July 2009 - Having My Say

INSIDE THE CURRENT ISSUE

July 2009

Having My Say

Forecasting supply cost vs. labor cost

A new industry cost trending tool

by Tom Hughes, Strategic Marketplace Initiative and Gene Kirtser, Resource Optimization & Innovation

It is widely recognized by healthcare provider executives that labor is their
highest cost category, at times representing more than 70% of a total annual operating budget. As industry labor costs continue to increase due to labor shortages and other factors, they also continue to attract much management attention. But in the last few years, healthcare supply chain executives have begun to recognize an acceleration in the rate of overall supply costs, with supply cost increases sometimes exceeding the increases in labor costs. A provider’s total cost of supplies – including medical devices, pharmaceuticals, physician preference items, non-clinical and commodity costs – can represent over 25% of a provider’s total annual operating budget. Total supply cost increases can be attributed to new products, technology improvements, increased raw material costs, and the evolution of new pharmaceutical and biological products. With newfound attention being paid to this accelerating growth of supply costs, supply chain thought leaders are starting to ask the question:

Could supply costs ever exceed labor costs?

Executives from both the Strategic Marketplace Initiative (SMI) and from Resource Optimization and Innovation (ROi) embarked upon a project to help the industry’s organizations answer that question. With a vigilant focus on the future, senior leadership at ROi had developed an early version of a cost forecasting Trending Tool.

The Trending Tool, designed to forecast an organization’s annual supply costs versus annual labor costs, uses a variety of user-driven factors to forecast. Together, SMI and ROi leaders envisioned the Trending Tool’s value to supply chain professionals in gaining attention and support for increasing the strategic relevance of the supply chain function within healthcare providers.

Project organization and objectives

The project involved field testing the Trending Tool, providing feedback to the Trending Tool creators, and identifying potential enhancements to the Trending Tool through the following objectives:

To elevate the importance of Supply Chain in the provider’s executive suite by bringing attention to the escalating cost of supplies.
To support short and long term supply chain strategic planning efforts with the forecasts produced by the Trending Tool.
To support provider supply chain executives’ efforts to secure additional management focus and the appropriate resources to strategically manage the industry’s forecasted cost challenges.

The project was organized into two phases, and goals were identified for each phase:

Field Testing Phase

The project’s field testing phase had five goals:

To train key users in the logic and functionality of the forecasting Trending Tool
To field test the forecasting Trending Tool’s logic, functionality and usability in real conditions
To solicit feedback that supports final development of the forecasting Trending Tool
To document results and develop a summary document
To collaborate with others on best demonstrated cost containment tactics

Documentation Phase

The project’s documentation phase had two goals:

To assemble a summary document about the field testing and collaborative development
To assemble an educational presentation to introduce the Trending Tool to the industry

The trending tool overview

The Trending Tool is an easy-to-use multi-faceted spreadsheet built in Microsoft Excel that allows users to input their organization’s costs data and to forecast data at multiple levels.

The Trending Tool’s design is based on four elements of supply cost growth in healthcare:

Four elements of supply cost growth in healthcare:
Price	The traditional target for supply cost reduction. It is the easiest to understand and calculate impact. Traditionally driven by volume, compliance, terms, and efficiencies, this element is reflected in the Trending Tool as part of an organization’s annual cost data.
Volume	This element is easily understood but often not given prominence as a contributor to supply cost escalation. Volume can have a positive financial impact if linked to positive reimbursement. This element is reflected in the Trending Tool as part of an organization’s annual cost data.
Utilization	This element is a measure that relates to volume, pricing, and process. Best practice comparisons often times expose large savings opportunities. This supply costs element is reflected in the Trending Tool through forecasting of future changes.
Technology Adoption	In most cases, new technology costs more that current technology. Adoption without sound justification or reimbursement evaluation can lead to significant cost growth. This supply cost element is reflected in the Trending Tool through forecasting of future changes.

Below is a screen shot of the Trending Tool’s medical supply product area data input section, with yellow areas requiring user data.

Click image for larger view.

