When materials managers at West Penn Allegheny Health System went looking a few years back for innovative methods for reducing supply-chain costs, they didnt turn to the health systems group purchasing organization for guidance. Instead, the Pittsburgh-based provider, which has four hospitals, 160 physician offices and a hospice-care facility among other operations, held a meeting with a supply-chain software company that specialized in setting up Internet auctions.
The auctions had a twist. Instead of bidders increasing their dollar offers in an effort to win the items being auctioned, the scenario featured suppliers lowering their prices in an effort to outbid one another and receive coveted, multiyear contracts to supply healthcare systems. The bidding process is called a reverse auction, and over the past few years a growing number of hospital systems and GPOs have begun to use the tactic to secure better pricing and terms on supply and service contracts.
David Zimba, vice president of corporate contracting for West Penn Allegheny, says his system has saved $27.5 million in supply-chain costs since adopting the tactic six years ago. The system has used reverse auctions to purchase a wide variety of supplies, from basic commodities such as linens, slippers and transcription services to more sophisticated items such as spinal implants, imaging equipment and reference-laboratory services.
We were introduced to (reverse auctions) by a company called FreeMarkets, which has since been acquired by Ariba, a Sunnyvale, Calif.-based supply-chain management company, Zimba says. They were trying to recruit us as a client, so we went to one of their seminars and heard how nonhealthcare companies like Heinz, Alcoa and Emerson had had great success with the system. Several had saved about $1 billion on their supply-chain costs. We thought, theyre pre-eminent companies that have had great savings using this tool, so well give it shot, he says.
As it turned out, significant savings werent the only benefit to using reverse auctions to secure supplies and services, Zimba says. By employing reverse-auction technology, West Penn Allegheny also has been able to reduce the contract negotiation period from three to six months to as little as three weeks. The not-for-profit hospital system also has been able to standardize many of the product definitions that had previously led to a proliferation of physician-preference items.
We used to use a brown-envelope (bidding) process where vendors, no matter what we asked for, wouldnt compare their products, and that was just frustrating, Zimba says. We werent able to compare apples to apples because often the negotiation happened around a conversation. But now that (the sourcing process) is automated, the vendor can only reply to the requirement by saying they can or cant fulfill it.
Chris Merchant, director of spend-management services for Ariba, echoes Zimbas observation, saying the dozens of hospitals his company has introduced to reverse-auction technology have found similar benefits in the process.
I think hospitals have a long his-tory of suppliers dictating the terms of contracts, but I think reverse auctions turn that (history) on its head, Merchant says. With reverse-auction sourcing you tell the suppliers exactly what you need and they respond (electronically) with whether or not they can supply it. It kind of takes out a lot of the noise about product uniqueness, he says.
But while reverse auctions can generate substantial savings and favorable contract terms, healthcare systems need to do extensive due diligence before jumping into the arena, say those familiar with the process. Hospital executives need to consider everything from whether their materials-management culture will support the commoditizing of supplies typically considered physician-preference items to whether their annual spending on a particular item is significant enough to generate interest in the bidding process from potential suppliers.
The process itself is not inexpensive, so unless you have a very large spend in a specific category, it probably isnt worth it, to execute an independent reverse auction, says John Biggers, group vice president of sourcing for GPO Premier Purchasing Partners. You not only have to have the software or a company to run the auction for you, you also need to hire backup (bid representatives) for the suppliers in case the system goes down.
Going, going, gone
Similar to online auction spaces such as eBay, reverse auctions take place in cyberspace. But unlike eBay, the events are done in real time, with preapproved bidders who drop, not raise, their prices. Bidding suppliers can also sweeten the deal by tweaking certain details of their offer, such as service and delivery terms, during the bidding process. But Merchant says auctions typically run smoother when potential-contract terms have been worked out prior to the auction.
Typically, the auction takes no more than a couple of hours, with preapproved suppliers logging in to the event and placing bids from their own computers. During the bidding, suppliers are able to see where they stand in the competition and determine whether dropping their price will be enough to get ahead in the bidding.
Reverse auctions can secure better savings than the typical blind-bid process because they infuse an element of immediate competition, says Robert Benson, senior director of contract process and technology for GPO Novation. Weve been able to achieve in the neighborhood of 15% to 20% savings over previous contracts, Benson says.
Like Novation, GPOs Premier and Broadlane also are using reverse auctions to secure better pricing on commodity items for their member hospitals. But as systems such as West Penn Allegheny and the Health Alliance of Greater Cincinnati have discovered, hospitals can set up their own reverse auctions. Dennis Robb, senior vice president of supply-chain management for Health Alliance, says his system tested the waters late last year when it had the GPO Broadlane set up a reverse auction to contract with an IV-pump supplier.
The contract called for upgrading from manual IV pumps to computer-controlled ones that provide safety controls to prevent medical errors such as overdosing. The system needed to have an extensive drug library and wireless technology that could be easily up-dated. The supplier would also win an ongoing contract to supply the catheter lines and other disposable IV supplies. We had very specific demands from clinicians about how the IV lines should be set up, Robb adds.
With those stringent demands, just two vendors chose to participate in the bidding process. The final contract was awarded to medication-delivery company Hospira. Confidentiality terms prevent Robb from revealing financials on the winning bid, but he notes the contract was worth millions of dollars and the hospital netted substantial savings as well as favorable equipment servicing terms that allows for updates of the pumps computers as the technology advances. Such terms are important contract elements for hospitals to keep in mind as theyre employing the reverse-auction technique, he says. You want to be able to have some ability to update equipment if the technology improves or leapfrogs.
Worth the cost?
Hospital systems that determine their purchasing needs meet the criteria for a successful reverse auction have three options for setting up an event, notes Novations Benson. Ive seen situations where a third party (such as a GPO or supply-chain management company) will do a reverse auction for just a few thousand dollars, or where hospitals will license (reverse-auction) software systems. Also, there are organizations that have built their own internal (auction) systemsbe they GPOs or hospitals, he says.
The cost for executing a single reverse-auction event can vary depending on who provides the service and whether pre-event preparation demands a significant amount of research to compare and evaluate products from various vendors. The due diligence on our (IV pump) auction took over a year of research and development, Robb says.
While there is no standard cost for third-party management of reverse auctions, Broadlane President and Chief Operating Officer David Ricker says hospitals should expect to spend several thousand dollars for a single event.
West Penn Allegheny, a system with substantially more experience with reverse auctions, opted to subscribe to Aribas software system for use in executing its reverse auctions. The subscription costs can range from a few thousand to hundreds of thousands of dollars annually depending on how many hospital purchasing agents are authorized to use the software and the level of pre- and post-auction services used, Merchant says.
Zimba says his hospital system became comfortable with the concept of reverse auctions and determined that the process was one they wanted to use frequently before investing in the technology. Materials managers conducted reverse-auction events through a third party for $48 million in recurring annual supply costs before subscribing to Ariba in 2003, two years after the system began doing reverse auctions. They have since used the software to manage their own auctions for another $102 million in recurring annual supply costs.
Zimba wouldnt say exactly how much the hospital system is paying for the software, but he put it in the area of six figures annually. While the fee is sizable, the supply-chain manager says it is easily justified by the savings West Penn Allegheny has experienced to date. If you put that into context, weve saved $27.5 million, so the return is way over 1,000%