The Good, the Bad and the Opportunity

Today’s contracting model has to change if the United States is to maintain the world’s leading healthcare delivery system.
by Ron Armstrong

We’re at an exciting but challenging point in healthcare contracting. There are real needs in our market. But in order to fill them, providers and suppliers must work to develop mutually beneficial business goals. Imagine, savvy suppliers in the same room with progressive hospital executives, working together to find appropriate revenue opportunities, guaranteed outcomes and cost reductions. Such a scenario would change the business model and help this country maintain its world-leading healthcare delivery system. It is possible. In fact, it’s happening today. Still, more work is needed.

The Good
The contracting process of regional healthcare organizations and group purchasing organizations has brought some excellent benefits to hospitals over the last 10 years. The lure for suppliers to grasp large portions of market share created the most obvious benefit – significantly lower prices. In some product lines that has led to as much as a 50 percent price reduction over two or three contract periods.

The next large savings was realized as hospital purchasing departments became smaller, due to the fact that they no longer had to spend time contracting for hundreds of items already handled by the GPOs. They could focus on driving savings in the non-GPO-contracted product areas, especially new technology and service-related offerings.

Contracting by regional healthcare organizations and GPOs has also taken many “high end” product lines and transformed them into commodities, forcing further price reductions and lowering physician preference in many areas of the hospital. This created a clearer contracting path and eliminated soft advantages and relationship buying. And in order to offer their members more choices and to maintain their own competitiveness, many groups elected to award dual source agreements.

Meanwhile, contracts initially helped suppliers gain large portions of market share, at least partially overcoming the loss of margin from price reductions. But as price continued to tumble, award-winning suppliers realized that different strategies needed to be developed.

The Bad
Price reductions adversely affected manufacturers’ bottom lines and, consequently, their shareholders. Corporate management received appropriate scrutiny from Wall Street, retirees living on stock dividends and boards of directors.

How did these companies respond? First, they reduced their workforces, and then they increased their manufacturing productivity through better processes – probably an overdue opportunity. Taking these actions certainly helped suppliers’ bottom line. As expenses were reduced, R&D expenditures reduced.

But suppliers’ main strategy was to increase volume. They attempted to drive compliance in the contracted groups with long-term contracts, with the understanding that better targeting and better sales execution drives more volume.

However, driving volume for the sake of volume increased costs to hospitals. For example, product waste is rising, and is estimated to be as high as 35 percent. The reason is that suppliers have reduced their workforces, limiting the resources they can devote to education, as well as to standardization and utilization programs. Today, few suppliers are able to drive process change.

The Opportunity
The time has come to change the business model. However, doing so will require change from both sides of the desk. Many opportunities exist.

For example, providers can work with suppliers that have changed their marketing approach to create initiatives that are in harmony with hospital management goals. Suppliers can help hospitals optimize revenues by helping with proper coding, process changes, software changes, improved buying methods and smarter marketing techniques. Providers should demand programs that provide performance guarantees or guaranteed cost reductions. Suppliers must be able to measure the effects of their programs in hard dollars and to take responsibility for the outcomes.

Providers must start taking a real look at cost vs. price. Although they may talk about cost, they’re not good at evaluating and measuring it. To be sure, many cost parameters exist, making the process more difficult. As a result, providers often fall back to price negotiation only. Instead, they should insist that their suppliers develop models to accurately measure the effect of a product on total costs (assuming the price is competitive). Questions to ask include: Does the new product require greater volume? Will it increase waste? What is the proper size and units of the product to perform the procedure? If it’s a service, does it carry any hidden costs?

Here are some examples of how suppliers have helped hospitals reduce costs:

  • Some suppliers that are very knowledgeable about product utilization have dedicated resources to educating hospital personnel in proper usage to eliminate waste. The result has been significant and measurable reduction in waste, and therefore costs. They have managed to do this while keeping the price of their product offerings competitive.
  • One supplier has addressed the challenge of being just one vendor in a multiple-vendor situation. Recognizing that this multiple-vendor practice produces multiple prices, multiple payables and multiple credentialing methods, this supplier has created a vendor management program, helping hospitals significantly reduce costs and achieve standardization.
  • Another supplier has brought new imaging technology to significantly reduce the cost of producing referring physician images, guaranteeing the cost reduction.

In addition to helping providers cut costs, suppliers can also help them optimize revenues. Given the expected increase in the over-60 population over the next several years, hospitals will be forced to increase bed numbers, and equip and staff those beds. They will need to grow their revenues in order to finance that growth.

One challenging area of revenue is that of uninsured patients. One supplier we know is addressing this complex issue with new software that identifies the ability of an uninsured patient to pay for the hospital services he or she receives. It creates the appropriate paperwork for the hospital to get paid correctly for its services.

Another supplier has created a new buying method that allows the hospital to purchase equipment while preserving capital. The supplier also guarantees cost reductions.

Lastly, the new model must have a way to measure the real effect on the hospital’s business. Can optimized revenues by measured? Can supplier performance and cost reductions be guaranteed and their progress tracked? Does the tracking process provide for results to be reviewed quarterly?

Suppliers and hospital management must work toward a common business model, with rewards for both. Suppliers that adopt these marketing practices and train their staffs to execute them with excellence will win the support of hospital management.

Congratulations to those suppliers that are performing at this level today. We need more of them. These solutions are not always easy, because they go beyond the simple transaction of “product for price.” However, we need to persevere. Meanwhile, hospital management needs to listen to these solutions and contract with suppliers whose solutions truly impact the business model.

Ron Armstrong is CEO of the Strong Value Group, a marketing consulting firm working with suppliers to drive real value to providers. For more information, visit, or contact Armstrong at 954/385-0780 or