A Prescription to Improve Financial Health
Monday, September 15, 2014
Posted by: Joy Ingram
by Dave Thorpe, Director, Expense Reduction Analysts
Take now for cost savings
It's a business reality — trying to do more with less. Community health centers' budgets are tight, or shrinking. Yet patients and families rely on you for primary and preventive health care every day. Your community's well-being is closely connected to your center's financial well-being.
As an executive of a mission-driven health care organization, you've already taken a close look at expenses. Perhaps you identified savings opportunities in several expense categories, and made some changes leading to improved cash flow. You believe additional savings are unlikely. But are there ways to unearth even more savings without compromising quality or service? Consider what you could do by recovering cash flow hidden in your supplier base. You could fund new projects, or enhance existing services or programs to help improve the health of residents in the communities you serve.
Discovering additional savings isn't wishful thinking. It's achievable. How? A refocused approach to examining and evaluating expenses is the answer.
Just as you incorporate best practices in your business, I'd like to share some practical tips to help you move further along the continuum from "good" to "exceptional" — best practices based on my experience helping organizations like yours. First, let's focus on the value of a dollar saved, identify some common misconceptions related to suppliers and cost savings, and then discuss best practices.
The significance of savings
What is a dollar saved really worth to you? Every organization is a bit different, but generally speaking, in the non-profit world, a 20% reduction in cost can be equivalent to a 30% (or more) increase in top-line revenue. For example, a community health center with revenue of $30 million —minus $25 million in direct/labor costs and $3 million in "indirect" costs — would realize a $2 million "profit." A 20% reduction in indirect costs would result in a savings of $600,000 for a "profit" of $2.6 million. To achieve the same result without the cost reduction would require that revenue be increased by 30%, to $39 million —a difficult goal in any economic environment. This concept — the intrinsic value of cost reduction — is why you should vigorously pursue cost savings opportunities.
The "business as usual" purchasing mindset drives these conclusions:
- Suppliers give similar pricing to similar customers.
We routinely see pricing discrepancies of up to 30% between clients with the same supplier(s), similar volumes and product/service requirements.
- Your expertise in purchasing in one cost category will produce similar results in another.
Each industry has its own dynamics, cost drivers and business models. This is why it is critical to develop an in-depth understanding of your suppliers' markets to achieve the optimum results.
- National pricing agreements are better than local or regional agreements with the same company.
Actually, we often find in many areas that local contracts can produce superior results. One of our clients was a parts distributor for a large national multi-billion dollar manufacturing company. When we asked them about their rates, they said they had an agreement that leveraged the "deal" the large manufacturer had negotiated. When we reviewed the pricing, we determined that in fact the distributor could be doing much better with a customized local agreement.
- Supplier loyalty translates to best price and service.
Sometimes organizations will focus almost exclusively on high-priority projects to the exclusion of other projects. This may lead to a false sense of security that a loyal relationship is serving them well, and best left alone. We see clients leaving dollars on the table if they don't perform a regular, formal full-market review.
- Volume will get you the best deal.
Purchasing volume is only one of many factors that determine the ultimate price.
- Three (3) bids will get you to the best price.
Although the go-to-market strategy best practice is to source at least 3 qualified bids, access to broad market benchmark pricing and knowledge of the supplier's industry will contribute more to driving the best deal/value for your organization than simply positioning 3 vendors against each other.
- You're asking the right questions in your RFPs.
Possessing access to inside industry knowledge is the key to asking the right questions. We often see the same RFP templates used for bid requests across multiple expense categories. RFPs should be tailored to each individual expense review. This takes time and industry "insider" knowledge, but the effort is well worth it.
- Group purchasing will lower your costs.
Group purchasing through a GPO can lower your costs, but often this is only part of what is actually possible due to the way GPOs are structured. Cost reduction can typically be improved — in some cases by 10 to 20% — by taking a customized approach.
- Lower price means lower quality and service.
Many factors comprise the total cost of ownership, including the quality of the product/service, service delivery and the underlying business process with the supplier. Also, the increasing role of technology could lead to a lower cost structure, and how well a supplier is managing its own supply chain may translate to more competitive pricing without sacrificing quality or service.
- The lowest price is the lowest cost.
