Dealing with Inflation

May 2022 – The Journal of Healthcare Contracting

Inflation – no matter when it strikes – is an unwelcome guest. Still, providers are asking why now, when the American Medical Association reports that Medicare physician pay has increased 11% over the last two decades but the cost of running a medical practice increased 39% during that same time? Why now, just a few months after healthcare consulting firm Kaufman Hall projected that hospitals nationwide would lose $54 billion in 2021 and more than a third of U.S. hospitals would maintain negative operating margins through the year’s end? And why now, just as nursing homes were reported to have lost 220,000 jobs between March 2020 and October 2021 and were projected to lose $94 billion in 2020 and 2021?

Manufacturers and distributors are asking themselves similar questions, as the cost of raw materials and transportation keep going up.

How long will it last? How bad will it be? Well, in December, the Federal Reserve Board said it was committed to achieving “maximum employment and inflation at the rate of 2% over the longer run.” Other sources aren’t so optimistic. In the same month, mortgage financing firm Fannie Mae projected inflation would hit 7% in the Q1 2022 before decelerating to 3.8% by the end of 2022.

In the medical products and equipment industry, three factors will contribute the most to inflation in 2022, says Margaret Steele, senior vice president of med/surg for Vizient: rising labor costs, transportation costs and raw materials. “However, labor costs will likely have the most long-term impact as this metric doesn’t typically decline unless new technology is introduced to create more efficiencies in the manual labor aspect of production.”

Labor costs

“COVID-19 had a dramatic impact on the world’s workforce and production that we’re still feeling today,” says Kim Anders, group vice president, strategic supplier engagement for Premier Inc. Healthcare has also felt the pinch as workers in high-demand groups, from nurses to pharmacists to ICU physicians, have been in short supply and subject to a more competitive recruiting landscape. Early retirement and employee burnout have also contributed to the healthcare worker shortage.”

U.S. healthcare was experiencing a workforce shortage prior to the pandemic, but it has been exacerbated by the mental and physical strain of COVID-19, says Anders. She points out that healthcare had the second-highest quit rate (6.4%) in November of all industries. Among nursing homes, employment remains far below pre-pandemic levels, and hospitals and health systems remain nearly 100,000 jobs below their pre-pandemic peak in February 2020.

In healthcare, workforce shortages mean higher costs, not lower ones. An October 2021 Premier analysis revealed that U.S. hospitals were paying $24 billion more per year for qualified clinical labor than they did pre-pandemic, says Anders. For the average 500-bed facility, this translates to $17 million in additional annual labor expenses.

“Many hospitals and health systems were forced to turn to staffing agencies to supply urgently needed health workers to care for the increasing number of patients,” she says. “However, the pandemic’s longevity has pushed hospitals to rely on these temporary workers more than ever – ballooning the typical costs for travel staff.”

Supply chain costs

As of mid-January, global logistics remained “an overloaded and stressed combination of port congestion, vessel shortages, equipment and container shortages,” says Anders. Not surprisingly, the cost of land, air and water transportation increased to record or near-record levels. Lead times for the manufacturing of additional cargo ships, shipping containers and freight trucks were also significant.

Although shipping container availability has improved slightly, costs remain at record levels, she says. Compared to prices in March 2019, freight rates from China to the U.S. increased 500 percent with spot rates up to about $10,000 per container, compared with the more typical price of $1,200. In addition, the pandemic and other restrictions have limited the availability of dockworkers and truck drivers, causing delays in cargo handling after it arrives at ports, she says. “There’s no clear consensus on how long this situation will last, with some experts assuming that these logistical challenges will remain for the foreseeable future.”

Raw materials

All that notwithstanding, a key driver for inflation in medical products lies at their very source – that is, the raw materials needed to make those products, says E.V. Clarke, CEO of Health Products Xchange, whose HPXConnect is an electronic marketplace connecting manufacturers, distributors, providers and others. In most industries, too much money in the market leads to inflation but doesn’t necessarily lead to a greater demand for medical products, he says. Instead, it increases the cost of the raw goods, such as minerals and resins and other natural resources.

“If metals are diverted from the medical side to making higher-margin goods, like washing machines, that will have an impact on the medical market,” says Clarke, who co-founded Health Products Xchange in 2018.

“It’s especially true for commodities, like crutches – though it also applies to things like suction canisters, OR towels and tubing,” he says. “In the case of crutches, there’s no sudden surge in demand, but the price of aluminum and logistics has increased 40% since the pandemic began. So you have a low-cost, bulky item – crutches – and the manufacturer can’t pass along all those costs, at least not immediately, given the nature of the U.S. healthcare system and the contracts between distributors, manufacturers and providers.” Consequently, manufacturers may lower their inventory of crutches and shift production to higher-margin goods. The result is a shortage of crutches, which can push up prices of that commodity.

