The (Foibles of the) Health Care Value Chain

Edition: June 2002 - Vol 10 Number 06
Article#: 1262
Author: Repertoire

Hold on, everybody. This might be our 15 minutes of fame.

A new book, The Health Care Value Chain (copyright © 2002 by John Wiley & Sons), places all the players in the supply chain – providers, distributors, manufacturers, GPOs and e-commerce companies (who perhaps get a little more play than they deserve) – front and center, for the whole country to read about. The question is, will anyone except us take notice? And if they do, what will they think of us?

The author is Lawton R. Burns, professor of health care systems in the Wharton School at the University of Pennsylvania. He spoke about his book at the recent HIDA Executive Conference, and is scheduled to speak to other supply chain groups, including the materials management association, later this year.

No newcomer to healthcare, Burns has worked for years on the organizational end of the business. A one-time hospital executive, he has studied physician-organization integration for 15 years. He's an expert on the formation of IDNs, physician practice management companies, investor-owned networks and group practices.

But until just a couple of years ago, he knew as little about the supply chain as most healthcare executives. He wrote his book at the request of some of those executives eager (or maybe desperate) to explore whether linking up with distributors, manufacturers and GPOs might help them control healthcare costs any better than their earlier attempts to link up with physicians and managed care companies. (See interview pg.18.)

Those executives who take the time to read the 444-page book will find that their upstream supply chain partners are as baffling and contrary as physicians and managed care companies. In fact, Burns' book shows why the healthcare value chain doesn't deliver a lot of value – or, to put it in a more positive light, how it could deliver a whole lot more value than it currently does.

The good news for Repertoire readers is that distributors come off looking pretty good in this book. They appear to have providers' best interests at heart, and have taken some constructive steps toward helping providers improve how they take care of sick people.

The True Value Chain
What would a true value chain look like? In the beginning of the book, Burns points to ''extended enterprises'' in other industries, such as the auto industry, which span manufacturers and suppliers. For such enterprises to exist, he says, there must be three things at work:
• dedicated asset investments in one's supply chain partners;
• effective management of knowledge and knowledge flows among trading partners, and sharing of information rather than secrecy; and
• trust.

Burns puts it mildly when he writes, ''In the health care industry, this view represents more aspiration than reality.'' Credit the author with being a quick learner. He continues:

''Within healthcare, information on the value or cost added at each link is severely lacking. Indeed, the current state of knowledge on product value/cost among producers may be so low that meaningful knowledge sharing is impossible. Moreover, there is some consensus that multiple links may perform duplicative functions or wasteful, non-value adding functions due to this lack of information or reluctance to share information.''

And all this by page 12!

Burns' book is like Alexis de Tocqueville's 1831 book, Democracy in America, a candid, unsparing look at early America by an outsider, in this case, a French citizen. Tocqueville, like Burns, holds up a mirror to all of us. And after gazing at the image we see in it, we all have to admit, ''Surely, we can look better than this!''

With so much at stake – namely, the health and lives of thousands of people – why oh why can't we look more like other industries? Says Burns:

''…[I]ndustry observers suggest that healthcare supply chain characteristics and practices resemble those of industry from the 1960s and 1970s rather than 1990s and 2000s. In healthcare, the business focus is unit cost, whereas in industry it has shifted to total supply chain cost. In healthcare, the supply chain is managed through budgets; in industry it is managed through measurable process and quality improvements. In healthcare, the supply chain is viewed as a cost center, whereas in industry it is viewed as an opportunity for innovation. In healthcare, the organizational structure is oriented around independent, functional department silos, whereas in industry it is oriented around an extended enterprise with trading partners; that is, both upstream (supplier) and downstream (customer) integration. In healthcare, the information system strategy is lacking or departmentally focused, whereas in industry it is oriented toward both internal and external visibility with one's value chain partners. Finally, in healthcare, planning capability is reactive and historical, whereas in industry it is synchronized with end-user demand.''

Anyone looking to Burns to either justify their own actions or to condemn those of others (two favorite pastimes in this supply chain of ours) will be disappointed. Instead, they'll find a fairly dispassionate look at the motivations, shortcomings and strengths of each of the players, and how those motivations, etc., bring them in conflict with the others.

For example, Burns states the obvious when he points out that IDNs ''pose an important competitive threat…and source of uncertainty for GPOs.'' With more than 450 hospital systems and networks out there, with an average size of ten total members and eight hospitals, he's got a point. ''[M]ost of these systems and networks are local or regional in scope, which presents an interesting buying opportunity,'' he says. But the jury is still out on how many IDNs are really serious about taking advantage of that opportunity – or even whether they should at all.

