APICS is the premier professional association for supply chain management.

Health Care and Supply Chain Management Strategy

By John M. Donnelly, CPIM, C.P.M. | January/February 2012 | 22 | 1

Essential opportunities to enhance the bottom line

No matter how you feel about current health care laws and regulations or how they may change, one thing is certain: Health care has undergone a transformation. How it moves forward will be critical to how it operates as an industry, and supply chain management will have a new and important role to play in health care’s emerging dynamic.

There are two forms of routine inventory ordered in health care—stock inventory and non-stock inventory. Stock inventory is material purchased and stored in a central location. The material is considered inventory, and it is expensed as it is issued to departments that request it. Non-stock material is purchased for a specific location or department, and the expense is recognized upon receipt.

The central materials group orders stock inventory. When the reorder point—the level of inventory that signals replenishment—is reached, a reorder process begins. This may involve a material requirements planning order suggestion, an automatic reorder, or a stock requisition that is converted to a purchase order. Replenishment systems can be as simple as visual and manual reorders or a fully automated system that maintains a perpetual inventory. The process is not unique to health care and is, in fact, quite similar to other industries.

Non-stock inventory is material ordered for a specific department or location. The expense is recognized at the time of receipt. The materials are not on a perpetual inventory—though the specific location may have a system that accounts for the quantities on hand—and often are repeatedly ordered. They may be items that are used in multiple areas, but this material is “owned” by the requesting location. Quite often, the ordering, stocking, and counting of non-stock inventory fall on either a resource nurse or a health unit coordinator whose primary focus is patient care, not materials management.

Industry transformation
In the past, the traditional health care organization was focused on stand-alone hospitals. Over the last 20 or 30 years, however, they have shifted into loosely affiliated systems or become formal parts of a hospital corporation. Loosely affiliated health care systems generally enable individual hospitals to manage themselves, and the negotiation of purchases is handled by the central health systems in order to take advantage of the combined volumes generated by multiple hospitals.

Even with this system, the individual departments in each hospital often operate independently of the same departments in other hospitals within the same system. Each department orders and maintains its own inventory. Typically, each hospital within the system also operates on its own tier and has different pricing for the same products from sister facilities within the same system.

However, a concept that is growing in health care today is self distribution. While the idea is new to professionals in this industry, self-distribution models in other businesses are useful in redefining supply chain management in health care.

According to the Firestone-Callahan & Associates report “Health Systems: Consolidated Services and Logistics,” there are three basic models for self distribution in health care systems. Each can be customized to optimize inventory and customer satisfaction. The first is a central distribution plan that is owned and run by the health care system. The second is a completely outsourced operation run by a third-party logistics (3PL) provider or a medical supply distributor. The third model involves a collaborative effort among unaffiliated systems, which develop and operate a central distribution operation under a joint-venture arrangement.

An example of the first model is Providence Health System’s Oregon division, which operates its own central service center in Portland. The service center enables Providence’s Portland operation to reduce costs through efficiencies and standardization. One central distribution model run by a 3PL is that of Iowa Health Systems, which uses Owens & Minor to manage its dedicated distribution center. The decision to outsource the central distribution and logistics functions came about because Iowa Health systems wanted an expert to manage the operation. A joint-venture example is the Swedish Medical Center in Seattle, which partnered with Providence Health Services of Renton, Multi-Care Health Systems of Tacoma, and the Washington Hospital of Wenatchee to create a 59,000-square-foot distribution operations center that helps cut costs by combining purchases.

All of these methods of centralizing the purchasing and distribution of health care supplies have a common objective—to reduce expense. The most evident way to achieve this goal is by centralizing the point of purchase, thus enabling health care organizations to leverage increased volume and negotiate better pricing.

Of course, there are other elements beyond price. One is the cost of issuing a purchase order. According to Health Care Purchasing News, Broward Health in Fort Lauderdale, Florida, was able to cut in half its total number of purchase orders from 32,000 to 16,000 annually, which resulted in a savings of $390,000 per month, or $2,400,000 annually.

Another element of potential cost reduction is product standardization. When an organization standardizes the number of items carried in inventory, overall inventory exposure is reduced. Health care systems thus would have more cash available to focus on patient care and operations versus inventory on the shelves. Furthermore, minimizing inventory has the additional benefits of reducing up-front costs, decreased incidence of item obsolescence, and freeing up space used for storage and warehousing.

Moving the materials management to a central or self-distribution model also offers the opportunity to move traditional non-stock items to the central distribution operation. This frees up clinicians who perform supply chain activities, such as inventory and ordering, to focus on patient care. It also enables supply chain management personnel to focus on their core specialties with the aim to reduce expenses, effectively manage stock, and consolidate items.

Lastly, when seeking to minimize expenses, freight and logistics costs also must be considered. Many leading-edge supply chain management organizations are turning their attention to inbound freight, which can produce significant savings.

A healthier future
As hospitals and health care providers become more squeezed on revenue generation—and Medicare and Medicaid reduce payments in the next few years—professionals in this industry must look beyond traditional methods and, instead, consider the supply chain as a key means to improving the bottom line.

Effective supply chain management fulfills customer requirements by matching demand with supply and accomplishes this with little-to-no inventory. By linking the major business functions and managing costs across the entire supply chain, an organization can begin to maximize value-added activities and reduce and eliminate waste. This can be accomplished through inventory reductions and increases in turns, alongside suppliers working to reduce costs for all parties and managing various aspects of the business, including logistics and distribution.

According to “Reducing Health Care Costs through Supply Chain Management” from Knowledge magazine, supplies are the second-greatest expense for hospitals after labor. This is justification enough for hospital and health care professionals to focus on managing the supply chain and engaging supply chain experts. These people may or may not come from the health care field, but they should be ready to push the envelope and think creatively.

This type of operation requires a centralized item master that gives locations access and eliminates duplicate items at different costs. An enterprise resources planning system that enables multiple organizations to share a common database is important. As is so often the case, commitment from the top down is essential—without it, there is no opportunity for success.

The organization also must employ successful change management practices. This type of change inevitably leads to fear of reduced control or changing responsibilities. There also needs to be significant purchasing volume to warrant the cost of establishing a central or self-distributing operation, even if it is run by an outside or 3PL firm.

Another essential element is a central purchasing organization to coordinate the requirements of the various locations and to maintain the standardization and inventory reduction efforts.

Finally, dedicated supply chain management staff and managers are essential. An operation of this magnitude is not something that a stockroom supervisor should oversee. The emerging technologies and the discipline required to continually look for ways to remove waste require people who have the experience and education to move the organization forward.

John M. Donnelly, CPIM, C.P.M., has more than 25 years experience in supply chain, materials, and operations management, having served as director of materials, operations manager, materials manager, manufacturing systems manager, director of procurement services, and more. He is the president of the Dayton APICS chapter. Donnelley may be contacted at jdonnelley1@woh.rr.com.

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