president, Medical Action Industries, Hauppauge, N.Y.
Medical Action Industries recently updated and increased its injection molding equipment and automated some processes at its 240,000-square-foot Gallaway, Tenn., facility, says Losada. The company also maintains facilities in Arden, N.C. (which houses its minor procedure kit business and OR supplies), and Clarksburg, W.V., where containment products for medical waste, such as plastic can liners and biohazard waste bags, are made.
“We’re looking aggressively at American sources for manufacturing and raw material supply,” adds Willem deGoede, COO and executive vice president of B. Braun Medical, Bethlehem, Pa. But such a move makes sense only for processes that can be heavily automated. “Labor in America is definitely not cost-competitive with the Asian or Mexican markets. So what sets you apart is automation and process control, where you need fewer people but more technical equipment.” In Pennsylvania, more than 300 of B. Braun’s people went to local vo-tech schools to learn how to maintain and troubleshoot automated equipment.
Improving internal processes
Short of moving manufacturing operations, manufacturers and distributors are working to improve their internal processes as a way of staving off price increases to their customers, according to those who spoke with JHC. “We have been forced to look at our business in ways that we haven’t had to historically,” says Scott Clausen, vice president of sales, Ansell Healthcare, Red Bank, N.J. “We’re looking at everything – inputs, freight, product movement, the organization of our sales force, how we pay them, when we pay them.”
For its part, B. Braun has been seeking alternate suppliers for raw materials, to create some competition and hopefully bring about lower prices. At the same time, the company is aggressively implementing lean manufacturing techniques in its U.S. and overseas factories. So-called “lean manufacturing” is a management philosophy borrowed from Toyota, which emphasizes alleviating all steps in the production process that fail to add value for the customer.
Another area B. Braun is focusing on is transportation. “Over the last four or five years, we have totally changed our model,” says deGoede. In the past, the company operated about 30 warehouses in the United States, as well as its own trucking fleet, and distributed between 70 and 80 percent of its products directly to end-user customers. Today, it relies on distributors to sell and deliver most of its products. “We realized we’re not the expert in transportation,” says deGoede. “Our expertise is in manufacturing and selling medical products and devices.” Distributors can fill their trucks with many kinds of medical products, and optimize fuel and labor costs.
B. Braun has also gone to once-a-week deliveries, as opposed to two or three times a week, in order to cut costs. “Just-in-time is a good concept,” says deGoede. “But if it causes inefficiencies, and you can no longer level-load your factories or optimize your customer service and trucks’ schedules, then it’s not.” (Level-loading refers to the ability to optimize labor, capital and inventory carrying costs.) Today, rather than just-in-time, B. Braun uses the “economic order quantity” model of inventory management to help it optimize inventory levels and customer service. Another step the company is taking to reduce its transportation costs is to rely on rail service whenever possible.
Like B. Braun, Cardinal Health has made some big changes in the way it moves products to its customers. Earlier this year, the Dublin, Ohio-based company outsourced its logistics function to Penske Logistics, Reading, Pa. The change reflects Cardinal Health’s desire to improve customer service more than an effort to offset price hikes from suppliers, says David Anderson, president, Hospital Supply. But in the end, it helps the supplier meet both goals.
“The simple way to describe [the outsourcing] is that our employees – primarily our drivers and supervisors – did a badge flip,” explains Anderson. In other words, they moved from Cardinal Health’s payroll to Penske’s. “Our trucks look the same, although they have the Penske Logistics logo on the side as well,” he says. And in most cases, customers have the same drivers they had prior to the change.
Cardinal Health depends on Penske to do such things as optimize route design and mode of transport (e.g., private fleet vs. LTL carrier vs. some other form of transportation). “They bring new capabilities to the process surrounding optimization of fleet and delivery,” says Anderson. And Penske is doing so in close collaboration with Cardinal Health’s operations team. “Penske has been a good match for us.”
In addition, Cardinal Health is “broadly and aggressively” implementing Lean Six Sigma principles to improve its processes and take cost out of its supply chain, says Anderson. Six Sigma is a management strategy to systematically identify and remove the causes of defects and errors in business processes, while improving customer service. “We’re applying it with customer relations, both downstream (hospitals) and upstream (suppliers),” he says. “We continue to utilize things like this to manage costs in the marketplace.”
What customers must do
Suppliers may be doing all they can to improve their internal processes, but customers must get involved too, they say. Today’s market demands “increased cooperation between trading partners – manufacturer and distributor, and distributor and downstream provider customer,” says Andrew E. Van Ostrand, vice president of policy and research for the Health Industry Distributors Association. “It begs the question – how can we change behavior and collaborate to mitigate the effects [of adverse economic conditions]?”
The lean manufacturing approach “incorporates a partnership with our suppliers and customers,” says deGoede. For example, manufacturers, distributors and end users can coordinate their inspection processes and inventory levels to reduce redundant steps, he says.
