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Healthcare Consolidation And Purchasing Management


S. Randolph Hayas
S. Randolph Hayas, President, University Hospitals Network Services Company, Cleveland, OH, 44106, 216/844-6830.
Randall W. Luecke, CPA, CMA
Randall W. Luecke, CPA, CMA, Principal Healthcare Specialists, Inc., Cleveland, OH, 44140 216/892-3923.

80th Annual International Conference Proceedings - 1995 - Anaheim, California

The healthcare industry is going through tremendous upheaval. Medical inflation rates are down, but, the United States continues to spend a greater percentage of gross national product on healthcare than any other industrial nation in the world. In many respects we have the finest medical system in the world ("the best money can buy") and yet as a nation, rank surprisingly low in some very basic indicators of health (e.g. infant mortality).

Meanwhile, hospitals are consolidating, affiliating, merging or closing. In an attempt to restore an acceptable level of profitability, hospitals are streamlining their management staffs, reengineering care delivery to include fewer personnel, outsourcing more and more "hotel-type" functions (e.g., dietary, housekeeping and laundry) and striving to amass greater purchasing power through the consolidation of purchased material with fewer and fewer vendors.

The physician component of the healthcare delivery system is also going through radical change. Physicians engaged in solo practice are diminishing and group practices are getting larger and more diversified. New physicians coming out of medical school are seeking more job security, reduced administrative burdens and an improved quality of life. Schools of medicine continue to produce too may specialists, and too few generalists and primary care physicians.

Other factors are dramatically impacting the healthcare system. In Cleveland, the Greater Cleveland Health Quality Choice program is making a strong effort to gauge hospital quality through an elaborate and complex set of performance measurement criteria. The State of Oregon is experimenting with healthcare rationing. In some locales, business coalitions have congealed to force cost containment. Some corporations are engaging in direct contracting with hospitals. Managed care enrollment continues to increase at a significant rate. Health reform, as proposed by President Clinton, has been rejected by Congress and the American people, yet some reform is inevitable.

In order to diversity their revenue stream and operate on a more cost effective basis, many hospitals are developing a comprehensive array of services which expands the continuum of care that the hospital is capable of providing. Rather than simply providing their historical "bread and butter" (i.e. inpatient hospitalization) hospitals are attempting to expand their service offerings to include expanded outpatient services, skilled nursing facilities, home care and wellness. The motivation for hospitals branching into these areas is multiple: (1) They allow the hospital to move the patient more quickly from a relatively expensive care setting to a less expensive care setting; (2) they allow hospital utilization personnel to better manage the care of the patient from illness through diagnosis through treatment through recovery to wellness; (3) they allow the hospital to prevent patients from "escaping" the network of care of the hospital to that of a competitor; (4) they allow the hospital to provide more services with relatively greater financial return, thus, offsetting the losses sustained in providing obligatory services with lesser margins; (5) they allow the hospital to continue employment of personnel as they shift from providing inpatient services to providing other services; and (6) they better leverage hospital management.

The challenge that lies before hospitals as they strive to build this continuum of care is to achieve a seamless delivery system where the patient moves freely and conveniently from one treatment modality to the next without duplication of registration processes, duplication of diagnostic testing and multiple invoices for service.

In addition to the consolidation that is taking place in the healthcare provider arena, there is also consolidation taking place in the supply and service delivery industry. Makers and distributors of medical supplies, pharmaceuticals and equipment are merging to achieve economies of scale and greater market penetration. Some corporate conglomerates that had "dabbled" in healthcare are now shedding their periphery business to allow them to focus faced with an ever changing cast of players in the acquisition of these materials.

Throughout the country, hospitals are consolidating to accomplish a number of objectives: (1) establish strategic alliances that provide geographic balance and a complete array of clinical services; (2) operate more efficiently by leveraging management staffs; (3) achieve an enhanced bargaining position with managed care companies; and (4) retain as much control of their destiny as possible. We will examine the changing hospital scene in three specific localities: Cleveland, Ohio; Minneapolis, Minnesota; and St. Louis, Missouri. The changes taking place in these three cities are believed to be representative of what will continue to take place throughout the country, namely a consolidation of formerly independent hospitals into multihospital healthcare delivery systems.

In addition to the aforementioned efforts toward vertical and horizontal integration, hospitals are also attempting to integrate the healthcare financing mechanisms by buying or developing insurance companies or products. Likewise, some insurance companies are seeking integration by buying hospitals. We will examine the preliminary results of such efforts.

As much change as we have seen in the healthcare industry over the past five years, we will probably see that much and more so in the next five years. Hospitals will continue to merge and consolidate; many will close as fewer and fewer hospital beds are needed. Physicians in greater numbers will seek to be employees of health systems, rather, than individual entrepreneurs. The federal government, along with state government, will seek to cap rising expenditures. Corporate businesses will seek greater levels of employee payments toward their healthcare coverage, thus, further incenting prudent and responsible purchasing habits.

