Purchasing is the formal process of buying goods and services. The purchasing process for medical equipment and services can vary from one NHS organization to another but there are some key elements that are common throughout.
The process usually starts with a 'Demand' or requirements - this could be for a physical part (inventory) or a service. A requisition is generated, which details the requirements (in some cases providing a requirements speciation) which actions the procurement department. An RFP or RFQ is then raised (request for proposal or Request for quotation). Suppliers send their quotations in response to the RFQ, and a review is undertaken where the best offer (typically based on price, availability and quality) is given the purchase order.
Purchase orders can be of various types including:
- Standard - A one time buy
- Planned - Planned PO is an agreement on a specific item an approximate date
- Blanket - Blanket PO is an agreement on specific terms and conditions - date and quantity and amount are not specified.
Purchase Orders are normally accompanied by 'terms and conditions' which form the contractual agreement of the transaction. The supplier then delivers the products/service and the customer records the delivery (in many cases this goes through a goods in inspection/acceptance process).
An invoice is sent by the supplier which is cross-checked with the purchase order and document specifying the goods received. The payment is then made. With the introduction of modern technology, purchasing processes have been able to change dramatically. Improved methods of communication have meant that order requests can be transferred electronically, notification of delivery emailed, supplier payments automated.
While many Hospitals may find the utopia of fully automated procurement a strategy rather than reality, NHS purchasing departments often find themselves in a hybrid where a mixture of technology, partners and culture may be unable to accept a fully automated approach and traditional and contemporary processes co-exist.
In designing purchasing processes it's important to take into account both how information systems can be leveraged and where Hospital constraints and govenance exist. Whilst some fundamentals e.g. originating need - communicating the need to the supplier - delivery - the payment of the supplier - may exist in most processes - how they are deployed can vary depending on the overall strategy of the Hospital and the prevalence of, and confidence in, information systems.
When designing purchasing processes it's helpful to understand both the traditional and contemporary methods in order to select the appropriate element that applies (or can apply) to your organisation.
Traditional Purchasing Process
Where information technology is not heavily ingrained - traditional purchasing processes tend to be characterised by high levels of bureaucracy, encumbered with manual authorisation (often requiring multiple signatures independent of the order value.), slow communications and a focus on unit price rather than long term commodity arrangements. Due in part to the lack of readily available management information.
The process may require authorisation at various intervals - including at the requisition, Purchase Order, supplier payment process - this may be multiple authorisations at each stage e.g. the operator and his/her supervisor. Sourcing and tendering may focus on obtaining multiple cost/availability options from various suppliers rather than leveraging formal long term contracts. There may be little to no pressure on limiting the number of suppliers used.
Manual Purchase Orders are raised and sent to suppliers:
- Manual acknowledgements are also requested.
- Communication is slow and paper based.
- Periodic expediting activity takes place to ensure delivery schedules are adhered to.
- Items are delivered and forms/documents are transferred within the Hospital to close down orders.
- Manual invoices are submitted and subject to authorisation procedures often requiring signatures to indicate that the Purchasing process has completed satisfactory (and that the order has been met).
Modern Purchasing Process
Where information systems are prevalent much of the authorisation and communication methods that are present in the traditional process can be automated or abolished. Management information is also more widely available (and of better quality) and enables the organisation to move towards automated processes which rely more on exception management rather than transaction management.
The resultant culture is therefore one that focus's more on supplier relationship management and a long term approach that one that focuses purely on transactions.
Modern ERP systems monitor inventory and trends and automate requisitions based on forecast need.
- Automated workflow and approvals engine route requirement to be authorised (where applicable)
- Where formal orders are required suppliers informed electronically either as part of established network or via electronic message. Supplier acknowledgement and changes to terms updated in realtime.
- For low value or less complex commodities - a mixture of Procurement Cards and online catalogues can be used negating the need for formal orders whilst ensuring that robust controls are still in place.
- Use of barcodes/RFID speed up the delivery process, electronic messages covering proof of dispatch and delivery are transmitted by the ERP and stakeholders are advised in realtime.
- Electronic Invoices are submitted and are matched by the ERP against the Purchase order and delivery and then routed for payment negating the need for human intervention. Where Procurement Cards are used - Transaction Management systems route and aide process activity.
- Systems can dramatically reduce the amount of paper documents within a purchasing environment while streamlining the process via use of workflow systems.
Purchasing Activity is usually responsible for significant amounts of Hospital spend, it's important therefore that processes balance risk and control - technology can be beneficial - automating processes, facilitating decision making and it's prevalence within an organisation can have a significant influence over the structure of procurement process. Technology can also eliminate bureaucracy - streamlining processes and eliminating waste.
