May 15, 2020 | John Strong, ASPI
I was trained. Conditioned, really. Groomed. It took at least a decade. Perhaps many more. Buyers love it. Who doesn’t believe in product standardization, lower prices and a whole host of other benefits? Suppliers love it. Who wouldn’t love a tight, close relationship without the fear of competition—at least for a few years?
Dawn of Corporate Agreements
In the early 1980’s a number of large companies decided that their various far flung divisions could actually sell together under the mantra of so-called “corporate agreements.” This might take products as diverse as bandages and imaging equipment and bring them under a corporate “umbrella” that awarded discounts, “bonuses” and cash rebates for using more product from more divisions of the same company. Some of these were even arranged like a betting sheet, going through higher volume and commitment with named tiers such as “silver, gold and platinum”.
The allure of these programs was significant. Working towards discounts and cash rebates made some sense if a healthcare provider could convert products to the corporate contract holder and increase volumes. Unfortunately, this scenario often led to increased purchasing and came under some scrutiny in the late ‘90s.
In addition, some buyers discovered that they were not always getting “the best price” on certain items. This led to discontentment with some programs as well as some of the trading partner distrust that remains in the market today.
Smaller Health Systems,National GPOs Form
Large scale volume aggregation was around in the 1960’s and early 1970’s but really burst onto the scene with the formation of Voluntary Hospitals of America (VHA) in 1977, with its first ‘class’ of large, prominent health systems. As it and other national GPOs, such as The Consortium of Jewish Hospitals (now Premier), met with eager suppliers who were keen to gain its business, they often provided better pricing for so-called “sole source contracts.” These were different than what many national GPOs had been doing, which was issuing contracts to several suppliers for the same products, thereby giving its members choices in brands.
In the 1990’s many, though not all, of the national GPOs began doing more multi-source contracting. In response to their growing size, members wanted less need to “convert” product to a different brand or supplier. GPOs discovered that this strategy would generate far more revenue in the form of Contract Administrative Fees (CAF), and it satisfied their members’ demands for more choice. By the early 2000’s, two national GPOs, HealthTrust Purchasing Group and Consorta, were building a reputation of having low prices because they were sole-sourcing commodity items and in some cases “customizing” contracts to individual member’s use.
Which Pricing Tier am I on?
This led the remaining national GPOs to begin allowing sole-source contracting within a multi-source contract, using compliance levels (usually set at 80%) whereby a purchaser could achieve better pricing within a multi-source contract by selecting a primary supplier.
This was beneficial to suppliers as well. They could determine who got the ‘best’ price based on certain criteria they often selected, such as the volume of purchases or level of compliance to a particular product or group of products.
Hence, sole source contracting within multi-source agreements was born. There are a number of risks and rewards associated with sole source contracting, as illustrated in the chart below.
A Changing World
We’ve all heard it by now. “Everything is going to be different”, or “COVID-19 changes everything.” While it is likely true, the healthcare supply chain, which is overly complicated, contains too many middlemen, and never has used a common numbering and nomenclature system, is probably ripe for more change than almost any other.
A number of experts have raised the question of whether the healthcare supply chain “has become too lean” in the quest to take costs out of it. It is likely true. Looking back 40 years, our healthcare supply chain was arguably better prepared for a pandemic years ago because many buyers had dual suppliers of many items—with more inventory resting on more shelves. Inefficient? Sure, it was. But it had the built-in advantage of a “disaster” or significant-use event.
In areas where “higher” brand differentiation and technology exists, it has been common wisdom to have several suppliers. While some of this phenomenon is due to clinician preferences, it also allows for coverage in the event of a supply shortage, back order or shipping issue—while the patient is being wheeled into the operating room.
When Price was King
In the healthcare supply chain’s rush to better pricing, several things got missed in that equation.
· Source of supply – We wrote sole source contracts while failing to confirm the geographic sources of supply, the length of the supply chain, and sourcing from countries that arguably were not always our friends.
· Backup sources – We often forgot that having a second source was important, whether for the same brand—or the identical product.
· Disaster preparedness – Healthcare has done a good job of preparing for disasters, but these are usually isolated events and stock can be drawn from other parts of the country. We didn’t think about what could happen globally, such as a pandemic.
· No backup manufacturing capacity – Because it was simple, low cost, and generally non-problematic, we did not consider rewarding critical suppliers for maintaining backup production capacity. It is not economical for a manufacturer—and needs to be considered in pricing — but we need to take several steps:
o Bring more critical equipment manufacturing back on shore;
o Beef up onshore manufacturing with additional capacity built in; and
o Consider both“primary” and “secondary” contractual awards that reward the risk manufacturers take on to scale product manufacturing quickly.
While “stockpiles” can offer a rapid response and certainly have their place, government agencies have learned that inventory needs to be rotated. This is one of the first lessons a college intern learns while working in the supply chain department of a hospital. This pandemic has shown that sole source contracting alone has its risks, and when combined with other factors in the healthcare supply chain can be especially detrimental to a rapid response.
RISKS & REWARDS OF SOLE SOURCE CONTRACTING
Rewards
1. Usually a better price, sometimes as much as 10% or more.
2. Reduction of inventory in stores, and on department shelves
3. Faster inventory turns
4. Product standardization allows easier training of staff in all areas, including clinical.
Risks
1. Supply interruptions from the sole supplier.
2. Flexibility to change products is lost.
3. Little or no backup in case of global or national pandemics.
4. At mercy of supplier if product is "improved" or product is changed, sometimes at higher costs - required review.
SUPPLIERS
Rewards
1. Little risk of competitive threat over a finite time period (usually up to three years).
2. Easier production planning.
3. Easier and lower-cost component production cost.
4. Higher profitability in the right circumstances if carefully managed.
5. Fewer sales representation demands for 'selling' vs. 'servicing'.
Risks
1. Pricing discipline must reflect value of sole vs. dual source purchasing strategies.
2. Less flexibility if operating at or near capacity reflecting demand increases.
Conclusion
After this pandemic, large purchasers—and their suppliers— need to carefully look at the incentives behind sole source contracting and consider the risks versus the rewards. If we fail to take the lessons learned in the past three months and apply them now, we will again be behind when the next pandemic strikes or this one resurfaces.
There is already sentiment growing for more diversity of suppliers across the healthcare supply chain, and shorter chains. An honest discussion between trading partners of how to gain such diversity without compromising access to important supplies is required well before the next pandemic. While sole source contracting is not the only villain in this crisis, it may have played a significant role.
