Healthcare – Where Supply Chain Digitalization is Life or Death
How supply chain digitalization in healthcare can change the competitive landscape
Imagine: You are in the operating room on the table having surgery. The surgeon just opened you up and as she turns to the instrument table to reach for the pacemaker required for your procedure, she realizes there is no pacemaker to be found. It turns out the hospital employee in charge of managing inventory did not order a sufficient number of pacemakers because he eyeballed the required inventory, and there are no pacemakers left in stock.
Of course this is an extreme example, and the consequences in this scenario are drastic. However, it reinforces the point that inventory management in hospitals is incredibly important. As such, the bias is to over purchase inventory to avoid the aforementioned situation, which leads to increased inventory holding costs. Hospitals currently spend approximately 45% of their operating budgets on supplies and materials, and industry experts expect that hospitals will spend more on supply chain management than labor costs in the near future1.
The impact of supply chain digitalization in any industry is hard to ignore, but the stakes in healthcare are higher. With increasing pressures from insurers and looming uncertainty on healthcare policy, cost containment has never been more important.
Investment in electronic inventory tracking that transfers data on medical supplies allows hospitals to automate the inventory replenishment process when items are used or expire. This differs greatly from current practices where inventory supplies are counted or eyeballed, frequently resulting in either a surplus or deficiency of inventory.
Recognizing the opportunity for increased operational efficiency, BJC Healthcare, one of the nation’s largest nonprofit healthcare organizations located in the Midwest, recently made an investment in technology that attaches radio frequency identification (“RFID”) tags to medical devices. This investment enabled the automation of inventory replenishment and allowed for in-network hospitals to lend supplies to one another, which drove BJC to realize a 23% reduction in required inventory on hand. In addition to cost savings related to inventory holding costs, BJC also realized cost savings from expired product avoidance and decreased labor costs of nurses and clinicians spending time on inventory management. BJC estimates that it will recover the cost of its initial investment, through cost savings resulting from the new procurement program, within a period of 18 months2. BJC was named the ‘Supply Chainnovator’ national healthcare provider of the year award in 2015 by Gartner, a global research and advisory company, for the company’s efforts in supply chain digitalization3.
A major benefit of digitalizing the supply chain is that it makes patient cost-to-serve easier to calculate. This cost-to-serve knowledge is critical to managing healthcare costs, especially in an environment with shrinking reimbursements from insurers3. Also, the potential of the industry moving away from a fee for each service reimbursement system to being paid based on the quality of overall care received will only increase the focus on costs.
The simplicity of this concept, which is common practice in other industries such as retail, could revolutionize the healthcare industry and provide substantial cost reductions. Industry experts estimate that supply chain management practices in healthcare lag other industries such as retail and manufacturing by approximately 10 years1. One of the major hurdles to adopt supply chain digitalization is the decentralized decision-making capacity in hospitals with multiple parties involved in current inventory management practices. This issue is perpetuated by a disconnect between the individuals making the purchasing decisions (doctors, clinicians, etc.) and those actually doing the buying (staff, administrators). Purchasing inventory is only further complicated by the current business environment in which larger healthcare networks are acquiring smaller providers, and a single network is operating on multiple inventory management and enterprise resource planning systems.2
While consolidation in the industry can complicate acquirers’ inventory systems, it will also provide more opportunity to centralize inventory management practices and achieve operational efficiencies across provider and supplier networks. Furthermore, those providers who are earlier to adopt will see a longer period of competitive advantage before digitalization becomes the industry standard. For example, medical professionals’ time spent manually monitoring inventory levels can be refocused to providing patients with a higher quality of care and researching cures for diseases.
In an industry where technological advancements have been made at a glacial pace, how long will it take for providers and suppliers to adopt this model? If supply chain digitalization becomes the norm, will lower supply chain costs drive lower reimbursement levels?
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1 Daniel Chen, David Preston, Weidong Xia, (2013) “Enhancing hospital supply chain performance: A relational view and empirical test,” Journal of Operations Management, Vol. 31, Issue: 6, pages 391-408, http://www.sciencedirect.com/science/article/pii/S0272696313000624, accessed November 2017.
2 Loretto Chao, “Hospitals Take High-Tech Approach to Supply Chain”, Wall Street Journal, October 21, 2015. https://www.wsj.com/articles/hospitals-take-high-tech-approach-to-supply-chain-1445353371.
3 BJC Healthcare, “BJC HealthCare Recognized for Innovation in Supply Chain Management”, May 2015, https://www.bjc.org/About-Us/Newsroom/BJC-News/ArtMID/897/ArticleID/144/BJC-HealthCare-Recognized-for-Innovation-in-Supply-Chain-Management.
4 Bruce Johnson, “Future of the healthcare supply chain”, January 18, 2015. http://www.supplychaindigital.com/procurement/future-healthcare-supply-chain.
Student comments on Healthcare – Where Supply Chain Digitalization is Life or Death
This is an incredibly compelling argument for – as you’ve written – a “simple concept.” The costs of stockouts in the medical world are far higher than in retail / consumer goods; “higher” is definitely an understatement, as illustrated by your opening example. So why is the industry where this really matters so far behind? Hospital management – not doctors, clinicians, or staff – are likely the ones identifying strategic cost-cutting initiatives.