The option of last resort
But in the end, despite all the supply chain players’ best efforts, it might come down to price hikes. Manufacturers and distributors can sustain only so many price increases from their suppliers before passing them along to their customers, they say. The trick, of course, is to justify those hikes to skeptical contracting executives.
“The challenge we face as a manufacturer is that we’ve provided a service at a level of quality and cost savings over a very long period of time,” says Losada. “Now the economics and environment have changed and we have to make an adjustment. “We’re trying to … get back to a level where we can continue to operate the business efficiently and make sure the level of service and quality are maintained.” Price increases are only part of the strategy, he says. “Product innovation and rationalization are also strategies to explore in order to reduce costs.”
Today, most of the company’s contracts contain “resin riders” or raw-materials riders, which specify that if public indexes show that resin base material has risen in price, Medical Action Industries can request a business review and potential price increase from its provider customers and GPOs. “We review with the customer what the indexes are showing,” says Losada. “If they have exceeded a certain percentage increase, we can discuss cost recovery or price adjustment. The days of three-year price protection are over. And while this is an adjustment for the supplier side of the business, it will be an even tougher transition for the provider side.”
That said, Medical Action Industries is trying to minimize the impact on its customers. “If we were to pass the exact impact [of Medical Action Industries’ own rising costs] to our customers, they would be dealing with much larger price increases. We are sensitive to market conditions and our channel partners, and we are sharing and educating as much as possible in order to recover a portion of the impact in order to continue to service our customers’ needs.”
Adds Clausen, “The situation with all these costs is that [group purchasing organizations] have realized that we’re not able to provide their members with long-term, firm prices. A couple have recognized this and are going to work with us on pricing that isn’t quite as firm as it has been historically. We’re operating on 30-day pricing from our suppliers. That doesn’t fit the traditional GPO contract, in which three years is normal.”
Cardinal Health is facing a similar dilemma. “We’re not fully covering” the increases the company is facing in commodities and fuel prices, says Anderson. “We attempt to use our strong relationships with suppliers to keep our costs down. We offer our customers alternative products. And our customers can use … group purchasing contracts to mitigate the impact of cost increases. But where these efforts are unsuccessful, we pass through price increases to our hospital customers.
“We are having conversations with customers to educate them on the cost of fuel and to figure out how to set up a pressure relief valve, so that if fuel costs escalate, there is a way for that to be offset without affecting the service we provide.”
DeGoede says, “There’s no way we can internally absorb all these cost increases, even with longer-term contracts. We are talking to customers about price increases. At the same time, we expose them to the things we’re doing to optimize those costs and offset them. And then we try to help them with inventory reduction and other things.”
Customers are aware that the price of some commodities, such as gasoline at the pump, have increased, he continues. But they’re not accepting price hikes without some tough questions. “They’re asking us, ‘What are you doing to combat [price increases]?’ If we have sincere answers, they’re willing to share [the burden].”
Indeed, JHC readers, characteristically, are unafraid to ask tough questions of suppliers that are imposing price hikes. Contracting executives at Novation may be expecting price increases in the year ahead, but they’re not about to blindly accept them. “Some suppliers are coming in and looking for price increases,” says Jo Klein, vice president, strategy, planning and research. “Some have a real, rational case that’s tied to a particular raw material, such as resin, latex or steel. We’re also seeing suppliers … trying to take advantage of what’s going on.”
Novation has instituted a new policy for handling requests for price increases. “First, we want to make sure we remain market-competitive, so we look at how our price compares … and at the history of pricing on the contract,” she says. “Then we ask the supplier what actions they’ve taken to manage their costs.”
Novation assumes that if it accedes to price increases when the cost of certain raw materials goes up, “when prices go down, prices will go down as well,” says Klein. Content experts in Novation watch the steel, latex or resin markets, to keep everyone honest.
IDN contracting executives are also keeping a sharp eye on things. “If nothing else, the cost of petroleum and gas is going to cause transportation costs and the cost of [operating] manufacturing plants to increase,” concedes John Mateka, executive director, materials services, Greenville Hospital System/University Medical Center, Greenville, S.C. “Prices are going to increase. We’re starting to see some of that.”
Nevertheless, Mateka maintains a healthy skepticism for requests for price hikes. Given the well-publicized conditions in today’s market, “[t]here might be an inclination for [suppliers] to say, ‘If we’re going to put a price increase through, now’s the time to do it,’” he says.
He is mildly skeptical of fuel surcharges as well. “Whether they’re real and accurate or not, [fuel surcharges] are a good opportunity to offset some of [suppliers’] loss in profit because of the locked-in price protection. Some institutions accept them, some don’t. Some are not sophisticated enough to even catch them; they get added to the invoice and passed through.
“Inevitably, prices will go up,” he concludes. “Our concern is, ‘To what extent?’ And then, what will we do about it?” Healthcare providers are limited in the extent to which they can raise prices to recoup their higher costs, he says. And if and when reimbursement is raised, it may be a year or more after the spike in costs.
“It’s been a very interesting year,” says Mateka. “And it looks like it will be a very interesting few years ahead.”