Open Letter V: Sisyphus or the Flywheel

Effective supply chain management is hard. While its costs account for 25 to 35 percent of overall operating expenses, too many hospital CEO's still don't treat it like a core competency. Respectfully, that's a mistake.

I recently finished Jim Collins' book Good to Great. It chronicles 11 publicly-traded companies that made and sustained the transition from average performers to outstanding industry leaders, discussing the traits they have in common. These traits are often surprising and always illuminating. They range from the personalities / leadership styles of the CEO's to the use of technology as a core competency enabler rather than a strategy in and of itself (remember Pets.com?). It's worth the read, and its lessons apply very well to hospitals.

There was no sudden burst of speed, Collins writes, which launched any of the companies from middle-of-the-pack obscurity to market front-runner. Instead each spent years perfecting their business models, always with an eye on the world around them, until they executed better than anyone else. Over time, "good" became "great" as the companies generated momentum their competitors couldn't duplicate. After years of hard work and preparation, you might say, they became overnight successes.

Collins compares the journey to turning a 2 ½ ton steel flywheel mounted on an enormous axle. At first you push it with all your strength, yet its progress seems imperceptible. But you keep at it. You push relentlessly, fueled by informed conviction. You recruit others into your organization to push with you. Slowly, it responds to your force and begins to pick up momentum (as you knew it would). This motivates the team to push harder, keeping at it until the flywheel's own momentum lends a hand, cycling it smoothly around its axle.

Each of the good-to-great companies identified the key revenue and expense components that were critical to achieving their strategic goals. They put knowledgeable, self-motivated people in charge of them. And they made sure that these people had the tools to enable their success.

Winning hospital CEOs approach their supply chain this way. They view it as core to the business, (i.e. a component upon which strategic success depends). They invest in the right people – self-motivated people – and provide them the tools they need to make the supply chain more efficient and more effective. They enable them to create substantial savings.

All too often, I fear, some CEOs feel toward their supply chain operations as Sisyphus must feel about his boulder. Remember him from Greek mythology? He managed to anger the gods and was forced to push a massive rock to the top of a hill only to see it roll back to the bottom. "Now repeat, Sisyphus – for all eternity." OK, maybe not that bad but, to me, seeing hard-earned revenues eroded to dust by sharply escalating supply expenses definitely qualifies as a recurring nightmare.

Imagine this Sisyphean scenario: one of your value analysis teams spends months evaluating drug eluting coronary stents. The members decide they can consolidate from three separate suppliers to one, and the winning bidder commits to pricing that promises six-figure savings in the coming fiscal year. Your team has pushed a big rock to the top of the hill.

Unfortunately, you only see Sisyphus at work. Despite a successful project of stent standardization and market share leverage, the savings don't seem to make it to the bottom line. When your CFO reports new numbers from the cath lab, expenses are higher! The boulder has rolled back down the hill, right?

NO! It turns out that expenses increased because case volume increased. The savings on stents were actually higher than projected, because you used more. The value analysis team should be celebrating. Instead, they're wearily pushing the eternal rock again. The very legitimate six figure savings, and the stent project that should launch a thousand similar projects, are hidden under a thick overcoat of red ink.

Hospitals must employ tools (like this) that quantify projected savings in the supply chain and then track actual savings over time. If you're behind schedule, the tools will tell you why. (Perhaps it signals a need to focus on decreasing product conversion time.) If you're ahead of schedule, great! Replicate! But most importantly, measure. The drug eluting stent price reduction may not have salvaged the bottom line, but it sure as heck helped. And it's the perfect poster child for projects that can change P&L red to beautiful black.

As I said, the supply chain is hard, but it is also rich with savings opportunity. Quantifying and tracking realized savings with accuracy, accountability, and repeatability can be the difference between lugging giant rocks to the hilltops and seeing that flywheel spin in circles using its own momentum.

Sincerely,

Mike

An Open Letter Part IV: Keep Going to the Well

Over the past few weeks, I've noticed prominent hospital CEOs being more vocal in the media about their financial challenges and presenting some useful ideas for solving them.

