Hospitals overspend $39 billion a year on purchased services

Johns Hopkins Health System saved $13.3 million in purchased services over an eight-year span.

The Baltimore-based academic medical center began working with Medpricer in 2008 on its specialty bed rental services, which yielded about $560,000 in savings.

From there, Medpricer helped analyze about $94 million across 14 projects in Johns Hopkins' purchased services spending, which encompasses all outsourced contracts on both clinical and other services. The health system was able to aggregate all its contracts, benchmark its expenditures and rework existing agreements accordingly.

Often it's an oversight problem, said Mickey Meehan, Medpricer's chief customer officer.

"Many hospitals don't know what they spend and with who," he said.

Purchased services is often an overlooked sector of the supply chain. Hospitals outsource an array of services from laundry and food preparation to blood products and all the contracts can get lost in the shuffle.

Many are longstanding agreements that haven't been adjusted for years, which means hospitals could be leaving money on the table, Meehan said.

"Everyone worries about physician-preference items and med/surg," he said. "But they don't realize that they spend as much on purchased services as they do on PPI. And unlike other categories, every dollar you save in purchased services drops to the bottom line."

Hospitals overspend $39 billion a year on purchased services, Medpricer estimates.

Purchased services account for approximately 20% of a hospital's total operating costs, which amounted to $991 billion in 2017, according to the American Hospital Association. Medpricer customers regularly see 24% savings on their purchased services, which translates to $39 billion.

"More are taking on the centralization of purchased services like they have with goods, but the bigger the organization, the higher the challenge," Medpricer CEO Chris Gormley said. "This is the next iteration of supply chain management."

Sustainable cost control is top priority among top healthcare executives, according to Advisory Board's annual survey. Executives are still focused on growing revenue, but those endeavors have been eclipsed by trimming expenses.

While hospitals have begun to rein in expenses, it's not offsetting revenue declines. This has driven some urgency into the cost-cutting conversation.

"Revenue pressures lend themselves to needing expense reductions to improve margins," Meehan said. "Because some of these contracts like food service haven't been touched in years, they can offer quick returns. You're almost guaranteed to get at least 25% savings."

This is particularly helpful when there is nothing left to squeeze in the med/surg space or when hospitals don't want to deal with physician-preference items, Meehan added. Also, it doesn't necessarily mean that a hospital has to put out a request for proposals, many existing suppliers are willing to negotiate, he said.

Purchased services and the broader umbrella of supply chain spending is often an initial focus of extracting costs from merged hospitals. Executives hope that scale will translate to better prices with their suppliers and that a more standardized and centralized structure will lower costs.

But those expectations aren't always reached, according to a working paper from academics at the University of Pennsylvania's Wharton School published in the National Bureau of Economic Research.

Horizontal hospital mergers saved acquired hospitals $176,000, or 1.5%, annually on average, which represents only 10% of what is claimed in the merger justification, according to the paper, which analyzed hospital supply purchase orders from 1,200 hospitals from 2009 to 2015. Those savings primarily affect neighboring systems that maximize price negotiations for high-tech physician preference items. But there is mixed evidence supporting acquirers' savings.

Corporate culture is a major factor in how much integration can even potentially be achieved, supply-chain consultant Jamie Kowalski said. Merging hospitals and integrated delivery networks have a wide range of philosophies about how much corporate centralization or consolidation is needed, how much standardization can be achieved, and what savings those changes will yield, he said.

"Until IDNs and/or merging parties address that 800-pound gorilla, financial results via supply chain will continue to be overprojected and underwhelming," Kowalski said.

First, organizations must get a handle on what it spends and with who, Meehan said. Next, they need to get a team in place to act on it.

It is a combination of a tech platform that provides some visibility into expenditures, monitoring that over time to adjust when something gets out of whack, and having the proper experts who can communicate across departments effectively and ultimately help the organization adapt and grow, Meehan said.

"There's a huge opportunity for consolidating health systems where purchased services are decentralized," he said. "You can save lots of money quickly."