When Designing Purchasing Processes, consider the following
- How is the requirement identified
- What is the authorisation process within the Hospital
- How will the organisation communicate with it's supply base
- Is a tender process required?
- How are costs managed within the process
- Consider also where performance indicators/measures can be applied
Financial Analysis and PbR (Payment by results)
The NHS now operates a system of payment by results (PbR). Payment by results (PbR) is intended to support NHS modernisation by paying hospitals for the work they do, rewarding efficiency and quality. It also carries risks that need to be managed effectively both locally and nationally. It is essentially a way of paying providers a fixed price for each individual case treated. Each case, such as an admission to hospital, is grouped into a healthcare resource group according to the treatment carried out and the clinical condition of the patient. Then a fixed price or tariff will be assigned to each healthcare resource group, based on the national average cost of treatment in NHS trusts in England.
PbR is a commercial model to make the NHS operate in a more business like way. Before you conduct a financial analysis on a potential investment, you need to evaluate the non financial aspects of it. The data you gather for a financial analysis should identify the incremental (additional) cash flows related to the investment. Specific financial analyses can show you the short- and long-term implications of the investment and the time it will take for the investment to pay itself off.
Deciding how to invest capital resources is becoming more difficult. Purchasing procedural medical equipment is something many clinicians or nurses may consider, and sales representatives for the equipment can always make the investment sound enticing. But how do you really know if the investment will be beneficial to you - financially or otherwise?
To illustrate how the decision-making process works, the potential investment in a phaco-emulcifier is used throughout the article as an example. Keep in mind, however, that the same process and tools can be used to evaluate any type of medical equipment.
Before you consider the financial impact of any potential investment, you need to evaluate the non-financial aspects of it. This is especially important for investments that do not directly generate revenue through PbR, since the nonfinancial considerations of these investments may weigh more heavily on your decision.
Ask yourself the following questions:
(You need to consider whether any revenue will be lost from other activities that this procedure will replace)
- Does this investment fit with the overall Hospital strategy, goals and imperatives? For example, if your Hospital strategy is to focus on more elective day surgery patients, updating your day surgery and adding a waiting area may be more strategically in line with your business plan than buying a phaco-emulcifier. If you do decide to conduct a financial evaluation, it's important to keep your ultimate goals for the investment (e.g., to increase revenue through PbR and/or quality) in mind when you get to the point of making a purchase decision.
- What are the pros and cons of the investment? This question may uncover some significant issues that would make a financial analysis unnecessary. For example, if a neighbouring eye unit was opening down the road, this could impact on the choice, it would not be a good investment.
- What alternative investment opportunities does the Hospital have? When considering a significant investment, it's important to also consider other ways you could use the money and which investment opportunity would be the best fit.
A complete financial analysis involves gathering all of your pertinent financial information into one place and then using that data to analyze the feasibility of a particular investment. Simply gathering the data will help you to identify the estimated incremental cash flows related to the investment (the additional expenses and PbR revenues that you will see as a result of the investment), which can show you how a particular investment will improve your overall business performance rather than just whether a particular investment will make a profit on its own. It's important to further analyze data with a break-even analysis, a payback analysis and a net-present-value analysis. These analyses can show you the short- and long-term financial implications of the investment and the length of time it will take for the investment to pay itself off. While conducting one financial analysis on a potential investment may be adequate in some cases, in others you might get the most complete financial perspective by conducting the analysis three times using data estimations based on "worst case," "most likely" and "best case" scenarios.
Gathering the data
Number of procedures. To estimate the revenues for procedural medical equipment, you'll need to estimate the number of procedures that will be performed with the new equipment. This estimate should take into account:
- new procedures that will be performed on your current patients by you instead of someone outside of the practice,
- new procedures that are indicated but aren't otherwise being performed on your current patients,
- new procedures that will be performed on new patients attracted to your practice by the availability of the new procedure, and
- the number of procedures each of these patients would have per year.
Lost revenue: When a new procedure is added, you need to consider whether any revenue will be lost from other activities that this procedure will replace. If you would be doing these procedures during a time when you would normally be seeing patients in a clinic, for example, you would need to consider the offsetting loss of patient care revenue. To calculate the lost patient care revenue, you need to estimate the number of patients you could otherwise see during the time you expect to spend performing the new procedures.
