When most think about non-labor hospital expenses, consumables and capital investments often come to mind first. However, there’s a substantial category of non-labor spend that frequently slips through the cracks—purchased services. These are the services contracted out to third-party providers, covering a wide range of areas from clinical services like blood products to non-clinical services such as waste management, courier, and lawn services. Despite representing about 30% of a hospital’s non-labor spend, purchased services are often overlooked, leading to a significant gap in the supply chain where savings opportunities are frequently missed.
While often overlooked, “Purchased services is a gold mine of savings opportunity and should be on the list for supply chain leaders to reduce costs,” notes Janie Ott, VP of Spend Management for The University of Kansas Health System, who has led a significant cost savings initiative for purchased services with impressive results.
Understanding the spend breakdown
In a typical hospital’s non-labor spend, consumables take up the lion’s share at 50%, followed by purchased services at 30%, and capital expenditures at 20%. Given the significant portion that purchased services occupies, optimizing this spend could yield substantial financial benefits.
Why are purchased services often overlooked?
- Purchased services are managed through invoices rather than purchase orders (POs). This recurring spend is less visible than one-time capital purchases, making it easy to overlook.
- The decentralization of contract management across various departments limits the supply chain’s visibility into this spend.
- Evergreen contracts with automatic renewals further complicate the ability to track and renegotiate terms, often resulting in missed opportunities to adjust pricing as market conditions change.
- Another challenge is evolving services where new, uncontracted services in existing agreements lead to additional spend. For example, in the lab service category, trends frequently change, and when new services appear, they may not be on contract and lead to exorbitant costs.
- Finally, many health systems experience service area resistance to supplier reviews, leading to unmanaged supplier contracts and imbedded escalations.
The challenges of negotiating purchased services
When managing purchased services, bloated costs are common, especially when there’s a lack of visibility into industry benchmarks and trends. The diverse nature of purchased services, spanning over 500 categories, requires specialized knowledge where most supply chain teams are left with expertise gaps due to the diversity and complexity of these services. Additionally, the decentralized and varied contract structures across different services, such as landscaping versus blood services, make standardization and negotiation even more difficult.
As hospitals grappled with escalating costs during the pandemic, many failed to negotiate de-escalation clauses in their contracts. This oversight continues to burden them with inflated expenses, even in areas where market prices have normalized.
Janie shares, “After COVID, you saw inflation. However, it’s a matter of thinking through that strategically and understanding that it’s only a point in time, so you need to memorialize language that’s going to bring pricing down and have those conversations. For folks who didn’t get that language in, it’s easy to forget about those agreements, and they can become stuck with language that’s less than desirable as the climate changes.”
Why focus on purchased services now?
Despite the challenges, managing the category of spend is crucial in an era where hospital margins are compressed and vulnerable. Only 15% of supply chain leaders are confident their purchased services costs are competitive to their peers in the marketplace, and only 25% are confident their GPO pricing is competitive. Despite a lack of confidence, this category represents a significant opportunity for margin improvement and standardization. With recent spikes in labor and supply costs across industries, purchased services have become even more expensive, making the need for optimization more urgent. Many industries have responded to these pressures with innovations in technology and workflow improvements, providing new opportunities for cost savings and efficiency gains in healthcare.
The savings are real: a model from The University of Kansas
The University of Kansas provides a compelling example of what can be achieved by focusing on purchased services. Coming out of COVID, they embarked on a campaign to reduce non-salary costs by $75 million, with purchased services accounting for just over $17 million of this goal. By carefully analyzing their purchased services spend, which totaled $344 million in 2023, and negotiating contracts, they’ve already achieved $5.2 million in savings fiscal year-to-date.
Purchased services opportunities & strategies
Purchased services are ripe for savings, but it requires the right people, processes, and systems to tackle effectively.
- People: As Janie shares, “People are at the heart. You need dedicated resources with clinical and category-specific expertise that are focused on managing agreements, monitoring pipelines, and pursuing savings.”
- Processes: Just as most hospitals follow a value analysis process to evaluate and management consumables, a centralized process for managing purchased services is essential. This includes establishing contract controls, regular supplier reviews, and ensuring visibility into spend data. “For many health systems, there isn’t a purchased services process in place,” Janie explains. “There may be 30 VPs, and they all have different purchased services in their area, so you have to find a way to centralize it in order to address that spend.”
- Systems: Without the right technology tools, supply chain teams will struggle to contextualize market data, uncover benchmarks, and identify savings opportunities. “Without the tools, you’re going to hinder your people and process, and your results will be limited. There is a strong return on investment for technology,” emphasizes Janie.
The purchased services optimization roadmap
To optimize purchased services, you need a strategic roadmap. Start by demonstrating small wins, building a dedicated team and process, and engaging key stakeholders along the way to gain buy-in. With the support of a technology partner, segment, analyze, and benchmark spend at the category level rather than individual contracts to facilitate successful negotiations and service optimization. Finally, measure and communicate your successes to maintain momentum and secure additional resources.
By taking a strategic, data-driven approach to managing purchased services, healthcare providers can unlock significant savings and improve operational efficiency, making this often-overlooked category a goldmine of opportunity.