The Trending Tool requires a user to collect and input annual data in four major cost categories:

Labor Costs ( including salaries and benefits)
Pharmaceutical Products
Medical Supply Products
Other Supply Costs

For each category, a user can enter high level/summary data or more detailed data based on sub-categories in each category, as listed below. Users of the Trending Tool decide the level of detail they wish to utilize, often based on the level of detail available to them.

Trending Tool Cost Categories
Major Cost Categories	Cost Sub-Categories
Total Labor Costs (Salaries and Benefits)	• None
Pharmaceutical Product Areas	• Anti Infectives • Blood Products • Chemotherapy • Diagnostic Agents • Diagnostics – Radiology • Hematologic Agents • Laboratory Products
Medical Supply Products Areas	• Medical Surgical - Commodity • Medical Surgical Clinical Commodity • Medical Surgical High Preference • Medical Surgical High Cost High Preference
Other Supply Costs	• Office Supplies • Food/Dietary Supplies • Minor Equipment • Housekeeping • Print • Linen

Once the actual annual data is identified and input into the Trending Tool, users are then required to input their data under three scenarios as follows:

Forecasted salary and benefits cost growth (minimum, most likely, and maximum)
Forecasted FTE increases (minimum, most likely, and maximum)
Estimated % of non-labor costs covered by purchasing contracts
Estimated % of On-Contract purchase price growth by category (minimum, most likely, and maximum)
Estimated % of Off-Contract purchase price growth by category (minimum, most likely, and maximum)
% change in utilization/volume by category (minimum, most likely, and maximum)
% rate of technology adoption (minimum, most likely, and maximum)

Field testing revealed that collaboration with financial and specialty area leadership within the provider organization is critical to the determination of hard cost data and forecasts for the Trending Tool. This combination of actual historical data and well-researched forecasts yields a statistical output and three graphic scenarios of the year when/if supply costs may exceed labor costs for the organization:

1. Minimum

2. Most Likely

3. Maximum

Above is an example of a "most likely scenario" showing supply costs
exceeding labor costs in approximately the year 2030.

I. Field testing methodology

All provider organizations involved with the field testing of the Trending Tool followed the same general methodology for adopting the Trending Tool and its outcomes into their management practice:

Training

Members of the ROi organization first oriented a project team of SMI senior executive members to the Trending Tool and provided participants with the actual Trending Tool. Follow-up webinars were conducted with staff from the project participants to insure a full understanding of the Trending Tool’s functionality.

Data gathering

Participants reviewed data sources, worked with financial and accounting staff, and collaborated with key department managers and product specialists to gather the data and to make projections. SMI provided participants with links to industry sources for cost and inflation data, including group purchasing data and inflationary indexes available through the federal government.

Data input

Participants input their data into the Trending Tool and were provided with support from ROi and SMI resources as needed.

Quality assurance review

Participants reviewed the detailed results of the Trending Tool’s calculations and reports for reasonableness and accuracy.

Sharing

Participants reviewed the final outputs of the Trending Tool with their colleagues and senior management groups to promote a better understanding of the current and potential supply chain challenges.

Trending Tool field test participants

Four SMI Industry Provider members volunteered to participate in the field testing of the Trending Tool. Collectively, these four organizations processed over $9.5 billion dollars of labor and supply cost information through the Trending Tool. Each organization submitted the results of their field testing to SMI staff and provided SMI staff with feedback on the Trending Tool’s functionality and value as a management Trending Tool.

In order to protect the confidentiality of each organization’s data, the field testing participants are randomly referred to in the Appendix as IDNs A, B, C, and D. The table below reveals the total values of all the data categories involved in the field testing by the four participants.