In most medical practices, frequent decisions must be made about investments that do not directly generate revenue. How do you evaluate the finances of these decisions? Unfortunately, there is no easy answer. If the investment is large, such as an electronic medical record (EMR) system, conducting a financial analysis to quantify the related revenues (e.g., increased charges due to better documentation), costs (e.g., software, hardware, training) and cost savings (e.g., less staff time spent looking for charts, lower photocopy expenses) can be worthwhile. And even for some smaller investment opportunities, doing a financial analysis to quantify the financial impact of the investment on the practice is still important, although the decision may need to be made on the basis of nonfinancial considerations.
Capital, fixed and variable costs
Capital costs, or acquisition costs, are those associated with obtaining the equipment, such as the purchase price of the equipment (including any interest paid), the transportation costs to receive the equipment and the remodeling costs required for the equipment. Fixed costs are those that do not vary in the short term (e.g., property tax, rent, salaries, insurance). Variable costs are those that vary as the volume of activity changes (e.g., supplies, hourly personnel). Differentiating between fixed and variable costs becomes a little trickier when "mixed" or "step" costs are involved. Mixed or step costs are those that contain some characteristics of both fixed and variable costs. For example, if you're adding an hourly medical assistant to help with the new procedure, you'll need to classify the costs associated with hiring the person (e.g., Agency fees) as fixed costs and the hours they spend helping with the procedure as variable costs.
Rate of return: This is the percentage gain or percentage loss on an investment over a specified period of time.
Analyzing the data
Net profit or loss/cumulative incremental cash flow calculations. The net profit or loss for each year is the net revenue for the year minus the expenses and lost revenue for the year. The cumulative cash flow for year one is equal to the net profit or loss for year one. Then, for year two, it's the cumulative cash flow for year one plus the net profit or loss for year two, and so on throughout the analysis.
Break-even analysis. This is essentially a one-year snapshot of the profitability of an investment. It calculates the break-even volume, which tells you how many procedures you need to do for the equipment's revenues to equal its costs on an annual basis. At volumes less than the break-even volume, you could expect a financial loss; at volumes greater than the break-even volume, you could expect a financial profit. This analysis allows you to look at your expected volume of procedures in the future to see whether you can expect a profit in a given year. And continuing to conduct the analysis every six to 12 months can help you ensure that you are using the new equipment enough to at least break even as your expenses (e.g., nursing staff salary and fringe benefits) increase over time. The break-even volume equals the total fixed costs of an investment divided by the difference between the net revenue per procedure and the variable costs per procedure.
This tells you how many years it will take to recoup the money you spent on the investment with the cash coming in (assuming your cash-flow estimates are correct). This analysis involves the yearly net revenue from the equipment, the cost of the investment and the economic life of the equipment, which is the number of years over which revenue is expected as a consequence of the investment. Even if revenue is expected indefinitely, a maximum economic life should be set due to the uncertainty of cash inflow in the distant future. Generally, the economic life of a piece of equipment is equal to the number of years until the equipment wears out, typically five to seven years for most equipment used in surgical procedures. This number determines the duration of the financial analysis.
Knowing how an investment might impact your Hospital's financial performance can be well worth the effort. The payback period takes into account the number of years during which the cumulative cash flow is negative (the "number of years before full recovery"), the negative amount of cumulative cash flow left over that year (the "unrecovered cost") and the net profit or loss per year for the following year (the "next year's cash flow") to show you how long it will take to get your money back on the investment. If the payback period is greater than or equal to the economic life of the equipment, the investment is not financially advisable; if it is significantly less than the economic life of the equipment, the investment is probably worth making.
Based on the concept that money now and money in the future cannot be directly compared with one another, the net-present-value analysis subtracts the value of what all of the cash coming in to you from the investment would be worth today from the value of what all the costs and expenses of the investment would be worth today and shows you how your potential investment would compare to the rate of return of some alternative investment. This type of analysis, which helps you to decide which investment would provide the most value to your practice in the future, is useful when there is an initial lump sum investment at the beginning of a project followed by a stream of revenue over a period of years in the future, as is the case with medical equipment.
This can be illustrated with an example. Let's say you decide to buy equipment and one salesperson offers it to you for £10,500 with an interest-free loan for one year and another offers it to you for £10,000 with payment in full upon delivery. If you took £10,000 and invested it at 5-percent interest for one year, it would be worth £10,500 (£10,000 is the present value of £10,500 one year from now with a 5-percent interest rate). Therefore, to get a better deal from the second salesperson, you would have to negotiate down below £10,000. Otherwise, you would buy the device from the first salesperson.