William Roper, CEO of UNC Health Care answered questions from the Raleigh News & Observer earlier this month. A public health expert who headed the Centers for Disease Control and Prevention during the administration of George H.W. Bush, Mr. Roper describes the situation for hospitals as dire. He argues the need for universal health insurance, citing his own organization's expenses to make the point. In 2009, he expects UNC Healthcare to spend $260-$270 million for uncompensated care (these are the actual costs to his hospitals, Mr. Roper says, not marked-up patient charges), a 26 percent increase from 2008. The state of North Carolina will appropriate $48 million to help defray the costs. In order to make up the difference, Mr. Roper says UNC has no choice but to charge higher prices to insured patients.

Even so, the number of insured patients is decreasing along with rising unemployment. UNC Health Care's uncompensated care will continue to rise and it will be forced to cut costs aggressively to stay out of the red this year.

In the interview, Mr. Roper speaks to this as an elemental policy challenge: universal health insurance will help hospitals distribute costs equitably and put less burden on paying patients. I agree wholeheartedly with Mr. Roper's advocacy for a "full-scale assault" on current healthcare policy; and I try to share his optimism that fundamental change will be enacted quickly.

I wrote last week about Paul Levy, CEO of Beth Israel Deaconess Medical Center (BIDMC) in Boston. His hospitals face a $20 million operating shortfall this year. In addition to monitoring a monthly dashboard of revenue and cost variances with his executive team, Mr. Levy went to the well for ideas. Over the past few months, he has conducted town hall meetings with BIDMC employees to outline the IDN's challenges and seek their input.

By Mr. Levy's account, his people are rising to the occasion. He has received recommendations for cost reductions from clinicians, support staff, and executives alike. To avoid laying-off personnel, many employees are voluntarily foregoing scheduled pay increases and forfeiting some of their earned time accruals. (Read more about it here.)

I'm a big fan of Mr. Levy's candid and inclusive approach. By challenging his employees as a team, he is unleashing a deep reservoir of cost-reducing creativities and sensibilities. Because the cuts must be substantial and happen very quickly, BIDMC has little choice but to hit payroll and staffing; fittingly, he made that clear to everyone upfront.

I urge CEOs to follow Mr. Levy's lead as a matter of ongoing practice. Don't wait until the stakes are this high. Have open and frank discussions with your people about reducing costs and ask them to suggest new ways of saving money each week. Furthermore, the role is a natural fit for your supply chain executive. Put him or her in charge of the initiative and collaborate often.

Is this just wishful thinking? No. Look at this example from Stanford Hospital & Clinics. The CEO challenged her staff to reduce 6 percent from all non-labor operating costs. The supply chain and value analysis teams led the charge, finding consolidation opportunities by evaluating 20,000 items actively purchased from over 6,000 vendors, analyzing the terms of long-standing service agreements, and asking the entire staff to bring new ideas for assessment.

And it's working. The IDN is on track to save $14 million.

Stanford Hospital & Clinics did not wait until the expense situation reached critical state. Instead, they got ahead of the curve, creating a culture that celebrates finding ways to save money each and every day. It's a deep well you can revisit time and again.

Finally, the second (or third) of my own two cents: When you begin this process, make sure you have ways of measuring success. Projects can start with much fanfare and optimism, only to lose steam because you have no effective means to track your actual savings. There are tools out there to help, and – of course – I'm glad make recommendations.

Invest in creating a culture eager to root out unnecessary expense. Invest in the right supply chain tools to monitor your progress. And invest in your supply chain executives, charging them to lead the attack while working with them as partners. The time has never been more right, the motivation has never been higher, the savings have never been more needed. And – I know this – the savings are there.

Sincerely,

Mike

Peer Reviewed by HFMA

Let me briefly deviate from my normal blog content to congratulate the people of MediClick and our customers on a job well done! Late last month, MediClick for the Supply Chain became the only materials management system to receive the Healthcare Financial Management Association's (HFMA) prestigious "Peer Reviewed" designation.

HFMA took MediClick and the product through a rigorous review process, to say the least. They evaluated MediClick as a company, the quality of our customer support, and the value the application brings to our customers. They reviewed our financial statements, interviewed our customers, and conducted their own independent assessment of MediClick for the Supply Chain.

