Performance-based contracting comes of age

Performance-based contracting comes of age

With the increasing demands on both groups and manufacturers of hospital products to cut product costs, new contracting programs are evolving that provide both the manufacturer and the group leverage in the group contract.

Performance-based contracts, committed volume contracts and tiered pricing are evolving to provide strong incentives for the hospital to use group contracts.

For hospitals to realize the full potential of the savings resulting from these group purchasing contracts, coordination and teamwork are required. Materials managers are responsible for communicating the benefits of using products that can be purchased through these incentive-based contracts, and they need the support of top management in gaining access to important internal communications vehicles and product selection committees.

Both the GPO and the suppliers are becoming more sophisticated about negotiating contracts for supplies and services.

Though not new in its conception, the performance based contract has gained greater meaning with the growing influence of groups and the manufacturers' relationships with groups.

The continuing dilemma of the groups is the issue of compliance to the contract. Though high levels of compliance are claimed by almost all groups, only certain ones can meet the claims. The balance of the groups may reach high compliance for certain product categories, but they are not carried over to many of the other products under contract. The issue has been to give the hospitals significant enough incentives to use their contracts.

Establishing compliance

What must be recognized by the hospital is that on a line-item basis, the group contract does not always provide the least expensive option. However, the group has analyzed the contracts it offers to its constituency and can demonstrate that the overall effect of the contracts provides significant savings to the hospital over traditional purchasing methods.

A recent study of GPOs conducted by SMG Marketing Group found they all use the same general definition for performance-based contracting. All groups surveyed have some such contracts and are interested in doing more.

GPOs use various approaches to performance-based contracts, including targeting quantity discounts, market share attainment or capitated contracts. All groups that indicated a preference preferred to receive reduced pricing rather than rebates.

Groups recognize that contract terms within the industry are lengthening. Only a few groups, however, include mandatory contract review within the terms and conditions of their contracts.

As part of the continuing trend of implementing fees, most groups now charge manufacturers an administrative or marketing fee. Fees often vary by type of product, length of contract, product volume and marketing effort required to implement the contract.

The level of information available to groups to measure their members' potential use of a contract before the award of a contract varies greatly from group to group. For the most part, the groups depend on manufacturers'sales reports and their estimates of potential for contracting. After a manufacturer is awarded the contract, GPOs recognize the mutual advantage of sharing information and working with the manufacturer.

The ability to measure contract compliance continues to differ significantly between the groups. Many groups stress their reliance on manufacturers for compliance data. Others emphasize their relationships with wholesalers as the key to compliance data. Some groups use both the manufacturer and wholesaler data. Only a few are sophisticated enough to track product usage down to the institutional level on a timely basis to challenge manufacturer reporting systems.

As the first step to understand the evolving contracting environment, a hospital need to study each group's philosophy and its ability to support the contract through its constituency.

Obviously, GPOs want to buy supplies and services at the lowest possible cost, but similarities end there.

The methods each group uses in contracting, as well as the strategies they consider, are often best reflected in their organization's goals. Their philosophies are just as important as membership numbers in determining how best to evaluate contracts a group offers to its hospitals and the performance-based contracts the group has with vendors.

The most important thing to determine from suppliers involved in this new breed of contracts is their capabilities in electronic data interchange, inventory control, order completion rate and plans for improving their services.

Contracts work for hospitals

How does the performance-based contract work to the hospital's advantage? First, using price as a measure and with additional penetration or compliance by an individual hospital, the price of the commodity drops or the discount increases. Second, with additional penetration by additional hospitals, the price would decrease or the discount increase.

With these services in place, the manufacturer is able to assist the hospital in monitoring its adherence to the performance-based contract to achieve the savings negotiated through the contract.

The power of performance-based contracts for proprietary chains is demonstrated when incentive programs are tied to the volume of business. For example, performance may be measured based on a single, large order from an individual hospital, or on total dollars purchased by all members. If the contracted incentive goal is reached, the money is channelled right back into the facilities that earned it.

John A. Henderson is president of SMG marketing Group Inc., Chicago. SMG maintains databases on institutional health care providers and Henderson consults with vendors, (312) 642-3026.

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