Chapter Sixteen

1. Chapter Sixteen Health Care Purchasing and Supply Management

2. Learning Objectives • To learn how purchasing in the health care field is carried out. • To learn about the various supply management methods in the health care field. • To explain how inventory control is accomplished in the health care field. • To identify the current trends in health care purchasing. • To illustrate the capital equipment acquisition process. • To show how various health care plans are evaluated.

3. The Healthcare Industry • The health care industry is expected to grow and consume even a greater share of GNP in the next few years. • At the same time, many health care organizations will be driven from the market because of uncontrollable non salary costs and declining profits. • This radical shift is the result of increased price competition and the regulatory environment. • This is good news for health care providers who have planned for the forthcoming changes

4. Hospitals • Hospitals are complex organizations providing a multitude of services to patients, physicians, and staff. • These services include dietary, linen, housekeeping, physical plant engineering, pharmacy, laboratory, inpatient treatment (nursing units), surgery, radiology, administration, and others.

5. Hospital Supply Chain Management Systems • Each area has specific and often unique materials and supply needs, creating a requirement in these facilities for a supply management system that can provide the necessary supplies when needed. • In the current climate of increasing health care costs, systems inventory must be optimized without sacrificing the level of service provided. • The functions of inventory in the hospital setting, methods of inventory management utilized, factors that are unique to the health care setting, and current trends in hospital inventory management will be examined.

6. Purchasing, Supplies, and Services • As in any business concern, the functions of all departments must be consistent with the overall mission and purpose of the business. • In hospitals, the primary objective is to provide patient care; the supply management function is in place to support this objective. • Inventory control is an important component of supply management; there are many other functions that are also critical to a successful supply management system, and some of these functions will be addressed indirectly in this discussion.

7. Purchasing, Supplies, and Services • There are two primary functions of inventory in the hospital setting: “(1) Maximize supply service consistent with maximum efficiency and optimum inventory investment; and (2) [c]ushion between the forecasted and actual demand.” • The service levels required by the departments will vary depending on the degree of the cost of a stockout. • This phenomenon also will affect the optimal level of “inventory cushion” from a service perspective. • The criticality of an item may depend on the restocking lead time, the shelf life, or the special conditions under which the item must be held as well as the effect on hospital operations of a shortage of the item.

8. Purchasing, Supplies, and Services • Many of the items necessary in the operation of hospitals are independent-demand purchased items. • However, there are items that are produced in the hospital setting for which the supplies follow a dependent-demand pattern and the inventories supporting these functions are essentially raw materials used in production. • Departments that produce supplies include the print shop (forms, etc.), dietary production (food items), and the pharmacy (unit dosage packaging, IV mixtures, etc.).

9. Supporting the Surgical Schedule • Make-or-buy decisions here are key, and the corresponding inventory issues must be addressed. In addition, the demand for certain items may be derived in advance from the surgical schedule. • For example, a certain number of units of blood plasma of specific types may need to be held at the ready on certain days when open-heart or other complex surgeries are being performed.

10. Cost Containment and Service level Criteria • The hospital administrator’s measurement criterion is the highest level of customer satisfaction at the lowest cost, but this satisfaction must be achieved under severe cost constraints. • Operating cost in hospitals has become extremely important as the reimbursement system is no longer based solely on cost. • In the mid-1980s, a system of reimbursement based on specific diagnosis related groups (DRG) was instituted. Under the DRG system, the hospital is reimbursed a flat rate based on a patient’s diagnosis regardless of the associated costs.

11. Cost Containment • Today, cost containment is critical to an institution’s financial health. • Better supply management practices must be implemented in order to ensure appropriate service levels in the new cost containment environment.

12. Supply Management Survey • In 1993 a survey was mailed to 2,376 hospital CEOs. Approximately 523 useable questionnaires were returned. Forty questionnaires were received from Canadian hospitals. The balance of 483 was from the United States. • The same survey was mailed to an identical sample in 1987. Approximately 85 percent of the hospitals sampled reported that they had a supply management program. The results of the two samples are given in Figure 16.1.

13. Supply Management Survey • The primary objective of a supply management program is to ensure systems are adequate to keep departments supplied without stockouts. • However, it appears that training and education are also becoming a key priority for supply managers. • The reduction in inventory levels is becoming less important since the purchase price and adequate supply levels will implicitly resolve the inventory problem. All of the other priorities show very little change. • Another important finding is the reporting structure for the supply manager. Approximately one-third of the supply managers report to the chief financial officer and another one-third report to a vice president.

