Driving purchased services savings after a healthcare merger or acquisition

Oct. 5, 2019

After a healthcare merger or acquisition, the successor entity typically looks to drive supply chain cost savings by leveraging its increased purchasing power. An initial place a health system should evaluate for supply chain cost savings after a merger or acquisition is outsourced purchased services. Changing purchased services vendors is not easy and can entail several complicating factors. If done correctly, however, it could be one of the most significant sources of enhanced efficiency and supply chain savings available to all parties.

Aggregating services with one vendor: What to assess

The main issue to explore is whether aggregating services with one vendor makes sense from a cost and quality standpoint. There can be four scenarios when two entities combine:

1. Neither party to the transaction outsources the purchased service.

2. Both parties to the transaction outsource the service to two or more different vendors.

3. Both parties to the transaction outsource the service to the same vendor.

4. One party outsources the service to a vendor and the other party does not outsource the service.

Assessing Scenarios 1 & 2

In either of these situations, a health system should use a competitive bid RFP process to test the market for potential costs savings and quality improvements. After a merger, a health system will scrutinize department expenses across the combined system to identify cost-saving synergies. If neither party to the transaction is currently using a third-party contractor for a purchased service, then putting your services out to bid is a relatively easy way to explore the potential value you can unlock from management companies at a relatively modest cost. Likewise, if both parties to the transaction currently use different vendors, issuing an RFP to aggregate the health system’s purchased services spend with one vendor may drive cost savings, efficiencies and quality improvements.

There are three main areas of potential value:

Guaranteed vendor savings: Mergers and acquisitions often do not meet financial expectations because the parties are unable to realize savings from anticipated synergies. A health system can negotiate to have a management company contractually guarantee some of those savings. For example, most purchased services vendors are willing to contractually guarantee at least 10 percent cost savings when a hospital system moves from self-operation to a third-party contractor. Similarly, most management companies are willing to contractually guarantee savings if a health system increases the volume of its spend with the vendor. The value of these guarantees will increase depending on the amount of new purchasing volumes being made available. A guarantee means, in effect, that the contractor will write you a check if it is unable to achieve contractually promised savings.

Quality improvements through capital investments and outsourcing: Most contractors are willing to make significant capital investments in a hospital system’s operations in connection with their services. The size of the contractor’s capital commitment will increase based on the size of the contract. Accordingly, outsourcing is a way to make quality improvements to operations by using a management company’s funds, thereby freeing up capital for other uses. These types of capital investments, however, are not free. Either the hospital system will pay for them monthly over time or the cost will be factored into the rates that the contractor charges for its services. In addition, these capital commitments can create a barrier to an exit to the extent that they are subject to repayment if the contract terminates early.

Manage purchased services cost effectively: Third-party purchased services contractors have been called on repeatedly to find ways to cost-effectively manage purchased services departments that are regional or national in scope. This has been a trend given the wave of healthcare consolidation over the past nine years. Outsourcing to a third-party contractor leverages their expertise on the best way to manage far-flung regional or system-wide departments rather than the health system taking the risk of doing it.

 Assessing Scenarios 3 & 4

In either of these situations, the best way to maximize value from your third-party vendors is to use a competitive bid process.  However, because other post-merger activities may be a priority, a health system may want to delay a competitive RFP process if: 1) both parties to the transaction are using the same purchased service contractor and that contractor is currently meeting expectations or 2) one party to the transaction is using a purchased services contractor that is meeting expectations and the other party is not outsourcing. In these situations, there may be interest in allowing the existing contractor to combine or expand its operations without conducting an RFP even though electing not to use a competitive bid process might leave some value off the table.

If the health system elects to negotiate a new contract with the existing purchased services contractor without using a competitive bid process, it should consider the following:

Review existing contracts: If a health system has multiple contracts with the existing vendor, it should review the existing contracts and use the best features of each as the starting point for the new contract.

Assess current operations: Consult the operations team to assess what is working and what is not, and tailor the new contract to address any operational issues.

Keep the threat of a competitive RFP open: The existing contractor is not going to put its best deal on the table if the health system is not willing to go to market.

Consider other competitors: Invite a competitor to minimally provide a proposal to gauge what is available in the market compared to what is being offered.

Do not enter into a long-term deal: Even though a competitive bid RFP may not be appropriate because of other priorities immediately after an affiliation, it makes sense to limit the term of your new agreement to three years or less or have a right to terminate without cause so that you can engage in a competitive bid process to test the market at the earliest reasonable time. This will also protect you if the contractor fails to meet expectations.

Practical considerations

There are a number of practical considerations in the context of aggregating purchased services spend with one vendor.

Stagger transition dates: If a number of facilities are transitioning, stagger the transition dates so that the contractor is not biting off more than it can chew. Trying to transition too many facilities at one time can be disastrous.

Account for termination fees or potential costs: Are there any termination fees or capital investments that need to be paid off if you switch vendors? If so, make sure that the new vendor is aware of and has accounted for these potential costs so that the health system does not have to absorb them out of pocket.

Assess your existing spend: When combining two different group purchasing organizations (GPOs), it is critical to understand how much “exact match” spend exists and how much of the spend will need to be converted to new vendors because of the change in GPOs. The more spend that needs to be converted, the more difficult the transition to the new GPO will be.

Assess existing contracts: Confirm whether you can terminate your existing contracts due to a change in control/merger clause or through a right to terminate without cause. Even if you do not have an opportunity to terminate, an existing vendor may still feel compelled to participate in an RFP in order to be considered for the health system’s entire business.

Assess the status of existing employees: Be aware that some management contracts have clauses that prohibit either a health system or a successor management company from hiring the departing management company’s employees. You should not simply assume that either the health system or the successor management company can hire existing managers.

Consolidating your purchased services spend with one vendor is rarely an easy process. If done properly however, it can result in one of the biggest sources of efficiencies and cost savings available following a health system affiliation.

About the Author

Mark W. Phillips

Mark W. Phillips is counsel in Health Care practice in the Washington, D.C., office of Drinker Biddle & Reath. He advises health care industry clients on complex contract negotiations and strategic affiliations.