Purchased services represent opportunities worth millions of dollars for contracting executives and their IDNs. Seizing that opportunity is no easy task.
According to The Advisory Board, purchased services represent up to 40 percent of hospital expenditures, far greater than physician preference items (estimated at 13 percent). Yet few hospitals or IDNs dedicate staff and resources to writing contracts for them and monitoring their performance. That is a lot of untapped value, says Joe Walsh, assistant vice president of procurement, Intermountain Healthcare, Salt Lake City, Utah.
Walsh spoke about this opportunity at the 2014 Purchased Services Summit, sponsored by the Journal of Healthcare Contracting.
Tapping into the value of purchased services isn’t exactly a cakewalk, but it is worth the effort, given the unprecedented cost pressures facing today’s providers. “Supply chain’s capabilities and influence in healthcare continue to increase,” he says. “It was appropriate to initially focus efforts on medical supplies. However, each of us in healthcare supply chain has an obligation to get our arms around 100 percent of the controllable non-payroll expenditures in our respective companies. Purchased services is the next frontier, which represents a significant opportunity to address our cost structures. Although purchased services are extraordinarily challenging, the unpopular alternative is that we are forced to more critically evaluate our clinical staffing levels.”
What are purchased services?
Healthcare providers spend about $100 billion a year on purchased services according to MD Buyline, says Walsh. In some cases, their contracts with suppliers of services – such as food service companies – now outweigh (in dollar value) contracts with their med/surg and pharmaceutical distributors. “Can you imagine the complexity of managing a relationship of this magnitude?” he asks. “You have to hire someone with specific expertise to do that.”
Sourcing and contracting with providers of purchased services can make negotiating for spinal implants look – if not easy, at least more manageable. This is particularly true for more complex services, like information technology services, construction services, legal services, HR benefits, market research, etc.
There are a number of reasons purchased services is inherently complex. Purchased services involving outsourcing require a multifaceted decision-making process and requires a new set of capabilities to manage. Insource vs. outsource decisions force hospitals to reevaluate their core competencies, to reevaluate their long-term talent strategy and to consider their local public relations strategies. “Whenever there is talk about potentially outsourcing something that used to be done in-house, there will be understandable resistance,” says Walsh. “We empower our internal leaders to oversee these support operations and they each take great pride in these responsibilities.” But outsourcing is a trend that is gaining strength in healthcare, especially when comparable services can be provided at lower costs or improved services can be provided at similar costs.
Another reason is the level of effort needed to impact the cost structure of purchased services. For tangible products or devices, you can have an intelligent, transparent discussion about the supplier’s controllable cost elements, says Walsh. Suppliers and hospitals can work together to reduce the cost to serve and openly discuss strategies about fluctuating raw material costs. For example, “It’s relatively straightforward to sit down with a willing manufacturer [of a tangible product or device] and ask, ‘Raw materials make up what percentage of your product’s finished price?’ and ‘What are the top four or five raw materials that make up that percentage, and what can we do to reduce the price risk to both parties?’ Suppliers know the answers to these questions.
“You can’t have this conversation with purchased services, partly because the input costs of purchased services are often the people directly supporting your statement of work,” he continues. “It’s a completely different category, with far more variable expenses, and it’s therefore exponentially more challenging to create immediate value in cost transparency alone. Significant behavior or practice change is often necessary in order to drive out unnecessary cost.”
Here are more reasons why contracting executives may find purchased services a challenge:
- Sacred cows: In many cases, senior leaders have direct responsibility for some of the largest purchased services agreements. For example, advisory firms are often used by the C-suite, and a tax auditing firm likely has a long-term relationship with the CFO. Supply chain professionals are not always included when these service providers are selected. “My supplier is unique and therefore I shouldn’t be subject to the sourcing process” is something often mentioned by resistant stakeholders, according to Walsh.
- Imprecise and challenging requirements: It is more challenging to define requirements of an intangible service or software solution compared to a tangible product, such as a spinal implant. For example, Intermountain Healthcare recently selected Cerner as its partner to implement an electronic medical records solution (EMR). “We had to mobilize a team of 125 cross-functional representatives to help define requirements, provide feedback on demos and to help score the proposals,” says Walsh. This is very different than traditional medical products, where most hospitals have standing value analysis teams. “The requirements definition alone took nine months. We didn’t know what we didn’t know until we invested considerable time and effort in demonstrations. Only then could we begin to define and prioritize our requirements.”
- Purchased services are rarely commoditized: Since requirements vary by customer, service providers offer highly configurable solutions. The capabilities of competing service providers are more challenging to compare than the product attributes of competing manufacturers. In fact, services are often a source of differentiation for many product manufacturers for this very reason. “With purchased services, the effectiveness and value of the service is often a direct result of the expertise and fit of the people assigned to the project,” says Walsh. “You are contracting knowledge, expertise and/or a capability you don’t already have in your organization. Unique talent is never a commodity and can’t be compared as such.”