14. The Most Recent Hospital Findings • This study is the most comprehensive hospital CEO study to date. • However, based on an in-depth analysis of the New Albany Surgical Hospital (NASH) located in Columbus, Ohio, the results are shown to continue to be relevant. Some of the results also were confirmed by findings in a recent study by Li and Benton. • The most significant departure from the 1993 study is the inclusion of the physicians in the materials acquisition process. NASH is a doctor-owned specialty hospital. In most hospitals, there are supplies from a wide number of suppliers.

15. Two Examples • As an example, there are at least 25 kinds of different knee replacement kits, but NASH only uses five of them. The doctors were informed that five out of the 25 would be sourced and they would be involved in the selection process. Texas Health resources reports another supply management success story. • Texas Health Resources' annual supply volume reaches upwards of $275 million. Texas Health Resources is a 13 hospital health care system headquartered in the Dallas Fort Worth Metro area. The health care organization has established a corporate supply chain management department that is aggressively reduced annual inventory costs by approximately $30 million over the past 3 years.

16. The Health Resources System • The supply management system is driven by eliminating non-moving supplies and by implementing a stockless distribution service for most of the hospitals in the system; and changing the attitudes and behavior of the nursing staff and physicians.

17. Methods of Supply Management • Traditional inventory control methods used in manufacturing are not common in the hospital settings. • Modifications are necessary to fit the health care industry, but the fundamental theories are used. • Three of these approaches will be discussed individually in this section.

18. Fixed Order Quantity System • This system is referred to as a fixed order quantity (FOQ) system in which inventory is checked (theoretically) on a perpetual basis after each inventory transaction. • When the inventory is withdrawn to a point at which there is just sufficient material to cover the demand during the replenishment lead time, an order is initiated for a fixed quantity. • Economic order quantity (EOQ) calculations may be used in the determination of the optimum order size. However, the EOQ is usually based on inappropriate assumptions for the situation and can lead to erroneous decisions.

19. Fixed Order Quantity System • The assumptions of constant uniform demand and the instantaneous replenishment of stock at the zero level may not reflect clearly the inventory situation faced by most hospitals. • Modifications to the basic formula are necessary. Quantity discounts are not considered in the basic EOQ.

20. Fixed Order Interval • In the fixed order interval (FOI) method, users or buyers review quantities periodically at fixed intervals of time and an order is placed for a quantity sufficient to replenish the stock to a predetermined maximum level. • This level also is calculated to minimize the combined costs of holding and managing inventories. • The FOI method was developed primarily for use in mass production schedules in industry and has not been widely used in health care.

21. Fixed Order Interval System • However, there are several instances in which hospitals may be interested in this method: (1) when there is frequent ordering, calling for stringent control; (2) when it is convenient to order many items from one supplier; (3) when serving the needs of discrete or irregular usage; (4) when there large-volume orders that represent a large portion of the supplier’s capacity; and (5) when storeroom balances are calculated only periodically. • This will be a particularly important method for hospitals that move increasingly into assembly and “production” of their supplies. • Purchasing agents often encourage the use of FOI methods, since the review period often can be coordinated with a supplier representative’s visit to the hospital.

22. Stockless Inventory Systems • Just-in-time (JIT) inventory control is a common name for this concept, which has been used in industry since the 1950s when it was developed by Toyota. • Increasingly, hospitals are finding uses and methods for this concept in their own materials management systems. • The stockless inventory system is the process where a hospital’s prime suppliers manage product purchasing, storage, delivery, and inventory control of medical/surgical supplies used in the hospital. • Stockless inventory systems have the potential to reduce redundant activities in the system, the investment by the hospital in inventory, the storage space required, and the handling functions.

23. Stockless Inventory Systems • To ensure successful implementation, several criteria must be met, including the existence of a prime supplier contract and excellent communication and cooperation within the hospital departments, as well as between the hospital and its supplier. • Specialized departments such as the laboratory and radiology are particularly suited to a stockless inventory system, but implementation in the entire hospital is an idea that is gaining popularity.

24. Stockless Inventory Systems • When a supplier can manage stockless inventory systems for several hospitals, both the buyer and supplier can take advantage of the economies of scale in warehousing and in transportation inherent in such a situation. • The supplier may act as the buyer’s central warehouse, and less inventory will be needed to meet the same needs for several locations. • The reason for this phenomenon is that variances are pooled, with a lower variance in total than the sum of the variances over all locations.

25. The Best Method • It is true that there is no one system that is the best overall. • Certainly the size, purchasing power, and level of control that the supply management department has within the hospital are all factors that must be evaluated. • The degree to which the hospital is automated and to which computer systems are integrated is also a factor in the decision in terms of the complexity of the systems models and in the level of calculations required. • Clearly, cost/benefit analyses must be performed and systems developed that perform and provide the desired service level.