One company advertising such services cross-industry, Mvix, writes: “Consider the amount of inventory that exists across the U.S. healthcare supply chain network. If total healthcare costs in the U.S. are around $3 trillion, the system probably requires inventories equaling at least $300 billion. If a conservative 20% could be eliminated through better inventory management, $60 billion could be saved in working capital… That is a lot of new free cash flow.” 
With these sorts of cost savings, it’s hard to imagine why such technological advancements – which to me appear relatively risk-free – won’t be adopted at scale. As you mention, this is particularly relevant as the industry consolidates; fixed costs of investment in new systems can be spread across networks to make them cost-efficient and enable speedy pay-back. So to my naïve eye, upfront cost seems the major barrier – but I would imagine that with a more intimate understanding of hospital systems, it’s far more complex decision.
 “Can Hospital Digital Signage heal Inventory Management Problems?” http://mvixdigitalsignage.com/blog/can-hospital-digital-signage-heal-inventory-management-problems/
You make a compelling case for digitalizing hospital supply chains, and as other commenters have noted, up-front cost seems to be the biggest barrier.
Thinking through the entire supply chain, I wonder if there is an opportunity for medical supply distributors (e.g. Owens and Minor) to participate and make the up-front investment, rather than the hospitals investing themselves? As we’ve learned in class, transparency and free flow of information benefits every step in the supply chain, and I imagine in this case where distributors are bundling thousands of products for hospitals, the distributors stand to gain as much as the hospitals themselves. Furthermore, margins continue to be squeezed in the medical supply distribution business, so perhaps distributors have a greater immediate incentive to invest in digitalization and push the technology to their customers.
It appears Owens and Minor has already started selling some of its products through Amazon Business, and Amazon itself has been investing in it’s B2B platform, which may be an indicator of digitalization starting through distributors first.  One can only hope!
 “Amazon poised to deliver disruption in medical supply industry”
This is really interesting context to think about inventory management. On the one hand, demand for particular procedures is probably relatively consistent over time – I can’t imagine there being much seasonality or demand spikes for most non-elective, life-saving procedures – so unpredictable swings in demand are probably less pronounced than in other industries. On the other, stock-outs are often a matter of life or death, not just a lost sale . I’d be interested to see how significant inventory holding costs really are. As healthcare providers continue to consolidate, I’d imagine that holding costs will become less significant as provider networks can better share inventory between hospitals under the same umbrella.
Since consolidation of providers and purchasing organizations should address some of the costliness of holding inventory, I think digital has a much bigger role to play in transitioning systems from fee-for-service models to value-based care. I’ve included a few links below describing some of these models and the various technologies required for their implementation  . In particular, developing consistent standards for information sharing, linking costs to outcomes, providing visibility to payors is going to be needed for commercial payors to make any kind of meaningful transition . That said, the Department of Health and Human Services previously committed to transitioning 50% of its payments to value-based approaches by 2018, so the need to engage is both immediate and significant .
In the meantime, I wonder if there is a bigger role insurers can play in motivating hospitals to work invest in supply chain digitization – for example, by subsidizing some of the costs of implementing digital technologies such as the RFID tags you mentioned, in return to trimming reimbursement levels across the board (thus rewarding technologically forward-looking hospitals while punishing those that remain complacent). I fear that many hospitals (especially non-profit ones) are too risk averse and budget conscious to be motivated to put real dollars into digital investment without payor pressure.
 Challenges in digital-enabled JIT buying at hospitals: http://www.healthcarefinancenews.com/news/hospitals-turn-just-time-buying-control-supply-chain-costs
 Overview of emerging models in value-based care: https://revcycleintelligence.com/features/what-is-value-based-care-what-it-means-for-providers
 Role of digital technologies in value-based care: http://www.ropesgray.com/~/media/files/event-media-library/teleconferences/Transition-to-Value-Based-Health-Care-Digital-Health-May-2017-Teleconference-Slides.pdf
 Meeting the data challenge in [value-based] healthcare (BCG): https://www.bcg.com/publications/2011/health-care-payers-providers-biopharma-improving-health-care-value-data-challenge.aspx
Thanks for this writeup! In my last role, I managed a relationship with for a hospital inventory management company, so it is interesting to hear about additional companies disrupting the status quo of inventory management. I think the focus on digitalization will become even more important as organizations move to value based care. Fortunately, RFID technology is one of the technological advances that allows vast amounts of data to be leveraged broadly and incorporated into the supply chain process. The data element of this service is critical because it enables and supports the organization’s transformation from fee for service to fee for value. It does this by eliminating a huge proportion of hours spent managing data accuracy and data integrity. Therefore, in a value based care system where the low cost and high quality of patient care is critical to success, this labor cost reduction is extremely impactful.  The one element organization’s need to be cautious of is that while inventory management systems streamline and simplify the process, it is still essential that the organization has strong operations. While the technology is essential, the operations behind the technology is what enables the system to be scalable and sustainable.