SMI Industry Partner	Supply Chain Executive Sponsor
BJC Healthcare Headquartered in St. Louis, MO	Nancy LeMaster VP of Supply Chain Operations
Intermountain Health Care Headquartered in Salt Lake City, UT	Brent Johnson VP of Supply Chain, Chief Purchasing Officer
UK Health Care Headquartered in Lexington, KY	Jean Sargent Director of Supply Chain Management
Mayo Clinic Headquartered in Rochester ,MN	James Francis Division Chair/Assistant Treasurer – Mayo Clinic Supply Chain Management

II. Field Test Findings

Each of the field testing organizations followed the general methodology to populate the Trending Tool and to forecast the future trends. As anticipated, the Trending Tool’s results for each field testing organization were unique and different. The results for one field testing organization revealed that supply costs would not exceed labor costs at any time in the future. However, three of the four field testers "most likely" scenario showed that supply costs would exceed labor costs in the future.

Field Testing Organization	Calculated year when supply $ most likely exceed labor	Field Testing Organization	Calculated year when supply $ most likely exceed labor
IDN A	n/a	IDN C	2033
IDN B	2044	IDN D	2022

"Most likely" labor forecasts

Field testing participants were fairly consistent with their "most likely" forecasts for salary growth, ranging between 3% and 5%, with an average of 4% annual increases in salary. Greater variation among participants was revealed in the projections for "most likely" FTE growth, ranging between 1% and 8% growth, with an average of 3.5% annual growth in FTEs.

In addition to projecting when supply costs may exceed labor costs, the Trending Tool calculates overall projected growth rates for price and utilization/technology adoption in each of the three product categories - pharmaceuticals, medical supplies, and other.

The Trending Tool also calculates minimum, most likely, and maximum growth forecasts by product category and sub-category. This data for each of the field test participants is included in the Appendix of this study.

Overall projected growth rates for each organization are also calculated. Projections were again different and unique for each participant in the field testing of the Trending Tool, with wide variations in the forecasts for the impact of price growth and utilization/technology growth.

Interviews with participants revealed that forecasts rely heavily on a variety of factors particular to the supply chain management program that is currently in place. For example, the participant with the lowest forecast of growth in utilization and technology adoption explained that their product introduction process is mature, data driven, and clinician led with a history of helping to control the costs of new products. As a result, the low growth forecast. Similarly, the varying degrees of price growth projections are linked to the success of the overall contract management program at each organization.

Field tester feedback

Following the field testing and the submission of feedback documents, interviews were conducted with participants to identify issues of Trending Tool functionality and to compile feedback on the proper use and values of the Trending Tool. Excellent feedback was received on the Trending Tool’s functionality, leading to some minor adjustments to the Trending Tool itself and the development of an instruction manual. These adjustments to the Trending Tool will be completed prior to the Trending Tool’s release to the industry in July 2009.

Overall, field testing participants unanimously communicated positive feedback about the use and value of the Trending Tool. Four key points were emphasized by all participants:

Use of the trending tool promotes collaboration
The most common point emphasized by Trending Tool field testers was that the use of the Trending Tool required them to reach out and collaborate with leadership from supply intensive areas "The greatest value of using the Trending Tool is in the discussion!" Nancy Lemaster of BJC Healthcare reported after using the Trending Tool for the first time. Other participants expressed similar comments, noting that the proper use of the Trending Tool requires seeking out non-supply chain colleagues in supply intensive areas like surgery, pharmacy, and diagnostic services in order to have a meaningful and reasonable forecast. Participants recalled how the data gathering step included reaching out to both managers and clinicians in medicine, accounting, surgery, strategic planning, human resources, and other departments. Some participants reported seeking input from external sources, including their group purchasing organization and key suppliers. Some noted the eagerness of clinician leaders to participate in a new exercise about not only the direction of change, but the change’s impact on technology and utilization.

Use of the trending tool involves new territories

Another frequent comment from Trending Tool field testers was that using the Trending Tool requires supply chain to expand beyond customary boundaries, positioning Supply Chain’s role as total cost management leader in the organization. Jim Francis of Mayo Clinic may have expressed it best when he said "Using this Trending Tool requires supply chain professionals to get involved in non-traditional areas where they may currently have little or no involvement." While obvious examples might include food service and housekeeping, participants also noted that working with human resources on forecasting future changes was certainly new territory for supply chain.

Participants also worked with clinical managers to conduct "deeper dives" into the factors impacting overall costs, discussing future changes in utilization and the impact of technology.