26. A Hybrid System and Group Purchasing • There is little doubt that the system that would be most useful may not be one of the pure systems discussed but a combination of all of them. • This is particularly true because of the complex and various needs of the different departments of the hospital. • Group purchasing is currently the most popular buying approach for hospitals. Recently, 40 Amerinet facilities agreed to a three-year, $40 million contract with Baxter International.

27. Selecting Prime Vendors There are five important factors to consider when looking for prime vendors: • The supplier must have acceptable production capacity. • The supplier must have a well-developed distribution system to achieve “on-time” deliveries. • Electronic data interchange systems must be employed.

28. Selecting Prime Vendors • The supplier must have a high-quality product. • The supplier must at least meet disadvantaged business enterprise (DBE) goals. This is a federal aid program for women and minority businesses. • By combining these factors, the buying group can select the supplier with the highest ranking.

29. Complicating Factors Unique to Health Care for Inventory Control Two factors that are used in the application of all methods of inventory management are problematic for the health care system: (1) inaccurate demand estimations or forecasts and (2) safety stock.

30. Demand Problems • With the availability of computers in all areas of health care today, forecasting demand using past data and statistical techniques is a far more realistic possibility than it was in the past. • Forecasts are never perfect, but they can assist the supply manager to better control inventory to the best economic advantage of the hospital. • Demand, however, is impacted by several unique factors in health care. For instance, the length of stay and patient mix (types of patients and diagnoses) patterns are fundamental to the assessment of the types of supplies required in any given time frame. • This is particularly influential to inventory use in a hospital of 400 beds or less.

31. Demand Problems • Overall changes in treatment practices also will have an effect. If short-term forecasts for materials could be tied to the demand forecasts of certain types of DRG for patients admitted, then better material forecasts might be possible. • Similarly, some hospitals now have critical path plans (CPPs) for patients, where a plan is made for each new admission to a unit. • These plans are outcome-driven, where certain outcomes are expected at certain points of time during the patient’s stay. • If these critical path plans could be linked by computer programs to supply management, forecasting for material needs would be more accurate.

32. Relationship Building • Communication between the practitioners and the supply management function are vital, and this is inevitably the area in which the system breaks down. • Several situations exist in the hospital that make communication a difficult task. • Practitioners historically give little thought to the evaluation of supply usage, or to the prediction of future needs.

33. Relationship Building • Careful planning and communication are paramount to success of such a plan. Extensive audits and interviews using feedback and constant monitoring are the fundamental elements if supply master planning should be implemented. • Again, communication is the key. By whatever innovative method, cooperation and communication must be improved so that higher throughput and lower cost will result.

34. Dependent Demand • In the case of dependent demand in which the hospital is producing an item, an explosion-type approach can be taken. • This approach resembles a classic material requirements plan, based upon a master production schedule. • These concepts can be applied to the production of supplies in the hospital setting, and the resulting materials and inventory demands can be derived.

35. Requirements Planning • The master production schedule is a counterpart to the master surgery schedule and short-term (three- to six-week) forecast for other expected patient care. • Material requirements can be derived from the surgery schedule and forecast, and “exploded” backwards to determine when to begin the production of certain supplies assembled or within the hospital.

36. Safety Stock Unique to health care is a classification of the stockout tolerances of a hospital, categorized by Reisman as urgency requirements. They are as follows: • Use-location urgency. No stockout is allowed at a use location. These are the most urgent items and must be available to the materials users at all times. • Facility-location urgency. No stockout is allowed at a facility. Interdepartmental transfers can be used to satisfy these local stockouts. However, the item must be available in the facility as a whole.

37. Safety Stock • Regional-location urgency. No stockout is allowed for the region. Interdepartmental and interfacility transfer can be used to satisfy the stockouts, but the item must be available in the region as a whole.

38. Stockouts and Service levels • No urgency. Items for which stockouts are allowed at all levels. • Service levels and the corresponding safety stock levels can be derived for many items using this categorization. • As discussed earlier, if demand from several locations can be pooled, the overall variance of demand is reduced so that safety stock required to provide the same level of customer service is lowered. • Thus, in each situation of lowered urgency, fewer total units of inventory are needed.

39. Stockouts and Service levels • Costs of stockouts are influenced by many factors in the health care arena. • These factors include the costs of extra materials, personnel inconvenience, personnel and transportation costs, costs of expedited or emergency orders, lost sales as well as a myriad of intangibles ranging from mild dissatisfaction of the practitioner staff, to the serious impact that a shortage might have on the treatment and health of a patient. • Stockouts can be prevented on a temporary basis with substitutable products. • The substitutability issue is one of great concern to the supply manager, and often a difficult one to reconcile with practitioners. A current listing of one- and two-way substitutability of products must be maintained and updated.