If it's obvious that GPOs and IDNs are in potential conflict with each other, it's just as true that GPOs and their hospital members don't always see eye-to-eye. ''On the one hand, [GPOs] seek to provide a wide array of services to hospitals; on the other hand, they often perceive that hospitals fail to take advantage of these services, and sometimes resist GPO change efforts,'' writes Burns.

GPOs believe materials managers lack the vision or insight to grasp the true value of supply chain economics, says Burns. (Of course, one wonders if materials managers think the same of their GPOs.) What's more, Burns points out that some GPOs believe that materials managers lack the will or know-how to work with their clinicians on supply utilization and standardization. With perceptions such as these, it's no wonder that GPOs have a devil of a time securing their own members' loyalty.

Yes, Burns touches on the ongoing controversy – fueled most recently by a series of New York Times articles – in which GPOs are accused of squeezing out small, innovative companies. Rather than take sides, Burns suggests that the issue isn't as black and white as both sides believe:

''There may be some benefits to this contracting situation, however. As past incumbents and smaller vendors get excluded from the large contracts, they reportedly rush to the other GPOs and to IDNs ready to execute better contracts. Moreover, small vendors may be able and willing to service regional, second-tier GPOs and thereby serve as a source for change in GPO contracting.''

Burns sees distributors as potential champions in the supply chain. Recognizing ''the precarious nature of their middleman role,'' distributors have sought to become more important to their downstream and upstream partners, he says:

''Looking upstream toward manufac-turers, distributors have tried to develop large scale and field forces to provide 'product push.' They have also sought to broaden their channels to reach additional customers (for example, ability to reach new markets and alternate sites) and provide an information window to manufacturers on their customers. Looking downstream, distributors have used consolidation and automation of warehouses to pursue operating efficiencies, which are then passed on to customers. They have also sought to streamline and automate the ordering process by their customers, provide software support for their customers' materials management functions, reduce customer inventory management expenses, and reduce the cost per delivered item – all of which enable the healthcare system to cut supply costs, improve internal efficiencies, and better deal with managed care pressures. In this manner, distributors have shifted from sellers of products to hospitals to managers of the hospitals' assets.''

Don't these attributes belie any talk about distributors' ''precarious middleman role''? Indeed, others in the chain appear ready to acknowledge the distributors' valuable role in it. For example, manufacturers of med/surg products told Burns that distributors add value by moving inventory closer to the customer and focusing on the total supply chain picture. One told the author, ''Our distributors break large shipments into smaller quantities, assemble orders, manage all of the individual transactions with specific customers, and implement what we have negotiated with the GPOs.''

Yes, that is what distributors do. And it's worth a lot. Still, distributors are not immune to the conflicts that ravage the healthcare supply chain:
• Manufacturers are suspicious of the value-added programs that distributors offer their customers. ''They deliver value to customers but want to deliver more value and move up the food chain and gain more control over what goes into the end-user customer,'' says one med/surg manufacturer about distributors. ''This is not in our interest. We just want them to distribute.''
• Third-party logistics companies and dot-coms pose something of a threat to distributors. But the threat might be more in the area of process improvements (such as providing electronic catalogs and automating the procurement, invoicing and accounts payable processes) than product logistics, says Burns.
• Not all IDNs love distributors, despite the services they provide them, such as electronic linkages, the provision of information for standardization programs, and even some clinical expertise/consulting. Distributors themselves may have brought on some of this skepticism by insisting on folding the cost of their services into the price of products, says Burns. An activity-based approach might eliminate some of the skepticism.
Burns concedes that some IDNs have cut out their primary distributor and have chosen to deal directly with manufacturers. But he adds that the case for self-distribution is anything but clear-cut, considering the capital costs involved and the difficulty of accumulating product utilization data after products reach the floors.

Burns' book has much to teach newcomers to the supply chain – as well as providers, distributors and GPOs – about manufacturers' strategies and concerns. For example, just as the other players in the chain, manufacturers must contend with the fact that what's good for them isn't necessarily good for everyone else, and vice versa. For example, although consignment and case-by-case ordering of implants and instrumentation have reduced hospitals' inventory levels, they have substantially increased those of manufacturers. Not exactly a win/win deal.

Like the other players in the chain, manufacturers complain that even though they'd like to improve total chain efficiencies, they can't, because of the short-sightedness of their downstream partners. For example, they argue that ''the notion of total cost, as opposed to product price, has not been widely embraced,'' writes Burns.

But some of the resistance to change comes from within their very ranks. Amid all their concerns with product innovation, managing diverse portfolios of products and preserving their margins in the face of pressure from providers and GPOs, manufacturers can lose sight of the potential significance of efficient supply chain practices, says Burns.

