Few phrases have seen as significant an increase in search interest across the world as “What is inflation.” Likewise, the term supply chain, once the domain of specialists, has firmly become
a part of consumers’ everyday vocabulary. While more people may know what these terms
mean, how they operate in specific contexts or in specific industries is far less clear.
That lack of clarity is what David Dobrzykowski, Claudia Rosales, and Andrew Balthorp seek to address in their recent whitepaper, “Inflation and Healthcare Supply Chains.” Healthcare supply chains, as they demonstrate, function differently from the retail or manufacturing supply chains that many of us have learned more about over the past couple of years. Likewise, inflation affects all members of the healthcare supply chain from equipment and pharmaceutical suppliers to providers and patients alike.
How Healthcare Supply Chains Work
Despite its many nuances, the healthcare supply chain seems familiar on the surface since it consists of three major sections: upstream, midstream, and downstream. Upstream players consist of organizations that focus on the development of care: medical device and equipment manufacturers, pharmaceutical manufacturers, and biotech firms. The midstream sector focuses on two main types of organizations: distributors and purchasing groups that make sure healthcare providers have the materials they need and firms specializing in financing and claims administration associated with the delivery of care. Downstream are those who deliver care – physicians, nurses, hospitals, clinics, home-health services, hospice – and their patients.
But that is where the similarity ends. Over the past 30 years, hospitals have “largely outsourced key supply chain activities,” such as allowing Group Purchasing Organizations (GPO) and other midstream players to handle their sourcing and contracting needs and having medical device distributors cover transportation and distribution of the materials needed to deliver care. Hospitals outsource these activities because they would rather focus on their core competency: delivering care.
Surrendering these supply chain activities, however, exposed them to a few critical risks that inflation has brought to the forefront. Two risks – asymmetrical price stickiness and inadequate supply chain infrastructure – have become particularly noteworthy.
How Inflation Affects Healthcare Supply Chains
When suppliers’ costs increase unexpectedly, they can pass the cost increases, such
as fuel surcharges and other inflation-related costs, to their hospital clients. Across
the economy, input costs have increased by 14.3% whereas healthcare prices have increased
by 2.4%. Hospitals, however, cannot as easily pass those costs on to patients/payors
because fee schedules are typically set via annual or multiannual contracts. The hospitals
often just eat these costs. This dynamic creates textbook asymmetrical price stickiness.
Given that the median hospital profit margin before the pandemic was only 3.5%, the effects of unexpected cost increases on hospitals and clinics can be disastrous. In addition to those cost increases, healthcare providers have also faced increases in their staffing costs. These increases come partly from labor shortages caused by a general tight labor market, loss of workers due to burnout, but also from wage increases to retain and reward workers. The tight labor market and loss of workers due to burnout have increased healthcare providers’ reliance on more expensive services, such as traveling nurses.
It is no surprise, then, that a recent KaufmanHall report estimates that one-third of healthcare providers operated under negative margins in 2021. That represents a loss of $54 billion in net income. For comparison purposes, $54 billion is more than the annual GDP of many nations. Salaries, benefits, and expenses have increased for everyone, with big players like Mayo Clinic reporting an 11% increase in year-over-year expenses and a 66% decline in operating income and the University of Pittsburgh Medical Center reporting a net loss of $844.1 million in the first half of 2022.
While cost increases in supplies and wages have hurt hospitals’ bottom lines, inadequate supply chain infrastructure has reduced their ability to manage some of these cost increases. Healthcare supply chains often lack the technology or expertise to handle stock outs, product shortages, production delays, or other supply chain disruptions. If I order something online and shipment is delayed, it’s frustrating; for hospitals and healthcare providers, these delays cannot occur because patient care often cannot wait. Providers then, must purchase products “off contract” from alternative suppliers or buy more expensive substitute products, which means they cannot take advantage of GPO pricing. As before, hospitals cannot pass these cost increases along easily, further tightening their margins.
It is hard to devote time and resources to develop expertise or invest in technology to improve supply chain outcomes given these challenges. As one chief supply chain officer said, “[we] are in a knife fight just getting product in the door” and don’t have the capacity to make strategic or capital improvements to increase supply chain resiliency. What, then, can actors in the healthcare supply chain do to improve processes and reduce costs?
How to Strengthen the Healthcare Supply Chain
The bad news for the healthcare supply chain is that it will likely be affected by
inflation for the next 18 months. One way to mute these effects is by taking advantage
of new educational offerings and opportunities to develop expertise. Specialized knowledge
offered by master’s degree programs in supply chain management or in similar programs can “help healthcare leaders invest in skills they can leverage to bring innovation
that grows both revenue and efficiencies.” Developing more sophisticated thinking
around healthcare supply chain management, while not a quick fix, can unleash creativity
and create new opportunities for collaboration in the supply chain.
Other solutions include developing new revenue streams and finding new ways to improve efficiency. Direct-to-employer strategies, bundling of services, development of private-label manufacturing capabilities, consolidated service centers, and regional GPOs all represent possible methods for increasing upstream, midstream, and downstream players. Given the tight labor market, payroll pressure may force health systems to consider new forms of automation, including wearable technologies to monitor patient health and technology investments that monitor supply tracking and replenishment.
Across the board, the researchers expect more industry consolidation as the healthcare sector tries to navigate its way through these headwinds. The secret to unlocking more value in this supply chain – for patients, providers, and suppliers alike – may come down to collaboration. As the researchers state, “regardless of an efficiency or revenue-oriented strategy, collaboration through the supply chain will be the key to success…[but] will require changes to existing [processes] and developing new clinical and business processes.”
The organizations that put in the work building, rebuilding, and rethinking how they do business now will undoubtedly reap the rewards in the years to come.