Why Healthcare Needs to Think About Spend Management Solutions

July 17, 2010 mpotepa

Healthcare providers are facing continued lower operating margins, increased risks and potentially once-in-a-lifetime health care reform. With this backdrop, there is an increasing focus on Supply Chain Management as a means to minimize risk, optimize operating costs, improve revenue, improve operating margin and hence enable the hospital to better serve the patient. Executives are now recognizing that health providers have relatively immature supply chains, and that development of strategic management of supply chains is generally in a nascent level[1]. Healthcare organizations typically proceed through an evolution of basic processes in supply management. [i][2] Initially, many providers are not focused on managing the supply chain, but rely on an external Group Purchasing Organization to negotiate all of their contracts, and focus on driving compliance in the physician community. Organizations seeking to drive change must first begin by establishing a charter to do so with their executive team, and make a commitment to moving away from a transaction-price-based focus. Another critical element at this stage of development is the ability to isolate measure where and how third party spending is occurring in healthcare systems, through improved spend management.

Why is it important to capture spending transaction-level data associated with third party purchasing processes? Because from time to time the healthcare supply chain system must identify opportunities for savings through a process known as a spend analysis. A spend analysis becomes a critical input into building category strategies, but spend management involves the on-going maintenance, update, and refinement of the spend data to make it useful for decisioin-making. Category strategy development is a process applied to general families of purchased products or services that seeks to optimize spending while meeting or exceeding stakeholder requirements. (Stakeholders may include physicians, clinical and non-clinical staff and administrators, facilities management, etc.).

A spend analysis was often viewed as a one-time annual event to derive budgeting estimates, and develop insights into annual contract negotiations. Today, spend analysis is evolving into spend management, which is a much more dynamic and on-going assessment and tracking of spending patterns, matched to other cost drivers and activities. Spend analysis does not need to occur only on an annual basis, but can be applied also to reviews of a category or subcategory of spend that occurs when a contract is being negotiated, or when a strategic sourcing project is initiated for a particular category group. Spend analysis is also a critical component of effective budget planning, and setting key performance indicators for sourcing teams to consider in their assigned duties. An on-going spend management capability provides answers to the following questions:

What did the provider spend its money on over the past year? This value is an important component in calculating the cost of goods sold in the financial statement. Purchased goods and materials are often more than 40% of the total cost of goods sold in healthcare. Many systems fail to include indirect and nonclinical spending in their analysis, which is missing an important piece of the pie?
Did the healthcare system receive the contracted level of products and services based on payments made to third parties? Although many providers outsource their purchasing to GPO’s, there is nevertheless a need to audit and verify that services and products delivered met not only contracted pricing, but also service level agreements, statements of work, and appropriate levels of support services. A thorough spend analysis will often reveal areas where products and services are being paid for, but the goods or services are not even being received or being used by the system.
What suppliers received the majority of the business, and did they charge an accurate price across all the units in comparison to the requirements in the POs, contracts, and statements of work? (This is an important component to ensure contract compliance.)
Which divisions of the business spent their money on products and services that were correctly budgeted for? (This is an important component for planning annual budgets for spending in the coming year.)
Are there opportunities to combine volumes of spending from different parts of the healthcare system, and standardize product requirements, reduce the number of suppliers providing these products, or exploit market conditions to receive better pricing? (This is an important input into strategic sourcing).

Moreover, spend management provides insights and clarity into these questions and yields an important planning document for senior executives in healthcare operations, supply management, and finance. Despite the importance of this capability, many healthcare systems struggle to develop a comprehensive and accurate spend analysis report. This is because purchasing was for many years a paper-based system, and figures were not entered correctly into accounting systems. Even with the evolution of sophisticated enterprise systems such as SAP and Oracle, purchasing transactions are often entered incorrectly, which elicits the old phrase “garbage in, garbage out.” Another problem is that many enterprises have grown through mergers and acquisitions. When a new division is acquired, they may be using a different system from the acquiring system, and so the data is not easily translatable. For this reason, many healthcare systems are undergoing major initiatives to streamline procurement through electronic procurement systems that will revamp the purchase to pay process and automate different portions to capture transactions more effectively. Indeed, research suggests that “best in class” firms are more likely to have a higher proportion of their spend under management, which has led to important improvements such as cost reductions, reduction of noncompliant purchases, supply base reduction, and electronically enabled suppliers

In the blogs that follow, we’ll explore the current state of spend management in healthcare in more detail…

[1] Schneller E, Smeltzer LR. Strategic Management of the Health Care Supply Chain. San Francisco, CA: John Wiley,;2006.

[i] Handfield, RB; Supply Market Intelligence. Boca Raton, FL: Auerbach; 2008.