Notes from the Field:
Cost Reduction Potential

Perhaps the most common question we get is what the annual costs and cost reduction potential might be for your hospital. Do you know what your real supply chain costs are today? Very few hospitals, surprisingly, do know. Why?

Costs¹ generated by medical and surgical supplies handling are typically buried within many administrative expense accounts. While the most visible components appear in supplies-handling headcounts and payroll, the big costs are usually elsewhere and unseen.

¹ The costs we are looking at here are the process costs and not the cost of the supplies themselves.

Digging out these costs can be very time-consuming and expensive if done using traditional cost accounting or ABC techniques. There is a faster, far less costly approach, as we outline in the sidebar. Using this approach, we found for a mid-sized hospital that:

• 20% to 40% of supply chain spending on med/surg supplies was unnecessary — wasted.
• Supply chain costs were roughly $4,000 per bed per year — $1.6 million annually for a 400-bed facility.
• Cost reduction potential would be $320,000-$640,000 annually in this case.

The factors generating this excess cost seem likely to be present in many, if not most, hospitals. If this is the case, hospitals are probably looking at annual supply chain costs somewhere in the range shown below.

Larger hospitals may well be wasting in excess of $1 million per year handling med/surg supplies. But to tackle cost reduction, you have to know in detail how the excess costs are being generated and how large the reduction potential may be under various action alternatives.

Supply Chain Costing Example

We generally summarize supply chain costs in cost per (purchase) order line. This simple metric effectively reflects the principal cost drivers for most supply chains.

In this example, we have two main channels — direct to floor (i.e., point-of-use location), and via central stores. The added handling in central stores is reflected in the higher cost per line for this supply channel.

Multiplying each of these channel costs by the number of order lines flowing through the channel — roughly 300,000 a year in total in this case gives current annual med/surg supply chain costs of roughly $1.5 million.

How much of this annual cost might be reduced? That depends upon what you find to be generating each cost line and what practical action options are available to you.

 

Estimate the Costs

Supply chain costs are buried in activities, transaction volumes, inventory and space. These costs are hard to dig out without resorting to traditional cost accounting or activity-based-costing (ABC) techniques — both expensive and time-consuming.

An alternative approach, which we use, relies upon careful sampling, activity mapping by supply channel, and end-to-end transaction cost analysis.

If done correctly, this yields estimates that can identify the major cost generators and suggest ways to achieve cost reductions. You do not need process costing to the penny for this purpose.

An example is the the too-frequent ordering encouraged by just-in-time vendor supply processes and by automated stocking systems. Costs generated by the many unnecessary transactions pervade the supply chain but can be difficult to quantify.

But you have to know not just the current process costs but also the costs that might be achieved by process redesign. The difference is your cost reduction potential.

There are typically a number of practical alternatives for process redesign. Alternatives may also be used in combinations, making the estimation of cost reduction potential somewhat complex.

This is where we can help.