VHA is finally learning its ABCs, as in "activity-based costing."
The Irving, Texas-based hospital alliance is completing sweeping new distribution contracts that later this year would link distribution fees more closely to the true cost of filling hospitals' supply shelves, an approach known broadly as activity-based costing, or ABC.
All told, VHA's aggregate distribution costs will rise about 0.6% under the new accords, says Larry Dooley, vice president for distribution services. The new agreements would succeed expiring distribution contracts with Owens & Minor, Richmond, Va.; Allegiance Corp., McGaw Park, Ill.; Burrows, Wheeling, Ill.; and Shared Services, Omaha, Neb. As part of the overhaul, VHA also plans to add four new distribution vendors: Bergen Brunswig Corp., Orange, Calif.; McKesson Corp.'s General Medical unit, Richmond, Va.; Caligor Medical and Office Supply, Pelham Manor, N.Y.; and a subsidiary of Cardinal Healthcare, Dublin, Ohio, Dooley says.
"No matter what, prices would have gone up," Dooley says. But by making sure prices reflect costs and that costs, in turn, are more clearly disclosed, the agreements will encourage efficiency among manufacturers, distributors and healthcare providers.
VHA's move comes as materials managers increasingly are focusing on distribution as the next frontier for cost cutting. Last year, for instance, the Efficient Healthcare Consumer Response study group estimated improvements in the supply chain could yield $11 billion in annual savings-nearly half the entire amount spent on moving healthcare supplies each year.
VHA likely will unveil its revamped distribution program to materials managers sometime next month or in September, Dooley says. The new system would take effect in November or December.
Under the still-developing scheme for ABC, an a la carte menu of distribution services would be standardized. Fees would be calculated based on a combination of average value of purchase order line items and volume, Dooley says.
In a companion move, VHA would grade manufacturers by supply performance standards that would create a two-tiered fee schedule for the cost-plus distribution method.
Efficient, high-volume suppliers to VHA would qualify for a basic distribution charge that likely would average 5.8%, Dooley says. To qualify, suppliers would have to support electronic ordering and information exchange, demonstrate order fill rates in excess of 85%, and give distributors 45 to 60 days' notice before changing prices.
Manufacturers that can't meet those criteria-important indicators of supply efficiency-would be charged a higher distribution fee, Dooley says. The as-yet-undetermined fee likely would run upward of 10% of product costs, 5% higher than the one levied on preferred manufacturers, Dooley says.
That 5% spread would provide a powerful incentive for hospitals to move to more efficient suppliers, Dooley says. Within a year, he predicts, more than 90% of VHA purchases will be through preferred, or aligned, suppliers, he says.
Regardless of the middleman, most distribution charges still are levied as a fixed percentage tacked to the cost of an order. Although simple to administer, uniform cost-plus billing treats efficient and sluggish suppliers as equals. At VHA, for example, distribution services typically have been paid through a 7% surcharge added to each order.
About 85% of VHA organizations rely on a cost-plus approach to distribution, Dooley estimates. The remaining 15% of institutions use some variation of ABC already.
By moving to a tiered system for cost-plus charges that rewards more efficient behavior, VHA would bring a measure of ABC even to traditional distribution.
VHA's stab at restructuring distribution is winning kudos.
"Going to something more like activity-based costing does make sense," says Jamie Kowalski, president of Kowalski-Dickow Associates, Milwaukee, a materials management consultant. "I'm glad they're taking a shot at it."
Manufacturers that have invested in becoming efficient suppliers welcome the change. ABC removes a hidden "subsidy to people who are adding cost to the supply chain," declares Dan Marsh, vice president for sales at Medical Action Industries, Hauppauge, N.Y. Once those costs are in the open, Marsh says, wasteful suppliers will "either get more efficient, or their business is going to go away."
There may be an additional payoff for those hospitals that can use true ABC. Because it "separates the cost of services from the cost of goods," explains Tom Sherry, senior vice president for Owens & Minor, ABC lets "group purchasing organizations address the cost of goods, and (hospitals) focus on process improvement."
For most VHA hospitals, distribution costs under the new system would rise slightly or remain about the same.
"We looked at a variety of scenarios and . . . in most situations, it didn't look like fees would substantially change," says Terry Bell, director of materials management at Lakeland (Fla.) Regional Medical Center. Bell was part of a VHA task force that helped develop the new distribution system.
By unbundling charges, though, hospital executives should be better able to decide what distribution services to buy or provide internally, such as shipping direct to a clinical department rather than a loading dock.
When you know what services really cost, Bell says, you "can decide whether they're worth it, or you can do those functions for yourself."