40. Current Trends • The health care industry is increasingly looking to proven business techniques to improve performance in many functional areas. • This desire to adapt more businesslike approaches is a direct result of the DRG system of reimbursement and increased competition. • As indicated throughout this discussion, the most significant trend in the area of supply management in hospital settings is simply the magnitude of the importance and resulting attention to efficiency and cost-effectiveness. • Two trends are emerging: inventory management and control by a primary source or supplier and use of automation technology.

41. Primary Supplier • Primary sources assume most of the functions of the supply management department, much the same as the stockless inventory method described earlier. • There are many advantages to this arrangement in that manpower costs for the hospital are reduced and redundancy of activities as well as stock is reduced. • Perhaps the critical element of the success of such an arrangement is the level of communication and coordination between hospital departments and the supplier. • An outside entity may facilitate and optimize these behavioral issues by being objective as well as being interested in the provision of a high level of service.

42. Automation Technology • There is no doubt that high technology is a main component of health care today. • However, the advanced technology associated with hospitals is in the areas of diagnosis and treatment of illness. • Using automation technology and sophisticated information systems in the operation of a hospital is becoming more common but is significantly behind the advances in industry. • Its time has come, as evidenced in several studies of the implementation of bar coding in pharmacy inventory management. • Results of this application have been reported to be increased efficiency, decreased total inventory costs, improved storage space utilizations and reductions in inventory values. • Automated technology has been implemented for all aspects of hospital supply management.

43. Acquisition Of Capital Equipment Process Overview • Capital equipment acquisitions require health facilities to go through an internally defined process. Differing corporate policies and preferred methods of financing will impact this process. • As an example, the dollar value for an item to be classified as a capital item is $500 at one Columbus, Ohio, area hospital and $1,000 at another comparable hospital. Commonalities exist in the capital budgeting/acquisition process among health facilities. A sample of the common appropriations process used at Grant Hospital in Columbus, Ohio, is shown in Figure 16.2. • A capital item request initiates the process. The requesting departments are required to provide information on utilization statistics. It is important that this information be as accurate and precise as possible.

46. Overview of the Process • This capital item requisition (CIR) form is divided into two primary sections. • The first section is to be completed by the department requesting the item. • This section calls for details concerning the type of request, a summary of the requested item’s capabilities, how the item contributes to the hospital’s goals (specifically those relating to patient care), and the anticipated changes in operating costs. • The second section is for the actual financial review of the requested item. This section will be completed by the purchasing department.

47. Factors and Decision Rules • The financial merits of the various proposals are then considered. • That is, if two projects are judged to be of equal financial worth, the preference for expenditure would be for the project serving the larger number of people, the one that prevents disease rather than simply preventing fatality, or the one serving children versus the aged. • Several qualitative factors are also of utmost importance in identifying capital expenditure projects in health care, namely, community need, marketability of the project, urgency for the capital item, competition, and technological need. • Community need must be given the utmost consideration for capital expenditure project selection. An item must not be purchased and then the community told they need that item. • The hospital must be dedicated to serving the needs of the community and its purchasing practices should reflect this practice.

48. Factors and Decision Rules • Marketability is a concept affecting both the internal and external audience of the facility. • In conjunction with the community needs assessment, a hospital should consider how marketable a new piece of equipment will be to their community. • Internally, the hospital must “sell” the new items and its virtues to the medical staff. If the administration seeks to purchase a machine that is a “money-maker” for the facility or that is to be used to attract new physicians to the facility, the item must be marketable to the current staff. • This will lead to their usage of the machine when appropriate.

49. Factors and Decision Rules • Hospital Business objectives relates to whether or not the capital item is for the replacement of current equipment, expansion of current technology, or expansion into a new technological field. • From a business perspective, new technology usually is less urgent and more difficult to justify than updating or replacing current technology. • New technology coupled with external marketability suggests another factor to be considered, competition. Hospitals are businesses and must compete. • The hospital management, again, should not be telling the community what they need but must be aware of what is needed and seek to provide that need on a competitive basis.

50. Factors and Decision Rules • Technological assessment can be defined as a method of evaluating current and requested capital equipment by considering the results of published clinical investigations and of physical assessment of the equipment in the decision-making process. • Three key areas are addressed in technological assessment, namely, what the needs of the department are, what the abilities of the current equipment are, and what the abilities of new/replacement equipment would be. • The technological assessment is then integrated into the capital item request process shown in Figure 16.4.