It is a natural tendency for large buyers to look to eliminate middlemen in their purchasing. The concept is sometimes called disintermediation, and it can occur in any channel of business where customer consolidation creates very large buyers in relatively short periods of time. Our industry should keep this in mind as we consider the seeming trend by some hospital networks toward self-distribution.
If distributors feel threatened by the trend, perhaps we shouldn’t encourage it unwittingly in the way we price products and services. (Manufacturers and GPOs need to look at their policies as well.)
At first blush, it seems odd that any rational make-vs.-buy analysis of distribution services – which are available to many large hospitals and IDNs for low- to mid-single digit markups – would pose a savings opportunity for providers. Indeed it seems unlikely to most industry insiders that any but the very largest and most sophisticated provider entities could achieve anything approaching profitability in such a venture. Still, we hear on a remarkably regular basis of yet another group willing to take the risky and expensive plunge.
Not in a vacuum
This trend isn’t taking place in a vacuum; rather, it is part of a healthcare landscape that is chaotic with change. If there is a primary force behind this change, it may be the rush to form accountable care organizations, that is, entities organized across the silos of medicine capable of coordinating care for a population of patients, both inpatient and outpatient. The energy behind this movement seems to be a collective realization or belief that traditional fee-for-service reimbursement is the driver of escalating costs.
Former neatly separated markets for hospitals, physician/clinics, long-term care facilities and homecare agencies have become homogenized in the emerging ACOs. This presents challenges in nearly every element of distribution, but perhaps especially in contract pricing, a function where manufacturers, distributors and group purchasing organizations have traditionally maintained separate programs for each market segment.
The ACO is looking to save money for an array of now-allied healthcare provider entities, previously served by separate vendors and even channels. Their opening parry is predictable enough: They want to pay the hospital’s price for everyone they buy for. On the surface, why shouldn’t they?
Surprising resistance to pricing strategies
Well, for one, there is a difference in the cost to serve smaller-volume, physically separate and more remote facilities. ACOs may accept this difference, and with it, some difference in the distribution fee (often billed separately). But surely, the base cost should be the same for the same item sold to commonly owned entities, shouldn’t it? Often, of course, it is not, and distributors who have attempted this price-leveling exercise on behalf of their customers have met resistance from some surprising quarters.
We shouldn’t be surprised that manufacturers might object. Obviously, extending deeply discounted contract pricing to customers who previously bought without a contract, or at a higher tier, is a painful profit leak that some will resist. But how about GPOs? This is no indictment, but most GPO programs reflect a purchasing world that is changing rapidly. Most GPO contracts with manufacturers allow different customers in different volume tiers to be priced differently. Providers with multiple facilities may find their pricing varies by “ship-to” location, even for the same item.
Are you starting to see the “self-distribution” logic develop?
So, it is not only distributors that are facing the threat of disintermediation. Increasingly, self-distribution efforts also involve at least some degree of self-contracting (or self-GPO?), as the customer sees another level of fees it can capture, for a service that no longer seems to fit who they are.
Since providers who self-distribute are billed at the net contract price by the manufacturers, they avoid the costly and cumbersome rebate process commercial distributors endure. They are then free to redistribute among all their affiliates as they see fit. It is difficult to know if they are saving anything on the distribution, but the analysis on product cost is quite clear.
Commercial distributors must also reconcile rebates claimed to purchases directly from the manufacturers, thus stifling alternate sourcing of the plentiful gray market for medical products. Self-distributing hospitals and IDNs face no such prohibition, although admittedly, the incentive to do so is less.
The immortal Pogo’s words
In the words of the immortal Pogo, “we have met the enemy and it is us.” For many years, our industry has resisted the obvious efficiency of rationalizing pricing between markets. Yes, nearly infinite price discrimination can enhance profit, but does it do so at a rate greater than the cost of rebate administration, reconciliation, and auditing? And hasn’t it involved at least a bit of cost shifting too? I mean, “rationalizing” simply means reducing the variability in pricing, not necessarily moving to the lowest price when that may, in fact, be subsidized by higher margin sales.
Now it appears our own selfish refusal to change our contracting processes in ways that were clearly improvements may have created a whole new class of competitor.
Ted Almon is president and CEO of Claflin Co., Warwick, R.I.Labels: accountable care organization, aco, competitor, disintermediation, distribution, distributors, price
