Material Management in the Operating Room

December 1, 2000

Material Management in the Operating Room

Material Management in the Operating Room

By Darlene Amendolair, RN

Cut cost--cut cost--cutcost is all the OR managers are hearing today. Administrators continue to complain thatOperating Rooms are overstocked in supplies and those supplies must be standardized tosave money. One report for the EHCR1 states that management of supplies cansave $11 billion in the healthcare industry. OR managers are very aware that 50% of alltheir costs are consumable supplies, but it can be hard to determine where spending cutscan be made.

There are several strategies to use when formulating successful cost reductions. Onestrategy, managing supply inventory, is a combination of many tasks. Reducing or moving toshare risk with vendors through consignment for slow-moving items is one such task. It isalso essential to perform a physical count annually to assure that inventory documentsreflect what is actually on the shelf. Eliminating obsolete items will increase shelfspace and reduce labor cost encounters when counting those items.Decreasing excessinventory will probably result in the greatest "bang for your bucks." Developingadequate par levels for supplies to avoid stock-outs and losing access to capital is themost common approach to managing inventory. Lastly, it is important to develop trackingsystems to assure the right supplies are on the shelf when needed, but not in excess. Thiswill assure that the efforts to manage cost can be monitored as well.

Understanding the terms that are most familiar with material management is a goodbeginning. Many terms like PAR level, number of turns per year, stock-outs, backorder,on-hand, and economic order point are used to understand how to manage inventory or stock.Is inventory considered an asset or an expense? What is the value of your inventory, howmuch money has been expended, and how much is it costing to keep it there? Also considerthe cost of not having the items in stock when needed. Reducing inventory cost not onlyreduces the capital tied up on inventory, but also reduces the handling costs, waste, andthe risk of money loss due to obsolescence while freeing up valuable storage space. Once aproduct is on the shelf and until it is actually used, it costs the hospital money. Thisexpense is in the form of money that is not available for other uses such as paying offhospital expenses or accruing interest. In addition, this extra handling of the inventorycosts the hospital in terms of labor and processing expenses. It has been reported in theliterature2 that these holding costs can equal up to 10% of the value of theinventory itself.

Turns Ratios

Turns Ratios is a benchmark to help measure what you have on hand. It is therelationship between the value of the inventory on hand and the annual supplyexpenses.Inventory turns ratio = annual expense/ value of the physical inventory.

The more turns of a product in a year's time the less on-hand inventory. Surgerydepartments can have a wide range--anywhere from two to 24 turns. This great difference isthe result of the variety of products, the critical nature of some of those products andvarying utilization of those items. The higher the turns, the less money tied to productsthat are infrequently used. For example, an OR with an inventory of $2 million and withtwo average turns, the hospital can free up $1 million by increasing it to four turns.This may be considered a one-time savings, but by reducing the inventory, holding costscan be reduced by $100,000 which can be realized year after year.

Increasing the number of turns may result in a decrease in on-hand inventory but maycreate a shortage of supplies to meet the need. This can produce an emergency overnight,costing much more than what was actually saved. Yet optimizing the number of turns from anaverage of two to an average over 10 can free 30% of the inventory costs. ClinicalInitiative Center suggests that best performers have 12 -15 turns per year.

More common terms in defining how best to manage the inventory include3:

Lead Time is the length of time between ordering the item to when it is receivedand put away. Lead time can vary with the type of supply, vendor, critical nature of thesupply and delivery systems. Even though you can develop and average lead time for most,it is important to recognize that some items need be ordered a little earlier.

Demand is the average usage of the item over a period of time. Automatedinventory system can provide the best ideal of the historical demands of all itemspurchased. This is usually expressed in days or weeks.Demand and lead-time are criticalelements in developing the PAR level.

Safety Stock is the amount of inventory it takes to prevent stock-out. This isthe balance between the high cost of having the item on hand and the cost of not havingthe product. A good example is an internal stapler the OR may have more on hand becausethe cost of procedure cancellation would far outway the cost of additional inventory. Thiscan also be considered a PAR level.

Order Cycle, like lead time, is the point when it is recognized that an itemneeds to be ordered to the actual placement of that order.

Reorder point is the level of inventory on the shelf at which point an order isidentified. The mathematical formula to define the reorder point includes: the Demand (D =20 days), Lead Time (LT= 3 weeks) and Safety Stock (SS=10). Reorder Point = (D x LT) +SS.Reorder point = (20 x 3) + 10 = 70 units.

Reorder quantity is the number of items ordered each time the reorder point wasreached. This is based on either experience or a mathematical formula called EOQ =economic order quantity. The formula integrates S = Setup cost, which encompasses theorder processing costs. D = Demand (annual usage), CC = carrying cost (holding cost)usually 10% of the product cost, P = price of the product.

Consignment

One strategy that is important in managing the multi-million dollar hospital suppliesis developing partnerships, establishing shared risk activities and enhancingrelationships with distributors and manufacturers. Consignment is an effective means ofshifting the risk to the vendor. In this arrangement, the vendor would own the materialuntil the patient consumes it and the reduction or elimination of slow moving items shouldbe considered. Consignment maybe the best choice for items that live on the shelf morethan 6 months.If a vendor will not consign, look for one that does. Consignment is goodfor vendors because it is easier to sell something once it is in the hospital and on theshelf. This is particularly essential for high cost items such as heart valves. Innegotiating with vendors to consign merchandise, OR material manager should negotiateprice, demand no restocking fees, make sure that they break down the packaging to eachitem and establish and maintain good documentation. This practice reduces obsolescence,holding costs, and loss of the supply while freeing up capital for other purposes.