- Project-based and demand-driven: Some services, such as landscaping, are routine and consistent. However, many services providers are engaged on a project basis. This means that the quantity of these purchased services is based on the demand for the service. “The hours of consulting services contracted in 2013 does not predict the hours of consulting services we need in 2014,” says Walsh. “The projects we addressed in 2013 are completed and we now have new unrelated opportunities to address in 2014.” The EMR project, for example, was the product of a once-in-a-20-year demand cycle.
- Lack of internal subject matter experts: Want to write a contract for total joints? Enlist the help of the practicing surgeons. Want to contract with an EMR partner? Brace yourself. “When we did the Cerner deal, we didn’t have a team of experts who understood the EMR industry,” says Walsh. “We didn’t know the software suppliers or the landscape of the marketplace. We didn’t know what we didn’t know. That’s totally different [from medical products], where knowledge is deep. I’ll never forget the first time I sat with our vice president of HR and talked about benefits design; I had no direct expertise, so we agreed to find somebody with this specialized expertise. At that time, I didn’t even know where to start this search. This is typical of purchased services.”
Still, purchased services offer the IDN the opportunity to bring millions of dollars directly to the bottom line, says Walsh. About what other areas can you say the same?
Starts with executive support
The Intermountain sourcing team has been addressing purchased services for some time, says Walsh. “I’ve been part of Intermountain for six years, and purchased services were already in scope for the team before I arrived,” he says.
Executive support is essential, he says. Walsh sought and received such support soon after arriving at Intermountain, when a spend analysis reflected the significance of consulting services expenses and the historical lack of involvement of the supply chain in contracting these services. He gained early and strong support from the CFO, who required all leaders to engage the supply chain when selecting any third parties for professional services.
Walsh approached Intermountain’s stakeholders with the intent of establishing trust and credibility. Therefore, he and the CFO wrote a letter that was sent to all existing suppliers of professional services. The letter solicited ideas, which, if implemented, would result in at least a 5 percent annualized savings. Suppliers were encouraged to not simply reduce their margins by 5 percent. Although many leaders were initially skeptical of this approach and confident they had already extracted all of the possible value from their supplier relationships, this effort led to a 12.5 percent average cost reduction, improved service levels and newly engaged stakeholders.
“Having a well-organized sourcing department, staffed by talented people, is also essential,” he adds. “Our sourcing mission is to provide decision support and expertise necessary to help our stakeholders select the supplier(s) that meets all requirements at the most affordable costs for the patients we serve. Team members are organized by spend type (e.g., software and services, products, equipment and maintenance, etc.), they have a diversity of experience, most have master’s degrees and are certified by the Institute of Supply Management. Those responsible for purchased services understand that agreements for purchased services differ from those for products.
“Warranties are different, definitions of terms are different, everything is different,” he says. “We had to work with our onsite attorneys to develop template master service agreements, software agreements, staffing agreements and statements of work.”
The contracting process
Successful contracting for purchased services begins with early engagement with stakeholders, says Walsh. “We never award business to a supplier without our stakeholders and suppliers knowing what is expected of each other. This way, the sourcing team avoids the risk of awarding a contract for services that the end user neither wants or needs.”
“Purchased services contracting differs from product contracting in several ways,” he continues. “With products, we typically source based on the product attributes. We ask stakeholders, ‘What do you need [the product] to do?’ Then we evaluate the attributes of each product and determine which product best meets these overall requirements.
“Since services are intangible, it is far more difficult to define attributes. Therefore, we select suppliers based on their ability to solve specific problems and/or meet our defined service requirements. It is far more challenging to clearly articulate problem statements, service requirements and other intangibles than it is to describe attributes of tangible products. We had to adapt our processes to accommodate this important difference between products and purchased services.”
Measuring the performance of the service provider during the contract period is best done on the basis of outcomes, not processes, says Walsh. To illustrate this concept, which he believes is often misunderstood, he uses the example of a fish tank cleaning service. With a process metric, the IDN might require the service provider to come to the hospital twice a week to clean the tank. An outcomes-based metric, on the other hand, would only define that the water must have a pH level between a 6.5 and a 7.5, which will be measured randomly up to two times per week. It is then up to the service provider to use its expertise to ensure this outcome is achieved.
The point is, if the IDN believes it knows how the service provider should do all of its work (in the example, clean the fish tanks twice a week), the IDN should probably not be asking an expert to perform the service in the first place. “It is important to trust the experts you hire and empower them to do the activities they know best,” he says.
Purchased services: From base hits to home runs
Purchased services come in three flavors – base hits, doubles and home runs, says Joe Walsh, assistant vice president of procurement, Intermountain, Salt Lake City, Utah. Some examples:
Base hits (lowest levels of complexity, risk and upside):
– Travel services
– Transcription services
– Collections services
– Temporary staffing
– Translation services
– Credit card services
– Building maintenance services
– Fleet maintenance services
– Print services
Doubles (moderate levels of complexity, risk and upside):
– Coding services
– Software implementation
– Consulting services
– Banking and treasury services
– Telecom services
– Recruiting services
– Linen services
– Energy management
Home runs (significant complexity, risk and upside):
– Outsourcing (all forms)
– Enterprise software solutions (ERP, EMR, etc)
– Employee benefits
– Clinical services
– Marketing services
– Construction services