Hospitals have an opportunity to cull big savings from purchased services

The real possibility of reducing purchased services spend by 10% to 15% offers hospitals and health systems a compelling reason to pursue such an effort.

In their ongoing efforts to reduce costs without cutting staff, hospitals and health systems should take a close look at purchased services, where they may find many untapped opportunities.

A purchased service is broadly defined as any purchased, contracted or outsourced service across all functional areas of a hospital or health system.a The potential savings in this area can be significant and can represent as much as 30% of a hospital’s nonlabor expenses. Often, it is on par with the spend on supplies, which alone should make it an important target for cost reductions. But purchased services savings can average 10% to 30% of the purchased services spend, which may be far higher than the amount a hospital can realize on supply spend, for which much of the low-hanging fruit has often been harvested.^b

Despite the tremendous savings opportunities, however, hospitals have been slow to target purchased services because it can be a complex undertaking. But these complexities aside, hospitals cannot begin to access these opportunities if they do not lay the groundwork for initiatives aimed at reducing purchased service costs.

6 steps for embarking on a purchased services savings initiative

The following steps are key to implementing successful savings initiatives focused on purchased services.

1. Identify opportunities. A good starting point is to assess the hospital’s total annual spend by vendor and category. The team charged with identifying potential purchased services cost-reduction initiatives should examine all spend data, including accounts payable (A/P) and purchase order (PO) files; contracts expiring within the next nine months; and new service or technology requests. (To see who should lead the team, review the section labeled “Leadership of a purchased services cost reduction effort” below.)

Sorting the A/P file by vendor in descending order and eliminating supply vendors, tax payments and intercompany transfers will provide a high-level view of the main vendors for purchased services. The team should review this file to evaluate the spend by purchased service category and subcategory. The chief categories of purchased services and examples of subcategories are shown in the exhibit below. This analysis can help unearth opportunities for vendor consolidation, an important lever in achieving better pricing. 

Example of potential purchase services and categories

Information Technology	Food Services	Environmental Services	Facilities
Storage	Outsourced agreement(s)	Outsourced agreement(s)	Construction
User License strategies	Vending commission	Cleaning supplies	Depreciation
Clinical software	Employee café discount	Waste pickup	Water, gas, electric
Non-clinical software	Other retail prices	Red bag waste	Building automation
Professional services	Catering	Sharps disposal	Leases
Telecom	Food cost	Recycle	Property management
Cell phones	Retailing strategies	Window cleaning	Elevator maintenance
Disaster recovery	Distribution	Landscaping	Space rationalization
Data network – LAN/WAN	Floor stock	Hand sanitation	Architects
Security	Water coolers	Medical gases	Security services

The team then should prioritize purchased services opportunities based on annual category spend, contract end dates, number of vendors in each category and time last reviewed. Identifying all vendors and total spend per category can be challenging, but the general ledger category field and department field will provide good clues. The team should reach out to department leaders who use the service and can help identify all vendors used per category.

Once the team has fully evaluated the A/P file, it should turn its attention to the PO file. The majority of a hospital’s spend for each purchased service should be reflected in these two files.

2. Define initiatives. Once an opportunity is identified, the team should define a business case for how and why that opportunity should become an initiative, including an estimate of expected financial and qualitative benefits. This business case should include:

• Potential pricing opportunities
• Expectations for standardized contract, service and supplies, and reduced utilization
• Potential outcome

The business case also should include cost estimates regarding both one-time costs (e.g., purchase of equipment, construction, training) and ongoing costs (e.g., required labor, licensing fees).

3. Obtain executive support and initiative approval. Full support from the C-suite is critically important in a purchased services cost-reduction program. The team should present the business case to an executive steering committee for approval. This committee should consist of senior leaders in the organization and is often led by the CFO. The committee should help set the savings targets, hold the team accountable for meeting those targets and ensure a mechanism is in place to measure the results.

Many senior finance leaders incorporate the savings targets in the next year’s budget, which is an effective way to hold people accountable and manage the spend. Purchased services initiatives can encounter barriers such as technical challenges, stakeholder resistance, required resources or vendor pushback, so executive support is critical to maintaining momentum.

4. Form multifunctional work groups for each initiative. Because purchased services can be complex, each initiative should be managed by work groups composed of representatives from multiple functional areas who bring the right mix of skill sets. For instance, tackling a transcription services initiative should involve representatives of health information management, IT, finance and the medical staff. All stakeholders should understand and support the goals and approach for the cost-reduction initiative. This multidisciplinary approach ensures the group has a broad knowledge base that will put it in the strongest possible position when negotiating with external parties.

