Girard F. Senn
Alexander F. Senn

Oversight by hospital finance executives can help ensure that vendor agreements are airtight and terms are adhered to.

At a Glance  

Finance should lead purchasing contract development by:  

  • Establishing fair prices up front  
  • Gaining buy-in from physicians  
  • Developing a continuous system of controls  


Hospital contracts with vendors for the purchase of supplies-particularly expensive items such as implants and pharmaceuticals-require continual monitoring by hospitals to avoid costly price erosion and substitution of contract products with more expensive off-contract products. Strenuous aftercare, strict oversight, and stringent validation of executed contracts are necessary to:

  • Thwart price erosion and price creep
  • Prevent costly substitutions
  • Ensure that the contract is working for the healthcare organization

Having a sense of humor and patience will help minimize stress, because maintaining contract integrity requires constant vigilance and assertiveness.

Consider the experience of a small health system that was disappointed by the initial results of its implant contract with vendors. Although the health system expected significant savings from its newly negotiated prices, costs did not decline much. After two disappointing quarters, the system commissioned a contract performance audit-and the results were eye-opening.

Noncontract items were routinely being substituted for negotiated items, at higher prices, despite the contract's clarity. Vendors had kept certain costly items out of the contract formulary only to market them later to the surgeons at off-contract prices, with the hospital getting the bills. The surgeons had assumed the products were included in the contract.

Vendors had failed to abide by the contract requirements, despite their signed agreement. When the discrepancies were pointed out, the vendors claimed they had made innocent mistakes. Misclassified supply items, which somehow were overlooked in the development of construct pricing, had been billed at incorrect (higher) prices. In some instances, an operating room (OR) buyer did not thoroughly review the bills and approved payment for those incorrect prices.

Contractual interlopers-vendors not included in the original contract-were delivering and billing for supplies at any price they wanted. Physicians who ordered items while apparently assuming that all vendors would be bound by the contract were informed that implant materials outside the contract were not allowed, and the higher prices could not and would not be paid. Then the health system would short-pay invoices for noncompliant purchases. This move got the attention of the physicians and suppliers.

Although the health system had a strong contract that was saving them thousands of dollars monthly on implant supplies, the contract audit disclosed overpayments totaling $250,000 in the contract's initial six months. The health system proved its case, and the vendors refunded the disputed amounts. The contract auditing process continues, and continues to find overpayments.

Hard-nosed vigilance has netted the system reasonable control of its contract purchasing. Today, the system's finance executives can say, "If it's not in the contract at the price we negotiated, we aren't paying for it." And they mean it.

The Role of Finance in Contract Development

Before price erosion can be corrected, however, fair prices need to be established. Hospitals should develop contracts with fair pricing and seek agreement with the vendors whose implant products are used. Finance should lead this effort if fair pricing is to be accomplished. Finance executives should keep in mind the challenges of developing a contract, dealing with large quantities, and gaining cooperation.

A contract is essential. Although implants typically represent only about 3 percent of the annual line items purchased by a hospital, implant cost represents up to 40 percent of the hospital's annual supply expenses. Decisions should be guided by the hospital's revenue stream and payment history. Experience shows implant costs should not exceed 35 percent of the average Medicare payment for the procedure. And by 2013, the money will become even tighter as the private-payer "cushion" disappears.

The volume of items and vendors means writing such a contract won't be easy. Currently, about 450,000 implant supply items are available for purchase by hospitals from about 200 vendor companies. That's roughly nine times the average hospital's item master of 50,000 items.

Significant cooperation is required. Many hospitals have not developed contracts as a means of controlling supply costs, in part because doing so would involve challenging old assumptions of physicians and other clinical entities, materials management, and accounts payable. Great patience and willingness to listen and learn from others are required. But it can be done. Some hospitals and health systems have met this challenge with outstanding cost savings and quality improvement. Sharing the actual costs and pricing for implants with physicians is key.

Developing a first-class contract with vendors for physician-preference implants and supplies is the first step to controlling price erosion. A first-class contract is one developed by a hospital or health system so the organization can use its buying power to work to its own advantage. This effort should not be confused with a national purchasing agreement, which may cover some of the same supply and pharmaceutical areas, but is not customized to the hospital or health system's particular needs and usage.

And the contract should not be developed by a vendor sales representative, who may write it to favor the vendor and not the hospital.

Because the finance department has the most comprehensive view of the hospital's revenue picture and actual billing data, it is the appropriate source of leadership for the development of the contract. Finance has the necessary current and historical financial information, and it has the technology to display data accurately and quickly. In addition, finance has the scope to bring together the physicians, materials managers, clinicians, and other interested constituencies to form a materials use evaluation (MUE) committee to review and select supplies and set prices, especially in light of employed physicians and comanagement agreements. The MUE, a new concept, is modeled on the mandated drug use evaluation (DUE) committee, which reviews pharmaceuticals. Some hospitals may already have a value analysis committee (VAC), but VACs usually are not empowered to review implants and other high-cost supply items. An MUE should have the clout to get the job done since it has substantial physician membership.