''For manufacturers, supply chain costs may represent only a minor percentage of their net sales (for example, less than 10 percent), and thus command much less attention than product innovation and R&D issues. Given the high margins they earn on high-technology products, there is understandably little interest in pursuing supply chain efficiencies that might narrow such margins. Moreover, technological investments are viewed as better strategic bets than 'customer facing' efforts. Other, more important, issues concern growth in global sales and overcoming foreign trade barriers that hinder the export of their products.''

What's scary is that if the people who make healthcare products aren't concerned about supply chain efficiencies, why should anyone else be?

Burns does take time out to recognize a few manufacturers, who have jumped into the fray with both feet. Several, including Johnson & Johnson and Becton Dickinson, offer supply chain consulting to their customers. Others have reduced or ''rationalized SKUs,''while others have experimented with risk-based contracting.

That the author spends over a quarter of his book on e-commerce speaks more to the time period in which he wrote it than to the impact of e-commerce on the supply chain – at least as of today. Burns offers a good history of events, much of which has already slipped our minds. Not surprisingly, he dwells for a time on the relationship between GPOs and the dot-coms. ''The e-commerce start-ups face strong competition from incumbent GPOs,'' he says. ''At the same time, there is the potential for strategic alliances to form between them.''

Already, at the time of the writing, Burns was able to conclude that stand-alone business-to-business exchanges had relatively little chance of attaining success. Without the potential volume that a big GPO – say, Novation, Premier or Tenet – could generate, a had little chance of survival. That much has been borne out. (Still, the author does correctly identify the Global Healthcare Exchange – a creation of some of the big manufacturers – as a viable concern.)

Burns believes that marriages make sense for some other reasons as well. They offer, among other things:
• Consistent, accurate, dynamic pricing across a system.
• Automated GPO contract administration.
• Verification of contract adherence by GPO members.
• Information about on-contract vs. off-contract supplies.
• Aggregated information on product usage by members.
• Potential information for product standardization.

Of course, the failure or success of any e-commerce exchange depends on one thing: Will providers use it? On that score, Burns isn't optimistic. ''Hospitals and IDNs represent the final customer in the institutional portion of the supply chain. However, as the fourth tire on the automobile, their performance on several dimensions seems to be flat.''

The fact is, hospitals and IDNs are often the weakest link in the supply chain. Burns correctly points to their deficiencies in ''logistics, procurement, utilization, pricing, and support for the materials management role.''

For instance, take the buying process. ''[R]ecent evidence suggests that the number of personnel in the materials management department engaged in procurement-related activities is rivaled by the number of people in other departments (for example, nursing, radiology) performing the same functions.''

Orders are often entered manually and thus, are subject to error. Department heads buy off contract. Physicians snatch things off the supply shelves. Unofficial inventory – that is, inventory beyond the control of materials management – sits in shelves, cabinets and cubbyholes all over the hospital. Recording, let alone forecasting and managing supply utilization, is quite a feat.

Part of the problem is the lowly status of materials managers. Situated in offices near the loading dock, these brave souls are often invisible to the people they're trying to influence – the users of products. Many climbed up through the ranks, and lack proper training. At the same time, they're getting pounded by their bosses to cut costs. Says Burns:

''This [attention to costs] may command their attention and divert it away from more long-term, strategic actions such as e-commerce and other process improvements. They may not be rewarded for saving unknown process costs in the future. They may not even believe that process costs are the relevant issue, and instead focus on short-term savings on a particular supply item in this year's contract…''

Whether it is for these reasons or other ones (e.g., the unproven nature of dot.coms' savings and efficiencies) hospitals and IDNs have been slow to adapt to e-commerce.

What Next?
As all the players in the supply chain strive to move ahead, they seem to get mired in the same conflicts that have slowed them down before. The ''dueling dot.coms'' is just one example. Burns doesn't see a happy ending to the story. Too little information-sharing, too little trust, too little knowledge management. Incentives among the players are misaligned, and there is no consensus among them about the value of having a more efficient supply chain. (GPOs and distributors have spent far more time than providers or manufacturers documenting their contribution to the chain and the need for greater efficiencies in procurement processes, notes Burns.)

If ''supply chain management'' becomes a fad among healthcare executives, it will likely fail, just like physician-hospital alliances, says the author.

In fact, he says, fundamental improvements won't occur until providers can provide point-of-use product information, and until the industry adopts a common product-numbering system. ''This will permit value chain players located upstream to analyze and forecast demand for their services and initiate cost efficiencies across the entire length of the chain. Providers will also be able to tie their burgeoning outcomes data to specific products utilized…in a manner that facilitates better product comparisons and cost-effectiveness analyses.''

If The Health Care Value Chain helps hospital and IDN executives realize the potential savings from better supply chain management, great. But even if only a few people in that target audience reads it, the book can help those of us in the supply chain increase their knowledge of their upstream and downstream partners, and measure the impact of their actions upon them.