5. Implement the initiatives. The true work begins here, where each work group defines its full initiative, performs in-depth analysis, completes the business case, creates a work plan and assigns responsibilities. If applicable, the responsible parties can then distribute and evaluate RFPs, review and negotiate purchased services contracts and pricing, ensure processes are in place for fair and equitable selection of service providers and present final recommendations to the full team for approval. After a decision ismade, a business and legal review of the purchased services contract should be performed.

In the case of a utilization initiative (e.g., reducing office supply usage or temporary labor services), the work group will need to modify usage policies and processes, create a communication plan and provide training for end users.

6. Monitor results. The key to a successful purchased services savings program is ensuring the sustainability of initiatives through ongoing, periodic measurement. As each initiative is implemented, the work group should determine how to measure and track savings over time to ensure prices are consistent with renegotiated contracts and utilization does not creep back up.

Utilization is especially important to track, because organizations can easily slip back into old habits. For instance, a medical waste reduction program should measure the medical waste per adjusted patient days every month. If usage starts to increase slowly, the work group can identify the department causing the issue and work with it to get usage back in line.

Obstacles to effectively reducing costs of purchased services

Hospitals’ efforts to reduce costs for purchased services are too often impeded by a lack of centralized oversight for such services. The services tend to be managed at the local level within functional departments, across clinical and nonclinical lines, and spread over multiple vendors. Spend on purchased services also is not tracked in the same way hospitals track their supply spend. In many cases, services contracts are managed by end-user departments (e.g., surgical services, radiology, clinical engineering, and facilities management), with the result that gathering data necessary to analyze each initiative can be a time-intensive manual process.

Further, purchased services often involve many variables, making them difficult to benchmark. Consider, for example, the biomedicine maintenance service. To benchmark this service, it is necessary to understand several factors, including the scope of products and services, service hours, response times and service-level guarantees. These variables can make it challenging to understand whether the hospital is getting a good deal and how its experience compares with that of other facilities of similar size and scope. Having the review performed by a multifunctional team with expertise related to the specific purchased service helps to mitigate this challenge.

Leadership of a purchased services cost reduction effort

The effort may be led by the supply chain leader, senior finance leader or senior facilities leader; or by a program management office or decision support department, where such offices exist. The appropriate person responsible for leading these initiatives will depend on the culture and structure of the health system.

Regardless, it is imperative to have executive support for each purchased service initiative to motivate the team and hold it accountable for achieving results.

Purchased services cost-reduction projects can create tensions among stakeholder groups. For instance, the IT workgroup may want to eliminate certain low-use software applications. However, the users of those applications may object. Or the Food Service work group may want to change the catering guidelines to reduce food cost against the wishes of departments making frequent use of catering services. In each case, the steering committee should help evaluate pros and cons and help find solutions.

Conclusion

Given that many hospitals and health systems have untapped opportunities to reduce their purchased services spend by 10% to 15%, these organizations have a compelling reason to pursue such an effort.

Case example: How 1 hospital saved roughly $900,000

A 300-bed hospital in Western Illinois spent about $2.5 million on service contracts for diagnostic imaging and other clinical equipment. The hospital had an in-house biomed department, which serviced mainly small moveable clinical equipment. The purchasing director, biomed director and decision-support manager formed a team to review all outside clinical engineering service contracts. They made two key observations:

• The hospital paid for services it barely used, including premiums for a three-hour response time and after-hours services.
• With additional training, the house staff could perform many of the original equipment manufacturer (OEM) services that the vendors were providing.

The team determined it could shift some vendors from full- to reduced-service contracts or arrangements in which the hospital would pay vendors only for time and materials. As a side benefit, expanding responsibilities of the hospital’s biomed staff led to improved job satisfaction. This initiative achieved net annualized savings of roughly $900,000.

Case example: Credit card fees

A hospital system in Wisconsin identified an opportunity to reduce credit card fees, where the annual spend was about $400,000 with three banks. The finance department and business office formed a team to review current merchant statements and request processing fee schedules from banks. They performed a competitive bid process and selected the two banks with the lowest fees, saving $85,000. The team also reduced credit card utilization by moving specific high-volume credit card transactions to ACH direct deposits, resulting in another $105,000 in savings and bringing the total savings to about $190,000.

Footnotes

a. It also could be argued that professional fees, such as those paid for legal and consulting services and medical directorship, should be included under the heading of “purchased services.” Although a health system could look for ways to reduce these fees, discussing such an effort is beyond the scope of this article.

b. Sterling, P., “Top 4 things the CFO needs to know about purchased services,” Becker’s Hospital Review, July 1, 2015.