Only when the hospital has determined its implant supply needs and how much it can afford should vendors be invited in to agree to terms. Those that do not agree to the terms should not be party to the contract, and the hospital should refuse to conduct business with them until the next contract is negotiated.

Key Issues in Developing the Contract

Finance should address several important matters in developing a first-class contract.

Margins. Finance should maintain focus on margins, insisting on keeping costs in line with actual income. It may help to know that although the list price on a commonly used knee assembly is $12,500, the average Medicare reimbursement for the entire stay of 3.5 days in 2010 is approximately $11,653. Obviously, the hospital using that implant will lose money on each inpatient discharge.

Waste and explants. Controlling waste and explants (implant materials that are deemed unusable during the case) requires a continuous program of education and training for all physicians and clinical staff. Waste commonly occurs when the hospital is not managing its inventory, leading to wasteful supply usage. For example, surgeons usually need one cubic centimeter (1 cc) of demineralized bone matrix (DBM) to perform a one-level cervical fusion, but vendor reps often supply the DBM in 5 cc syringes, thus guaranteeing waste (and higher costs for the hospital). Although incidences of explants are sometimes caused by improper measurement by the surgeon, explants still should be rare, and the replacement implant should not be billed at full price.

Physicians' mindset. Physicians are much more comfortable with standardized prices than with standardized vendors. Giving them a choice of vendors is essential, as long as the vendors meet the hospital's price.

Shipping. As OR staff know, vendors' sales reps routinely bring implant items to the OR and are present for the surgery set-up on the day of surgery. Thank them if you wish, but don't pay costly, nonexistent "shipping" charges.

"New" technology. The introduction of "new" technology can be a means of sidestepping agreed-upon catalog prices. Don't be confused by new catalog numbers or citations of "FDA 510K classification," which indicates an item is substantially equivalent to current products. Even FDA postmarket approvals (PMAs) indicate only that a product causes no harm. Ask for clinical trial reports for new technology. Vendors make claims; hospitals don't have to accept their word.

Single-price strategy. An ongoing single-price strategy is required to cut through marketing "smoke and mirrors." Recently, an integrated delivery network published for its member hospitals a photo of 100 spinal fusion screws, all lined up in rows, from more than 50 spinal supply companies. All of the screws are "substantially equivalent," according to the FDA, and hospitals are paid the same amount no matter which screw is used. Hospitals with a single-price strategy for the screws are assured of paying the same price for similar products regardless of the manufacturer, while the surgeons are free to decide which screw to use.

Pre-approval. Vendors sometimes try to persuade physicians to use off-formulary products. Their efforts can be countered by specifically excluding all upcharges and off-contract substitutions from the contract, unless the hospital provides documented prior approval by an individual or entity with specific authority to give that approval. It might be the MUE committee; but it should not be an overwhelmed OR buyer.

Contract Controls

Unless contract requirements are continually monitored and zealously guarded, discrepancies can occur, prices can be raised, items can be substituted, and money can be wasted. Here are some strategies that have been successful for hospitals throughout the country.

Load the contract into the information system. Billing and usage discrepancies can be avoided by loading all the items covered by the contract (and their prices) into the materials management system. This task may seem daunting, as the number can reach 180,000 items or more, but it provides an absolute baseline for checking any questionable items or billing. If an item is not on the hospital's materials management list, or the price is not what was agreed upon, the hospital should not pay for that item.

Promise audits, and then deliver. Finance should conduct contract audits routinely, and let all parties know the results. If everyone is operating in good faith, they should be happy to know when discrepancies have been identified and billing errors corrected. Hospitals should rely on the prices they negotiated, not on the list prices.

Compliance. Despite the insistence that sales reps adhere to the contract provisions and rules, some may look for loopholes that could allow them to sell products that are not covered by the contract. If loopholes exist, they should be closed in the next negotiation. Finance also should support and develop the OR buyer to ensure compliance. The annual spend is about the same for all pharmaceuticals and for implants by typical hospitals, but while the DUE committee can rely on the watchful eyes of several full-time staff pharmacy buyers, that typical hospital has just one part-time OR buyer. This staffing disparity is clearly a weak link that should be addressed by finance and the MUE committee.

Rogue physicians. Physicians should be prohibited from requesting items from vendors that are not in the contract. A leak can become a flood in no time, so it is important to communicate frequently with medical staff leaders and individual physicians about how the contract is designed to operate. Physicians should be told that they will have to pay for any more expensive, noncontract items they order.

