The major changes to the market for non-clinical purchased services

Which brings us to the not-so-good news: Any area of growing spend will attract greater scrutiny. With hospital revenue growth stalling, long-term sustainability rests on health systems' ability to reduce expense growth. Hospitals are interested in service partnerships, but they're implementing more rigorous sourcing processes to make sure those contracts are driving long-term value to the organization.

Brett Warner, a director within Optum Advisory Services, works day in and day out with providers who are considering outsourcing deals.  I sat down with him to better understand how providers' service sourcing processes are taking on some qualities previously seen in the product space.

Jessie Goldman: Why do you think we’re seeing this boom in outsourcing? How should we make sense of this outsourcing boom in light of providers’ widespread cost-control efforts?

Brett Warner:  Outsourcing is an opportunity for providers to exit non-core businesses and reallocate their limited human and capital resources. For example, a hospital can offload some of the burdens associated with recruiting and training cleaning or security staff and in turn allow leadership to focus their time and energy on initiatives more directly related to care delivery. But outsourcing does not mean turning a blind eye to cost and quality control—especially given the fact that many providers are strapped for cash. To ensure these partnerships have a good ROI, providers are implementing more centralized and metric-driven sourcing processes.

Goldman: So who's involved in the purchasing process, and how does it differ from what a service firm may have seen three or five years ago?

Warner: In short, we're seeing that the department heads who unilaterally made sourcing decisions a few years ago are now just one voice among many. Centralized purchasing isn't a new concept—we saw it in products with value-analysis committees—but it's only more recently been applied to the services sector. These multi-disciplinary groups bring together clinical, financial, and operational reps. And more unique to services is the inclusion of an HR leader. Signature authority will depend on contract value, but most deals I've worked on have had dollar amounts that end up requiring sign-off from the CEO or CFO. In some cases, an outsourcing decision may also require board approval because of the impact it may have on the community at large.

Goldman: How should service firms think about their value proposition in light of this newly centralized decision-making process?

Warner: Each of these stakeholders is part of the evaluation process for a reason—and each stakeholder's needs must be addressed in some way. For example, finance leaders will want detailed and transparent cost breakdowns while clinical leaders will fixate on the impact of the service on care quality (e.g. HCAHPS scores).  While stakeholder priorities vary, there is a universal trend towards proving service firm value through data. Service firms should arm themselves with historical performance information and case studies that showcase their ability to inflect cost and quality improvement.

Get insight into what really drives providers' long-term margin challenges

Goldman: What changes have you seen with contracting?

Warner: The market is moving toward fixed-fee, performance-based contracts. Service firms are given a lump sum to run the department and then face additional financial incentives (or in most cases, disincentives) based on their ability to meet predetermined financial, quality, and/or operational goals. Given the entire industry shift towards value-based care, this type of arrangement may not seem groundbreaking—but it's actually a big shift from where service agreements were a few years ago. Outsourcing used to mean paying premium management and administrative fees in exchange for third-party efficiency. Service firm performance was evaluated when a contract came to term and many service firms fixated on contract length of term as the number of guaranteed business years.

Now, providers are not only demanding that same efficiency, but actually withholding fees from firms that can't demonstrate continual performance improvement. They're monitoring performance on an ongoing basis (e.g. quarterly) and embedding contract clauses that allow either party to opt-out before the contract comes to term. Interestingly, with this shift, we've actually seen less fixation on contract length. Yes, providers are signing five-year agreements—not because they're guaranteeing five years of business, but because it gives them better leverage for negotiating those long-term performance targets.

All in all, providers are turning to tried and true methods—centralized purchasing process, intense focus on metrics, and commitment to ongoing performance monitoring—as they seek out long-term cost avoidance and quality improvement.  And though not new to the health care industry, these changes are having a dramatic impact on the way providers evaluate and work with service firms.

Editor's note: Keep an eye out for next week's post, which will cover changes in the product sourcing process.