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

In my last visit to this space, I raised several questions about our network of hospitals in an era of health care reform. Fundamentally though, I had one overarching question: Should we attempt to plan the transition to a more efficient and right-sized network of hospitals, a change that could better serve the needs of our communities today while containing costs, or should we simply wait and let the market do it for us? With perhaps just a hint of presumption, I pointed out one or the other will most certainly happen.

The piece had barely appeared when news from the real world seemed to confirm my prediction. A for-profit chain of hospitals in nearby Massachusetts was granted a license to sell a health-insurance product which limited subscriber choice to its own network of 10 community hospitals and affiliated provider facilities.

The “market” it appeared wasn’t going to wait for us to deliberate. The very change I spoke about was seemingly under way. The PBN editorial page (“Quality, clarity, key to health-plan choice,” Dec. 26, 2011) noted the move and pointed out the need for accompanying quality metrics so that consumers could in fact make an informed choice. This critical element of transparency, essential to making a true value judgment, does not yet exist other than in sketchy and inchoate form.

The paper followed up with its readers’ poll question of the week: “What is your opinion of closed-network health insurance plans, which would cost less by limiting health care provider choice?” Not surprisingly, reader opinion was quite mixed, with more than a representative sampling of responders answering “I don’t know.”

Businesspeople, perhaps more than the population at large, might recognize the question as a mere microcosm of our national political debate. Advocates of central planning see health care as a basic human right, a social program, or perhaps at least a sort of public utility. To their right, the more conservative free market advocates want nothing to do with any public oversight or government interference in what they see as just an industry going through a natural transition. Which view is more correct and what are the policy and decision implications of each?

I see the need for regulation in financial and other markets. I recognize the corrosive tendencies toward monopolization in many channels, and I concede that certain commodity services are indeed public utilities. As a health care reformer for almost half my career, I have become frustrated with trying to force the industry into a market-based model in which it simply doesn’t seem to fit.

I don’t need to be lectured to on the rehashed lessons of Friedrich Hayek or Milton Friedman; much less the army of conservative, think-tank hacks who we all recognize are well-paid to provide intellectual justification for the positions that best serve the financial interests of their corporate sponsors.

I am genuinely trying to fix the system – to do the right thing.

So, here is our choice. If we listen to the right, we can leave health care alone. In my view this leaves to market forces the job of streamlining a business in which the government is already more than half the demand – and even the rosiest of conservative glasses don’t see that changing anytime soon. And it is a business in which the public interest demands significant excess capacity, due to seasonality and the unlikely possibility of disasters and pandemics, as well as a business in which society long ago codified a patient’s right to be treated in our emergency rooms regardless of their ability to pay. Fellows in commerce, does this sound like a business to you?

The alternative requires the intellectual freedom and courage to admit that a centrally planned model provides the most direct path to sustainability while avoiding the rough edges like bankruptcy and quality lapses that a true market transition would inevitably produce. It is a difficult exercise in introspection to determine when our positions reflect ideology or self-interest over what we know to be right.

Public oversight and planning of our health care system can be and must be above the political fray and free of commercial conflict, but it can be done. We must believe it is possible for an enlightened society to achieve such an outcome. The Health Insurance Exchange mandated by the federal health care reform now represents the next important and logical step toward this vision of reform. The General Assembly should engage in the meaningful debate it will take to codify Gov. Lincoln D. Chafee’s executive order and make it law.

We could also consider allowing our hospitals to merge into a single cooperative business entity. The recently proposed merger of Lifespan and Care New England would have effectively produced that result anyway. The hospitals have the management structure and expertise to realign their collective priorities around serving the needs of the community in the most efficient manner. They would also have access to the capital that will be required.

We need to free them from the petty concerns of inter-hospital competition and individual fiscal survival and allow them to form a truly world-class, academic medical center capable of competing regionally, and indeed, with the best in the world. To overlook the economic implications of such an entity for our state would be a tragic lack of vision. •
________________________________________
Ted Almon is president and CEO of Warwick-based Claflin Co.

Labels: business, economy, hospital, massachusetts