Unify departments for compliance goal. Unless a challenge arises, the key constituencies for contract compliance-accounts payable (A/P), the OR buyer, nursing, administration, surgeons, supply chain-rarely mingle. Finance should take the lead to involve all parties to establish and monitor procedure margins and safeguarding the contract. The OR buyer is the first line of defense; nursing can maintain utilization; administration focuses on control; A/P ensures payment compliance; supply chain maintains the item master of contracted items; the surgeons evaluate new products to balance the margin with quality and outcomes. Finance should keep all these disparate constituencies aware and alert.

Executives Tell How Controls Work

Kevin H. Walters, CFO at St. Rose Dominican Hospitals and the Southern Nevada Market Area for Catholic Healthcare West, says contract controls are essential: "Once significant effort is made to achieve a contract for construct pricing, it's only reasonable to protect that contract with a tracking system. Controls keep the hospital, the surgeons, and the vendors aligned and on the same page. Our implant supply contract changed how we did business. We expected pushback from vendors, who can play all kinds of games if they're not reined in. Controls were always part of our planning, including regular audits, to ensure that we were getting what we had negotiated in our contract-the right items and the right prices. The primary goal, of course, is to deliver high-quality care to our patients, and we never compromise on that."

Terry Miles, director of materials management, who reports to Walters, says: "The key control is hard-wired, with every item and its negotiated price entered into price files in our materials management systems. Entering those data was an extensive task, but now we can rely on these price files for the two years of our contract, and they should form the basis for future contracts. We're pleased with how well we can control our contract purchases."

Renato "Val" Baciarelli, CEO at St. Rose Dominican Hospitals, Henderson, Nev., was directly involved in negotiating the system's total joint replacement (TJR) implant contract two years ago, working with a consultant and his materials management director. "I wouldn't recommend it for every CEO, but it was necessary and appropriate for me to make the deep dive into the thick of it," he says. "My involvement made an unambiguous statement to our surgeons and to the vendors that we were no longer doing business as usual-that we were going to get our implant costs under control. In fact, now we have significantly simplified the TJR 'bits and pieces' into solid constructs for each type of surgery. We can say, 'This is what it takes to do a hip replacement,' and know it is the gold standard. At the same time, we know we're getting what we negotiated for, at far lower costs."

Three Key Contract Control Areas

Three key control areas for successful contract implementation are price, utilization, and consumption.

Price controls. These are a basic need for all healthcare organizations. When everyone knows what the contracted price will be, the rest of the issues will likely fall into line. Developing a contract is an opportunity to have sensitive conversations with physicians about the implant choices they make and their impact on the bottom line. Involving physicians from the outset in a cooperative effort with the hospital and vendors helps gain their buy-in.

Utilization controls. Utilization is about what you choose to use. Utilization control is primarily (and literally) in the surgeons' hands. They must care about costs for controls to be effective. They need continuous prompting and education about the contract terms and their significance. Peer reviews dealing with the average surgeon's spend and practice are recommended as an objective way to get their attention, as surgeons are acutely aware of their colleagues' opinions.

The nursing and purchasing staff also should be involved and educated on utilization control issues. They can be wonderful allies in controlling consumption and, thus, costs. They even can run interference to influence the surgeons. For example, in one hospital, nursing staff place the contracted blade in the surgery area before an ambitious sales rep can place a more costly, noncontract item in the set-up.

Consumption controls. Even when contracts are written using strong utilization and consumption control terms, costly errors can occur. For example, the standard dose of the orthobiologic Infuse™ used by most surgeons in lumbar procedures is "medium," which costs about $3,000. Yet some sales reps provide hospitals with a "large" ($5,500) dosage, resulting in waste on a grand scale: Hospitals lose thousands of dollars every time the wrong dosage size is consumed. Again, hospitals should manage their own inventory to control consumption.

Another consumption control is to specify that only four explants or other waste will be paid for at 50 percent off list price per month per surgeon. Any additional waste should incur no charge to the hospital. Terms such as these can protect price, utilization, and consumption. Manufacturers may disagree with these terms, which put them at a disadvantage. However, the terms remind all parties that while limited waste is acceptable, if excessive waste occurs, both the surgeon and the sales rep will be held responsible.

Developing a System of Controls

Hospital purchasing contracts with supply vendors are important, but a contract represents only the beginning of an ongoing, long-term process to develop a verifiable system of controls. The savings achieved by contract controls (as well as by regular audits and corrections when discrepancies are found) are substantial and well worth the effort required by the organization and its senior finance leaders.

Girard F. Senn, RN, MS, CNAA, is managing principal and executive director, Clinical Benchmarking, LLC, Glen Ellyn, Ill. (

Alexander F. Senn is a consultant, Clinical Benchmarking, LLC, Glen Ellyn, Ill. (

Publication Date: Tuesday, March 01, 2011

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