We're gratified to have our accomplishments recognized. Since 2000 the people of MediClick have been dedicated to developing the most innovative solutions for the healthcare supply chain while simultaneously providing the best customer support in the industry. You could say it's an obsession.

As always, our customers deserve my special gratitude. They have been gracious in their feedback and constantly push us to be better.

Thank you to the MediClick teams for their dedication to our company and these products; to our customers for their input and encouragement; and to HFMA for this recognition.

 

 

An Open Letter Part III: These Aching Joints

Last week I stepped through a hypothetical scenario in which a hospital CEO instructed his business office to increase revenue 10 percent. They tapped into the trend of a graying America and, anticipating a surge of baby boomer hip and knee replacements, secured an exclusive contract with a surgeon group performing a high volume of joint replacement cases.

We know the IDN will increase revenue as a result. So, this must be a prescription for success, right?

Well, maybe not. He may have put the bottom line at risk.

Let's focus on hip replacements, a procedure on my mind since my father had it done just last month. Over the past 10 years, the average DRG reimbursement for a hip replacement grew from $8,400 to $11,300. That's 35 percent, about a 3 percent rate of inflation. Over the same period, the average cost for a hip prosthesis has grown from $2,800 to more than $6,500. That's 132 percent or a nearly 9 percent annual compounded growth.*

In 1997, if the IDN decided to invest in more hip replacement surgeries, the business model made sense. The average implant cost was only about a third of the expected reimbursement, leaving plenty of room to cover overhead costs and still turn a respectable profit. Today, however, the implant itself accounts for nearly 60% of the average reimbursement, cutting dangerously deep into the potential margins of each procedure.

Perhaps we could live with a reduced margin if costs had stabilized, but the pace of new technology for joint replacements is accelerating. In an effort to increase sales and gain market share, the manufacturers continually introduce premium implant options (like custom ceramic-on-ceramic articulating hip systems) and market them aggressively to surgeons and patients. But it's the hospitals that absorb the additional costs of these competition-driven innovations. Reimbursement, even when outcomes are shown to improve, lags behind. The "state-of-the art" prosthesis can easily cost twice as much as the "previous generation" implant, turning your already slim margin into a loss.

Now take the unprofitable procedure and multiply it by the number of cases performed by your high volume surgeons. Far from a prescription for success, it is a major contributor to your disappearing margins. That's enough to make any hospital executive's joints ache.

(*Data presented by Kevin J. Bozic, MD at the 2008 Integrated Healthcare Association meeting.)

Healthcare Is Not Immune

A local journalist was surprised when I told him MediClick's customers, like all hospitals, are feeling the tight squeeze of this economy. "I thought healthcare was immune," he said. "You know, people always get sick."

I thought of his comment this morning when reading Paul Levy's letter to the employees of Beth Israel Deaconess Medical Center (BIDMC). As CEO of BIDMC, he delivers a candid report on the state of the hospital's finances, preparing his team for the hardships that accompany an expected $20 million loss this fiscal year. While soliciting innovative cost savings ideas from employees, he also warns to be prepared for lay-offs and salary reductions.

It's true that people always get sick. But like BIDMC, few hospitals are immune when being hit simultaneously with declines in reimbursement, soaring incidents of uncompensated care, and fewer patients registering for elective procedures (from which the relatively high margins help keep hospitals in the black year after year).

Labor is an obvious place to turn when healthcare executives are looking to reduce costs quickly. Wages, salaries, and employee benefits are by far the largest expense category for any hospital. But when demand picks back up (as we all know it will), it can take a lot of time and money to rebuild great clinical and support teams.

In my "Open Letter to CEOs" series, I continue to urge hospital executives to invest in their supply chains as a strategy. As the second highest expense category, the dollar figures are too high to treat it as a low priority. In these challenging times we must build cultures committed to rooting out costs and making smart purchasing decisions. While this won't always make us immune from layoffs, I am confident we can reduce them.

An Open Letter Part II: A Penny Saved Is a Penny Earned

By Mike Merwarth, President of MediClick

Though my teenage daughters roll their eyes each time I recite Benjamin Franklin's appeal to personal thrift, I hear a more empathetic response from hospital executives. After all, IDNs routinely survive on margins between zero and four percent. Because we operate so close to the edge, we've trained a sharp eye on the bottom line to make sure there's a buffer between us and the red ink.