Again, one must look at the complete picture to understand the total cost of ownership. A supplier may offer a lower price, but are they transferring responsibilities to the buyer in the process? Adding service/delivery fees for small orders? Substituting an item with an item that is not exactly like-for-like? These are common misconceptions many organizations share, which unfortunately lead to "leakage" — dollars left on the table that could be put to better use.
10 best practice tips to help your organization achieve additional savings
Here are 10 best practices you can implement, along with some of the key questions to answer, to begin charting your course to savings success:
- Develop a strategy and a plan.
What available resources can you dedicate to this initiative to discern and implement cost-savings opportunities? How much of your time can you set aside given your current duties and responsibilities? What about other staff members' time? What's a meaningful outcome (target)? Is this goal worth the investment of time and resources?
For instance, we recently worked with a client to obtain an initial RFP response that offered double-digit savings. The client was very pleased, and when we asked if they would stop there if they had done this on their own, they said yes. However, because we are running multiple projects in the same category with the same suppliers, we knew it was possible to significantly improve upon that savings outcome. The end result? Savings that were more than double what the client would have considered acceptable.
- Analyze and validate your actual purchasing history.
Who has the relevant data you need? Do you need to ask suppliers for information? Who are your largest vendors, and do you use multiple vendors for similar purchases?
- Understand your qualitative requirements for each cost category — it's not all about price.
Are there specific requirements for product use or selection? What about service "musts" — pick-up times, responsiveness to emergency product requests, delivery accuracy, etc.
- Understand your real usage models.
Reevaluate current needs and existing processes. Would process improvements or greater flexibility in service requirements allow you to save money and meet your needs?
For example, a client was spending more than $400,000 on small package freight with UPS and FedEx. In reviewing the client's service requirements, we noticed that one of their offices routinely requested first priority next-day delivery on all shipments. After further examination, it was determined that more than 50% of the shipments did not require this level of service. The result? More than 15% savings for that location alone.
- Understand your suppliers and their respective industries.
Examine market trends, characteristics and variables, including:
- Business cycles
- New developments
- Business processes
- Cost/price drivers
- Pricing benchmarks for similar companies with similar spends, and contracting methods
- Current pricing behaviors across the country
- Alternatives — solutions and suppliers
- True differentiation among competitors
Here's a case in point. We learned that a large vendor has a standard practice of quoting RFPs at a 7% margin. That is what the vendor determined they needed to offer to win the business. However, we also realized that within 6 months of capturing the business, their margins would go back up to 15% or better. Without this level of industry knowledge, how would you manage your negotiations, RFP process and post-implementation contract compliance monitoring? How would you know to even look?
- Reevaluate your current supplier relationships.
- Go to market better informed and prepared.
Request written bids and determine frequency of RFPs; ask the right questions based on your research.
- Negotiate more effectively.
- Develop leverage from your insights
- Separate the negotiator from the relationship owner
- Strategize and plan the negotiation
- Help the supplier save money
- Position yourself as their dream customer
- Know all the contracting options
- Decide, implement and monitor.
- Implement quickly — it's a cash leak
- Price creep — mistakes are likely
- Pay attention to invoice price variances, off-contract purchasing; publish pricing changes, rebates and incentives, discounts and credits, etc.
- Embed the expense control mindset into the company culture.
- Mindset first — techniques, policies and procedures second
- Reframe employee thoughts on spending — do they spend money as if it's their own?
- Do employees understand the impact of controlling expenses on the company and compensation?
- Are employees spending time inefficiently trying to save a few dollars when they could be focused on higher value projects?
- Are cost-savings suggestions encouraged and pursued?
- Do employees recognize the relationship between savings and quality?
As you can see, tracking purchasing history and regularly reviewing your full market options are only a part of the solution to identify additional cost-savings opportunities for your health care center. Clarify your organization's goals and resources, your suppliers' needs and requirements, and collect and assemble the appropriate benchmark data to make purchasing decisions with greater confidence. Dedicate the resources to becoming intimately familiar with your suppliers' industries, and infuse a cost-savings perspective throughout the organization. This is your prescription for better financial health.
Dave Thorpe serves as director with Expense Reduction Analysts, a trusted business advisor dedicated to helping organizations identify cost-savings opportunities to improve their financial performance. He has worked with a variety of health care clients to help them discover "hidden" savings opportunities. ERA's experience with more than 17,000 clients reveals that most companies are leaving 10 to 30 percent savings on the table across large expense categories.
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