Use of the trending tool increases understanding of supply cost trends

Participants in the field testing reported that the collaborative process of gathering the data on this new unique set of parameters also helps to increase the understanding and awareness of supply cost trends among the involved parties and among senior management once they have seen the results of using the Trending Tool. Jean Sargent of the University of Kentucky Health explained "Stakeholders that I engaged in the forecasting process now understand that total supply costs are driven by the collective impact of product price, product utilization, contracting, and new technology adoption. This new level of understanding helps to make supply chain’s efforts in cost control that much more successful." Senior management awareness of the various factors that impact supply costs is also increased once the results of the forecasting Trending Tool are shared. This awareness also helps current and future supply chain efforts.

Use of the trending tool improves the strategic value of supply chain

Overall, the use of the Trending Tool has helped to enhance and improve the perception of supply chain’s role and impact on the organization, especially with senior management, by reducing anecdotal management of supply costs. Brent Johnson of Intermountain Health Care reported that when he shared the results of the forecasting Trending Tool with his chief financial officer, the CFO was impressed with the multiple quantitative factors that the Trending Tool incorporates. The process of populating the Trending Tool also resulted in identifying any gaps in supply chain’s impact. "Using the Trending Tool forces you to do spend analytics, it forces you to recognize utilization’s impact, and it forces you to develop strategies." said Johnson. At Intermountain Health Care, the Trending Tool cost categories were aligned with the responsibilities of the strategic sourcing managers in supply chain. As a result, the Trending Tool is becoming part of the overall supply management program at Intermountain Health, using this consistent methodology as volumes and forecasts are updated on a regular basis to assist leadership in planning.

Conclusion

Supply costs and labor costs continue to rise. So many factors can influence these costs – some factors are strategic, others are local and regional. Regardless of the situation, today’s healthcare supply chain executive needs to consistently maintain a forward-looking approach in order to maximize their value to their organization and to the industry.

While the forecasting of future costs is not an exact science, it is becoming a required part of any progressive management program or budget planning. The Trending Tool revealed that, when used regularly, it can be used for forecasting, monitoring, and measuring supply chain progress. Gene Kirtser of ROi/Sisters of Mercy – one of the architects of the Trending Tool, has pointed out that the Trending Tool can also be useful in helping Supply Chain professionals secure the appropriate resources to control costs. Said Gene "The Trending tool validated our assumption – traditional cost management strategies will not work in the future. Practical demonstration of that assumption to Senior Leadership allowed us to secure funding for people and technology to address these trends."

SMI and ROi are pleased with the results of the field testing project and will be offering the enhanced Trending Tool to the industry in the summer of 2009. SMI expects industry professionals and executives to generate hundreds of downloads from the SMI website as this new industry Trending Tool gains acceptance. The use of this Trending Tool by healthcare supply chain professionals can serve as a major factor in redefining the scope of supply chain responsibility, helping to continue the efforts to positions supply chain’s role as the total cost management leaders for their organizations.

Appendix

FIELD TESTING PARTICIPANTS GROWTH PROJECTIONS – DETAIL

About SMI and ROi:

Tom Hughes is the executive director of The Strategic Marketplace Initiative, a non-profit, member-driven organization dedicated to improving the healthcare supply chain through direct information exchange and collaboration between senior healthcare supply chain executives and senior IDN supply chain executives. SMI members include healthcare providers, medical manufacturers, medical distributors, and other healthcare supply chain related businesses. SMI was created to influence, shape, and advance the future of the healthcare marketplace by providing an open forum for innovative idea-exchange and the development of collaborative process improvement initiatives.

Gene Kirtser is COO, Resource Optimization & Innovation, an operating division of the Sisters of Mercy Health System. ROi allows Mercy to successfully offer a single-source, fully integrated supply chain solution to serve its customers. As of fiscal year 2008, ROi has $560 million in contracted volume, more than 1,400 members and serves more than 4,000 licensed beds in 22 acute care hospitals. ROi is headquartered in St. Louis, MO, and has distribution operations at the Consolidated Services Center (CSC) in Springfield, MO.