In my last note, I urged hospital CEOs to make the supply chain a strategic priority. It remains the richest trove for rescuing dollars from the expense column of our financial statements, but that won't happen without making a firm commitment to the people running your supply chain and investing in the tools they need to get the job done.

In this note, I want to run through a simple model to make the case that investments in supply savings do considerably more for your bottom line than investments aimed at growing your revenue base. Stay with me on this. Even if it looks like an accounting exercise, you'll see that it goes to the heart of strategy and operations.

Let's look at a hypothetical IDN and its income statement:

Hypothetical 20 Hospital IDN (Income Statement)
		% of revenue
Revenue	$1,000,000,000	100%
Supply Expenses	($250,000,000)	(25%)
Payroll Expenses	($400,000,000)	(40%)
Other Expenses	($330,000,000)	(33%)
Margin	$20,000,000	2%

 

Its cost structure and margins are typical of an IDN its size. However, the CEO is not comfortable with the tight margin and wants to look at his options by modeling some changes to revenue and expense over the next few years.

He turns first to his business office and asks them to come up with ways to increase revenue by ten percent and show its impact on the bottom line. They've been studying demographic data for months and believe the graying of the baby boomers will soon lead to a spike in demand for knee and hip replacements. They recommend aligning with the highest producing (by case volume) orthopedic practices in key markets, repositioning the IDN as the place to go for hip and knee replacement surgery, and repurposing their OR suites for more orthopedic procedures.

Soon enough they expect the efforts to generate an additional $100 million in revenue per year. Their model looks like this:

Hypothetical 20 Hospital IDN Income Statement (10% Revenue Increase - More Hip & Knee Procedures)
		% increase
Revenue	$1,100,000,000	+10%
Supply Expenses	($275,000,000)	+10%
Payroll Expenses	($440,000,000)	+10%
Other Expenses	($363,000,000)	+10%
Margin	$22,000,000	+10%

 

While the move into orthopedics achieves the desired revenue growth, it carries with it a proportional increase in expenses. The additional volume means a need for more staff to cover the procedures and more supplies for the cases. As a result, the $100 million in new revenue only adds $2 million to the bottom line, for a 10% margin increase. For an IDN approaching $1 billion in annual expenses, that really doesn't put the bottom line on firmer footing.

The CEO turns to his supply chain team to tackle the expense problem. He challenges them to decrease supply costs by two percent.

The vice president of supply chain has been studying some data, too. At their current orthopedic case volume, she sees that the clinicians are using hip and knee kits from several different manufacturers at a wide range of price points. She knows that with the right tools, she can make a solid argument to the value analysis team to consolidate to fewer products, increase volume and market share with certain vendors, and negotiate an IDN-wide contract with much better prices. She anticipates savings of $5 million, and her model looks like this:

Hypothetical 20 Hospital IDN Income Statement (2% Supply Expense Decrease)
		% increase
Revenue	$1,000,000,000	+/-0%
Supply Expenses	($245,000,000)	-2%
Payroll Expenses	($400,000,000)	+/-0%
Other Expenses	($330,000,000)	+/-0%
Margin	$25,000,000	+25%

 

That $5 million in supply savings falls directly to the bottom line, increasing the margin by 25 percent and creating a wider financial cushion for the CEO. Better yet, with the analytical tools now available to her, the supply chain executive can better manage her supply contracts, analyze information in real-time, and demonstrate that the money she expects to save is making its way to the bottom line.

In an ideal world the CEO can pursue both projects simultaneously. But today's environment requires healthcare executives to preserve the hospital's capital while acting swiftly to protect their margins. If you're willing to make the investment in your people and the tools they need, your supply chain team is the quickest route to reducing costs and expanding margins.

So, Benjamin Franklin didn't just coin a folksy adage on frugality to pass from doting fathers to disinterested daughters. In the hospital world, each penny we save falls straight to our bottom line, fortifying our financial health and keeping our margins in the black.

Do you have a story similar to this hypothetical vice president of supply chain? If so, I'd love to hear how you contributed to your organization's profitability by rescuing dollars from the expense column.

Sincerely,

Mike Merwarth