If we are fortunate, the federal government will reform healthcare, removing the cross incentives that pit hospitals and physicians against each other, increasing access to care and insuring the presently uninsured. If we are unfortunate, the federal government in reforming healthcare will create the clinical equivalent of the post office but, without the efficiency!

Again, if we are fortunate, the American society will face up to, and address, some very fundamental issues that drive our healthcare delivery system. Issues like "how much should be spent on preventative care, and who should pay for it?", "how much should be spent on prolonging life, and who should decide when life is worth prolonging?", and "how should we decide as a society who among us is deserving of the investment of scarce resources?" If we can deal with some of these fundamental questions, we can then strive to put in place a healthcare delivery system that exceeds our expectations, priortizes the investment of our resources, and leads us to world leading levels of health status.

Rapid changes in healthcare delivery has required purchasing management to significantly modify the way purchased services are provided. The merger, consolidation and affiliation of healthcare facilities is effecting the purchasing managers as well as the suppliers to the facilities. The intent of the consolidations is to assure the financial viability of the healthcare providers and to reduce operating costs.

Additionally, healthcare is no longer delivered solely on an impatient basis. Healthcare is being delivered increasingly on an outpatient basis and disseminated to satellite clinics to better serve patients, increase revenue and decrease expenses. The satellite clinics and acceleration of physician primary care offices as integral components of the overall healthcare delivery strategy continues to complicate the purchasing manager's role.

A Foster-Higgins study indicated that in 1993, employers with more than 500 workers spent approximately 11.1% of the employer's payroll expense for health insurance. In addition, the per employee cost of traditional indemnity health insurance was 15% higher than the cost of health maintenance organization (H.M.O.) costs. Employers are demanding reductions in their healthcare costs and incentivizing employees to use more restrictive and less costly forms of healthcare insurance.

These factors and others are stimulating the consolidations to remain financially viable and to reduce costs. The need to reduce costs is requiring purchasing management to respond in new and different ways and often with less staff than previously. Purchasing managers have traditionally focused on cost per unit while matching appropriate purchase quantities with appropriate inventory levels. Purchasing managers must maintain that basic focus and expand the focus to a cost per procedure basis to control not only the purchase price, but, also the total cost of use.

Purchasing managers are experimenting with capitated contracting whereby the supplier participates in a risk-sharing contract to more closely match costs with the managed care revenue patterns. A Deloitte & Touche survey found that 18% of 1,191 hospitals respondents already have risk-sharing contracts in place and nearly two-thirds said they expect to have such contracts in place within the next five years. In fact, it is expected that by 1997, 40% to 60% of all healthcare will be delivered through some kind of capitated agreement between payers and providers, thus, precipitating the purchasing managers' shift to capitated supply contracts.

Again to maintain financial viability healthcare providers are moving their services to physician offices and off-site clinics and providing home care and long term care services as patients spend less time in the hospitals. The alternate care sites present a new complexity to purchasing management. The products are often different, in different quantities and with different sources of supply. The suppliers are often slow to respond to the changes in healthcare delivery. While most manufacturers have served the hospital and the alternate care markets, traditionally the profit margins are considerably higher in the stand alone alternate care business. The distributor business has developed into two distinct segments, those that serve hospitals well, and those that serve alternate care facilities well.

Purchasing managers must also educate the manufacturers and distributors about the direction of healthcare delivery and specifically the entity's strategy. Most purchasing managers are attempting to utilize the hospital's present supplier arrangement to service the alternate care business. The overall effectiveness of that strategy is mixed.

While Group Purchasing Organizations (G.P.O.) have flourished over the last twenty years, their future existence is in jeopardy. Under the prior cost reimbursement payment schemes, a "one-for-all" philosophy existed. However, fierce competition is threatening local and regional G.P.O.s and the weaker national G.P.O.s. National alliances of similar members are developing strong commitment and compliance requirements to strengthen the remaining membership and separate them from other G.P.O.s. The G.P.O.s are also forced to respond to changes in healthcare delivery and provide services to differentiate their members from the members' competition.

In conclusion, the delivery of healthcare will continually evolve as employers and others seek to lower the cost of healthcare. Purchasing management will be expected to have intimate knowledge of the entity's strategic plan and effectively interpret the strategy into a supporting purchasing strategy.

Thill, Mark D., "New Strategies Change Old Ways." Hospital Purchasing News, November 15, 1994, Vol. 18, No. 11, 1, 48.

Foster-Higgins, "Health Plan Costs Show Wide Variations." Hospitals and Health Networks, November 5, 1994, Vol. 68, No. 21, 60.

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