Strategic sourcing should hinge on utilization management

If pushed, most strategic sourcing managers will admit that their price savings record has been marginal over the last few years, since they and their group purchasing organizations have been hammering away at price concessions from their suppliers for decades.

Yet, time marches on and new and renewal contracts are bid, negotiated or renegotiated every day either to chip away at current prices or to locate new sources of supply to save a few percentage points. It is our contention that this tactic only results in 1 percent to 3 percent savings (total supply expenses/annual savings) annually for healthcare supply chain organizations that are married to price savings as their primary saving tactic.

Unfortunately, this course of action to keep pushing for better prices or even finding new sources of supply isn’t the ultimate answer for a hospital, system or integrated delivery network to bend their supply cost curve. What is needed for strategic sourcing managers to have a breakthrough in cost management is for them to also focus on their healthcare organization’s supply utilization to dramatically increase their savings yield on each contract in which they sign off. Here’s why this is important.

Operate in the know

If you knew you were running 21 percent over in the total cost-per-patient-day (or $126,999 annualized) on your disposable oxygen sensors just as you were ready to renegotiate a new contract, wouldn’t this information give you an edge on your negotiations? You bet it would. That’s why price and supply utilization must be intertwined in your negotiations with your suppliers (including your GPO contracts) if you want to increase your annual savings yields by as much as 7 percent to 15 percent overall.

To paraphrase Wikipedia, strategic sourcing is a purchasing process that continuously improves, evolves and re-evaluates the purchasing activities of a healthcare organization. The biggest life-cycle cost element of a new or existing commodity is its utilization cost, by a factor of 10, 20, 50, or more.

Therefore, a strategic sourcing manager would be malfeasant in this era of value-based purchasing if he/she didn’t approach each contract bid, negotiations or renegotiations with this salient fact in mind. This is because if you save 10 cents on 10,000 widgets you have been buying, when you only should be utilizing or buying 1,000 annually, have you really saved any money for your hospital, system or IDN? Of course not. Yet customarily the 10-cents-per-widget savings would be reported to your hospital, system or IDN’s management as a home run. This is fuzzy math!

Benchmark utilization data

I know that every strategic sourcing manager compares price benchmarks when preparing for bid/negotiations on any commodity group prior to the bid/negotiation event. Yet shouldn’t you be doing the same (benchmarking) with these commodities’ utilization costs? Of course you should be measuring, monitoring and managing all of your commodities’ utilization costs because this is where the real money is – not in price.

Here’s how it works. You have benchmarked the current price of a commodity under bid/negotiations and have set a target price for your new contract. Now you can do the same thing with this same commodity’s utilization cost if you have clinical supply utilization in place. If not, you can do a back-of-the-envelope calculation (e.g., cost per patient day, cost per procedure, cost per test, etc.) on your prior year’s contract utilization data on any product, service or technology you are buying then compare this metric to your peers.

For example, if your electrosurgical supplies are running $44.75 per surgical procedure and your peer benchmark is $21.42 per surgical for a contract year, your hospital is unnecessarily over-spending $186,677 (annualized) on this commodity group. These metrics need to be factored into your negotiations for the next multi-year agreement.

Use benchmarked data

Now that you have calculated a target price and a target utilization rate for your new or renewal contract you are now ready to share your utilization goal with your proposed vendor or vendors. In turn, you will need to ask them to come up with an action plan to rein in their commodities’ utilization to match or exceed your $21.42 benchmark. This is where the real negotiations begin with your suppliers and the huge savings yields emerge.

The point of this discussion is to encourage you to start partnering with your suppliers to reduce your commodities’ utilization cost at the time of negotiating or renegotiating your contracts. It’s too late to be doing this after a contract is already in place.

In addition to monitoring that you are paying your contracted price, you will now need to have your suppliers report quarterly on your utilization of the products, services or technologies under those contracts.

More than price

Profit or non-profit corporations can’t stay in business today if they only worry about the price they pay. Therefore, all corporations must ensure that every dollar spent isn’t wasted by misuse, misapplication, misappropriation or is a value mismatch to be truly competitive in their marketplace.

Strategic sourcing managers are tip of the spear on this forefront, and therefore can be real supply chain heroes if they not only strive to obtain the best price for the commodities they are buying, but also strive to achieve the best in-use cost for the millions of dollars they purchase annually by including price and utilization in all of their contract negotiations.