Clarke expects logistics and raw materials pricing to remain inflated for the next 12 to 24 months, and that’s not accounting for anomalies, such as rolling blackouts in China or domestic regulations about the sourcing of finished goods and even the raw materials used to make them. In economic storms such as the current one, alternative suppliers and brokers come out of the woodwork, he says. And that’s a market opportunity for digital marketplaces such as HPXConnect.

Todd Nelson, director of professional practice and partner relationships, and chief partnership executive for the Healthcare Financial Management Association, says that partnering with national, regional and local organizations will continue to be a key to addressing inflationary pressures. “For many it will take the form of looking at non-traditional partners to assist them in having access to products and equipment they depend on, which will require a level of creativity, building trust and relying on additional clinical and financial evidence to build that credibility with new partners.”

Think it through

What should providers and their suppliers do about inflation? For starters, avoid panicking.

Vizient believes inflation will continue through much of 2022, though at a lower rate than its most recent 7% pace, says Jeff King, research and intelligence director for Vizient. “Production costs will continue to put pricing pressures on product and service producers,” he says. “Vizient anticipates that raw material costs will decline, as resins already started their descent late last year. Unfortunately, the climbing labor costs won’t return to previous levels, and the issues impacting transportation appear to be long-term and will strain the ability of producers to maintain current price levels.”

“Everyone is facing increased costs,” says Steele. “However, it’s important that we look at these drivers individually. For instance, we may see some relief as it relates to ports and raw materials in the next few months, therefore those price increases should be temporary. However, labor shortages and increased labor costs are likely here to stay.

“Often, we look at all these factors collectively and accept the increased costs for the longer term,” she says. “We need to stay diligent and have transparent conversations with suppliers. This should allow for appropriate, temporary adjustments to ensure supply and business continuity rather than allowing the water line to rise across the board.”

Pricing strategies

For suppliers, contracting and pricing strategies only work when the economy for a category of goods or services is balanced, says John Strong, chief consulting officer for Access Strategy Partners, a national accounts consulting firm. “If I were still a supply chain executive in a hospital or health system, I would be more concerned about having goods available at a price that is reasonable and stop worrying about whether I’m getting the lowest price on everything.”

Lowest price isn’t the only measurable factor that goes into a supply chain executive’s annual goals and objectives, he says, Supply chain professionals are more likely to get fired due to declining order fill rates and services to the people on the front line. “A balanced scorecard requires looking at service levels, real value analysis and other factors – not just price.

“I’m a big fan of bringing products back to the U.S. to manufacture and sell,” he continues. “It provides meaningful work for our own country and has the added benefits of a shorter supply chain (and less carbon footprint) as well as the possibility of rebuilding industrial deserts in our largest cities. Yes, it is going to cost more in terms of a direct price. But I must ask, What have been the indirect costs to this country of offshoring much of our manufacturing base – inside and outside healthcare?”

Nor can supply chain executives “source” or “procure” their way out of the difficulties in today’s med/surg marketplace, says Strong. “You cannot get manufacturers to make things if they can’t make a reasonable profit. Consolidation has brought us to a total of three national GPOs, and many products that can be aggregated by them in a reasonable fashion already have been. Having scale, size and influence is important, but you can still reach a point in the economics of any goods or services where they cannot be provided any longer at a contracted price, [especially] in a period of short supply, inflation, supply chain/logistics issues or other factors along the supply chain.

“It is similar to the so-called ‘hog cycle’ in economics,” he says. “More farmers start to raise hogs when prices are high. This leads to an overall lowering of prices because of the increase in supply. So farmers get out of hogs and into something else because the price has become too low, driving prices up again. The cycle repeats itself.”

Provider strategies

“While it may be difficult to identify what major U.S. or global events will impact the world’s economies and supply chain, Premier aims to arm our members with the information, tools and support needed to tackle cost imperatives,” says Anders. The company is accelerating the development of its MedSurg and ASCEND Inflationary Calculators so members can stay abreast of the most recent inflation estimates, she says.

In addition, through collaborations with Prestige Ameritech, DeRoyal Industries, Honeywell, Exela Pharma Sciences and VGYAAN Pharmaceuticals, Premier is producing “millions of domestically made PPE and pharmaceutical products … thus helping to eliminate overreliance on overseas manufacturing and port congestion,” she says.

Meanwhile, the company continues to help hospitals and health systems deal with clinical and nonclinical labor shortages and rising labor costs. Its PINC AI analytics technology can provide health systems with productivity benchmarks to pinpoint areas in need of adjusted staffing levels, says Anders. Premier also has contracts to help health systems control the costs of FTE and/or contingent staff for both clinical and non-clinical assignments.

Buckle up

“Buckle up,” says Strong. “Many people working today don’t remember the Jimmy Carter years, when we witnessed a period of runaway inflation. I still remember being relieved to be able to get a three-year variable mortgage note on a condo at 14.5%. The average rate at the time for a fixed 30-year mortgage was somewhere around 18%.”

The demand for medical products and services won’t go away, he adds. “The question for [providers] is, What price am I going to have to pay in 2022 to see those goods arrive on my receiving dock?”

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