Management of obsolescence is a good category to tackle. It is very tempting to avoidnew technology and keep the less expensive, established products. Unfortunately, industrywill not let this routinely vary for very long. Few manufacturers desire to continuesupporting equipment that has been replaced with second and third generation items. Eventhough the Federal Government has asked that manufacturers support technology for at least10 years, this has been difficult in the world of medical technology. The best strategy tomanage obsolescence is to avoid it by developing ongoing teams to assess the applicationof new technology, keep inventory levels down to effective levels and keep abreast of thefuture with a well-defined plan.

Careful and thoughtful selection of new technology will optimize the outcome of thepurchase as well as assure efficient use of valuable supply resources. Obtaining newtechnology must be a team approach. The team should include physicians and materialmanagers as well as OR managers. In OR Manager, (September 1999)4, theauthor describes a very effective model to increase the likelihood of the best choice tooptimize the outcome of that new purchase.This model focuses on criteria-baseddecision-making. First the team needs to define the expected outcome--for example, improvepatient-outcome, reduce cost or improve operational efficiency. Once this criterion isdefined, the team will evaluate if the new product meets one or more of these criteria,and then progress to an evaluation phase. If the product meets the established trialstandards, it moves into purchase and implementation phase. Finally, outcomes are measuredover a set period of time to assure that the new product truly is meeting the expectedoutcome measures. This also will give the team an opportunity to evaluate their process aswell.

Capturing costs at the point-of-consumption through the use of electronic scanning andperpetual inventory allows the hospital to reduce inventory levels and at the same timedecreases the incidences of human error and eliminates labor-intensive manual counting.Automation increases the relationship between hospital and vendor. As the UPN (universalproduct number) becomes commonplace on medical materials, scanning at the point ofconsumption will be routine. Bar-coding technology will result in data being inputted intoautomated systems quickly and virtually error-free. This improved data collection willreduce both holding and labor costs. Bar-coding is essential to improving supply chainmanagement streamlining efficiencies and reducing the spiraling cost of materials.

Cost Analysis

The analysis of cost per case/procedure has been the focus in the last few years. Anumber of methods are being used to attempt to accurately predict the cost per procedures.Ratio cost to charge (RCC) is oldest method and most widely used in hospitals today. Thismethod estimates the cost of the procedure through evaluating the charges. The majoradvantage is that it is used widely in reporting Medicare reimbursement. The majordisadvantage is that the method does not help in cost containment.

The next method is Relative Value Units (RVU). This method measures the relative amountof resources consumed by each procedure. RVUs are clinically based instead ofreimbursement based, which is its major advantage. It also presents a method fordetermining the costs of obtaining resources. The major disadvantage is that this methodassumes that resources have equal weight and cannot account for variability. ActivityBased Costing (ABC) is the "new guy on the block." This method is the mostaccurate, but the most time consuming. Each task associated with this procedure is theanalysis of its labor and supply cost. ABC provides a precise accounting of consumedresources and allows adjustments for procedure variability. Unfortunately, this method isnew and time consuming to produce results. In order to precisely identify opportunitiesfor cutting cost and standardizing supplies/ procedures, ABC accounting is the bestmethod.

E-commerce is the emerging material management strategy that will reduce some of theholding and administrative costs related to purchasing and storing supplies. The evolutionto E-commerce is not only the result of the advancing technology of Internet access, butalso the realization that hospitals spend 39% of their cost of supplies on moving andhandling these supplies. This saving target makes Internet purchasing a very lucrativeopportunity. The train is moving very fast to find ways to save some of the enormousamount of money hospitals spend in managing their material inventories. The 1996 ECRIreport indicates that there is an $11 billion dollar savings opportunity. With thedevelopment and expansion of EDI (Electronic Data Interchange), GPOs are scrambling tolink individual customers with sellers. Companies like Neoforma, Medibuy and others areaccelerating their efforts and investing great sums of capital to deploy Internettechnologies. The companies using E-commerce will have less overhead and increase theirability to provide service faster. These efficiencies will play a part in lowering coststo the buyer.

Better understanding of the basics of inventory management will have positive resultsin meeting the demand to reduce expenditures within the Operating Room. OR managers mustfind methods to reduce the quantity of on-hand inventory. Organizational challenges suchas downsizing of personnel, the inflexibility in operational budgets and the constantdemand to introduce new technologies require that capital be freed up to meet those needsand reduce on-hand inventories. OR managers need to work on developing relationships withMaterial Management, distributors and manufacturers to improve in delivery systems; topurchase in desired quantities; consign slow moving supplies; and to negotiate optimalprice. Creating automated systems is a must if OR managers can hope to meet these demands.The future of E-commerce and just-in-time delivery systems lies with newer tools that canaide in that endeavor. OR managers need to continue preparing themselves for these andfuture challenges of the OR environment.

Darlene Amendolair, RN is the Director of Operative Services at the Medical Collegeof Georgia Hospital & Clinics in Augusta, GA.