Author Janice Davis, Senior Consultant with Novia Strategies, discusses the benefits of two options to reduce supply chain costs, self-distribution and fee management, in her new blog.
As the healthcare industry transitions from volume to value-based care, controlling supply chain costs becomes increasingly important. Supply chain executives must continually seek to reduce cost while operating efficiently in this increasingly demanding environment.
For many organizations, this leads to the question of whether self-distribution would be a viable alternative to a vendor-provided distribution system. Commonly, supply chain experts refer to this as “make versus buy” for the distribution channel. In other words, should the hospital continue to “buy” the distribution service from a vendor or should they “make” their own supply chain distribution channel? The answer very much depends on which supply chain distribution system will best support the hospital’s core patient care business.
The case for self-distribution
In a self-distribution model, the organization assumes the responsibility to obtain supplies and clinical products from the manufacturers and deliver them in correct quantities to the point of consumption (POC). These responsibilities include procurement, warehouse management, inventory control, order completion, transportation, and any other functions that are associated with a distributor. Supply chain leaders must design a self-distribution model robust enough to handle all the services and issues currently handled by the distributor, such as stock outs, back orders, satisfactory fill rates, and customer satisfaction.
However, designing and implementing a self-distribution option is expensive and carries financial and operational risks. All decisions impact the overall actual product expense and the organization must carefully evaluate each decision point to ensure the model meets the overall organizational objective. This requires detailed analysis to evaluate the feasibility of establishing a self-distribution network and determine the characteristics of the network that will meet the strategic goals of both the hospital and supply chain.
To begin the process, the supply chain leader should identify motivational forces driving the suggestion, examine potential supply chain approaches, and assess whether self-distribution would successfully address those issues while supporting the hospital goals and direction. Some situations make self-distribution more feasible. In our experience working with hospitals, healthcare systems and IDNs across the country, we find these situations often make the case for self-distribution:
- If the organization owns a warehouse, it might make financial sense to use that warehouse as a part of a self-distribution model.
- IDNs comprising many hospitals with different item files and supply chain processes might adopt self-distribution to standardize products and exert more control over the supply chain.
- Dissatisfaction with the current operations of a distributor supply chain might encourage the organization to explore the opportunity to “make versus buy”.
The supply chain leader also needs to assess whether key success factors are in place, or whether they need to be developed. In our experience of guiding clients through this process, we recommend various key success factors, including:
- Executive sponsors: Strong executive sponsors provide leadership and facilitate the decision-making throughout the evaluation, design and decision process
- Operational knowledge: In-depth supply chain knowledge facilitates the creation of a product management system that minimizes product touchpoints and inventory locations while maximizing efficiency and customer service
- Robust information systems: A self-distribution system relies upon comprehensive information systems and materials management software support that can electronically manage the information and establish records of transactions and payments, maximize use of Electronic Data Interface, and establish records of transactions and payments
The alternative: Reducing supply costs through fee management
Methodically implementing thoughtful strategies will significantly reduce product expense, effectively reducing the fees associated with product purchases from the usual 7% to 13% overall rate to less than 3%, as illustrated below.
In our experience, this strategy often provides the same or even more savings than building a self-distribution model – with much less risk involved. When implemented in a thoughtful manner, this approach will standardize products and reduce the overall costs. Managing these fees and creating a “blended” fee approach may be the key to reducing expense and improving your bottom line without embarking upon a self-distribution journey.
Supply chain leaders can reduce product fees by meticulously examining product contracts and the fees allocated to individual products within the contract, then increasing products in the product groups with lower fees. For distributed medical-surgical products, for instance, this is accomplished by moving from national-branded items with a fee structure of 3% to distributor-branded items at a zero-based fee structure with increased rebates. When there is no corresponding distributor-branded product, hospitals can renegotiate distribution terms for national branded items. This reduces fees to 1% or less. For distributed non-contracted products, contracts can be secured reducing the distribution fees or the products can be ordered direct from the manufacturer. This reduces fees from between 8% to 12% down to 5% or less.
In addition, some medical-surgical products are eligible to move through the pharmaceutical distributor, where the fee structure is a “cost minus,” thus eliminating any distribution fees and reducing the product acquisition cost. Vendor negotiation to reduce product costs also benefits other product groups, such as Environmental Services and Food; optimizing Group Purchasing Organization agreements will further add to organization-wide savings.
Through partnering with vendors, distributors and customers, supply chain leaders can optimize the blend of distributed products, use distributor-branded products where clinically acceptable, maximize the Group Purchasing Organization contracts, and minimize non-contract products. The result: incremental fee reductions that lower overall supply costs while maintaining quality care.
By Janice Davis, Senior Consultant, Novia Strategies