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Hospital Supply Chain Costs

Healthcare reform of some kind is coming. A primary target: reducing healthcare costs. For hospitals, this means broad-based reduction of operating expense, two major components of which are the costs of medical and surgical supplies and the costs of related supply chain activities — supply logistics, distribution, purchasing, inventory management, accounts payable, and the like.

How large are these costs in a typical hospital? We read that medical and surgical supplies purchases consume between 25 and 35% of total operating expense, with the rest of total expense being administrative and largely payroll-related.

Harder to discover is the specific supply chain component in the remaining 65% to 75% of total expenses. One estimate1 places this as high as, or higher than, the supplies costs themselves — which would be 25% or more of total operating expenses. Can this estimate be even close to being accurate?

If it is, supply chain costs would be an obvious prime target for cost reduction efforts. But how many hospitals today have a reliable estimate of true supply chain costs? Not many, so far as we can tell. Nor do they have a solid idea of how much lower these costs might be.

Supply Chain Costs Are Mostly Hidden

Supply chain costs are generally unknown because they are buried in general administrative expense, mostly payroll-related, that constitute the other 65% to 75% of total operating expense. Identifying specific supply chain costs within this large expense category is normally quite difficult.

To our knowledge, few hospitals appear to have done the detailed activity costing studies needed to root out costs specifically related to supply chain activities. This is probably because such studies in large organizations tend to be complex and quite costly.

Our recent work in this area, however, suggests that many major cost reduction opportunities can be identified and quantified without a great deal of effort. By building a high-level cost model on a foundation of actual supply chain data, we have found that we can readily see both where the main cost pools lie and, by using a simulation methodology, how various process change alternatives compare.

Initial results indicate that major cost takedowns may well be available in many, if not most, hospitals.

Hospital Supply Chain Activities

Since activities drive the majority of costs, we next look at Hospital Supply Chain Activities ...

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1American College of Healthcare Executives

Healthcare Team

Our Approach

Most business process improvement efforts employ activity-based cost models. These are typically accounting models based on detailed time studies.

Such models can provide good data on current activity costs but have problems dealing with cost reduction alternatives. This is particularly the case in supply chains where the relevant context can extend well beyond the typical activity costing domain.

We use a top-down approach that begins with a full supply chain model specifically designed for simulation. We populate this model with actual transaction and inventory data and configure its behavioral rules and settings. Once we can acceptably reproduce the current supply chain metrics, the model is validated for action planning use.

Most supply chains have a great deal of internal linking. A change in one aspect can affect many other model aspects. Trying to model these interactions and links can be nearly impossible unless the model is designed from the outset for this purpose.