American HealthCare Systems and the Challenge of Managed Care

With new initiatives in alternate site and pharmacy benefit management, AmHS is bridging national group purchasing and local managed care.

by David Cassak

• Long believed to be one of the best positioned to deal with the changing marketplace, AmHS is beginning to feel the pressure of addressing the needs of its shareholders, integrated systems.

• Innovative programs in alternate site distribution and pharmacy benefit management will take AmHS into areas that bridge the gap between hospital group purchasing and managed care.

• Some observers wonder whether AmHS’ historic strengths will prove to be weaknesses in the new marketplace as its national compliance program and network of local systems foster greater autonomy for its membership.

• The emergence of integrated systems challenges AmHS to make real the value it brings to members who are finding great temptation to create local solutions to their problems.

Just when product companies were begin-by hospital group purchasing, the market has shifted again. The arrival of managed care has brought a new model of health care delivery: local integrated systems. In the process, integrated systems are undermining the very principles on which group purchasing was built, finding a greater value in local rather than national affiliations and placing at risk the structures that groups have put together over the past several years.

Indeed, it is one of the commonplaces among companies that sell products into the new marketplace that the evolving role of integrated systems will all but put national groups out of business. Some GPOs have acknowledged the challenge either explicitly by allowing integrated systems to establish independent purchasing programs or implicitly through the creation of compliance programs that represent renewed efforts to rein in members that might be tempted to act independently.

San Diego-based American HealthCare Systems(AmHS) faces a difficult kind of challenge. Its historic strengths in compliance and a structure made up of local integrated systems have in many respects anticipated the moves made by other national systems. Still, a growing restlessness on the part of some AmHS shareholders is raising questions: does AmHS’ traditional approach to group purchasing give it an edge in an era of managed care? Or represent even more sizable obstacles?

More to the point, as it readies several innovative programs that bridge the gap between traditional hospital group purchasing and managed care, AmHS officials are wrestling with the issue of how to prove the cost-savings value of its programs, both traditional volume-driven discounted contracting and more strategic initiatives, such as pharmacy benefit management, to local systems who are courting and being courted by vendors looking to sign separate local agreements.

An Alternate Site Program

For AmHS, addressing the broader shift to managed care has begun with an innovative program to incorporate the non-hospital providers affiliated with its shareholder systems into its purchasing program. The first step: bring product pricing in the alternate site down to acute care levels. “Starting almost two years ago, we went to all of our corporate partners and told them that any business that is significant to our shareholders should be considered part of their class of trade,” says Lynn Detlor, president of AmHS Purchasing Partners Ltd., the contract negotiating arm of AmHS. “That means that their acute care pricing should be made available to any of our [providers].”

It hasn’t been easy, Detlor notes, but today most of AmHS’ corporate partners extend hospital pricing to AmHS’ affiliated alternate site providers. But this leveling of pricing isn’t what makes the AmHS program innovative. Indeed, class-of-trade issues are only one reason product suppliers have traditionally insisted on higher prices for the alternate site. Breaking down historic class-of-trade distinctions in order to gain hospital pricing system-wide is becoming routine: Health Alliance, Premier Health Alliance Inc.’s newly launched alternate site program, rests on defining a new class of trade that embraces both hospitals and their affiliated alternate site providers. Today, most national GPOs claim, at least, that they uniformly get acute care pricing for their affiliated non-hospital members.

Rather, manufacturers have also justified higher prices in the alternate site by arguing that non-hospital providers require higher service levels. Thus, the strong focus in most GPO alternate site programs on distribution and on forging relationships with distributors such as General Medicalor Physician Sales & Service Inc. AmHS’ solution: reinventing alternate site distribution as well. “The existing [distribution] mechanism of most manufacturers doesn’t really support the managed care portion of these integrated systems, the outpatient clinics, physician offices, and surgicenters,” says Detlor. “So we’ve had to build that.”

Working with General Electric Co. , AmHS’ corporate partner in diagnostic imaging equipment and related services, to create the order entry and processing programs needed (through GE Information Systems) and to deal with the slower accounts receivables schedule most alternate site providers have (through GE Capital), AmHS is developing, in effect, the first direct distribution channel to the alternate site market.

Key to the program is access, through GE again, to Federal Express, which in pilot programs currently in place at two AmHS systems, Fairview in Minneapolis and SSM in St. Louis, is distributing medical supplies to non-hospital providers on a JIT (just in time) basis. “GE is one of FedEx’s largest customers and through our corporate partnership, we were able to get their rates,” says Detlor. “That gives us overnight delivery to every known address in the country.”

AmHS’ approach is radical not just in the notion that manufacturers can go direct to the alternate site without a significant drop in service levels, but also in the economics of distribution. Where traditional distribution bases its fees on a percentage of the value of the goods being shipped, FedEx charges a flat fee, based more on the size of the package than its value. The economic impact, claims AmHS, can be staggering. Notes Detlor, “We can save our hospitals almost $200 million in distribution costs right now by switching to the FedEx model.”

Take, for example, an order for $100,000 in ophthalmic sutures, which can be contained in a box 16" x 12" x 18". Based on typical margins of 3-6%, the distribution fee for those sutures would be $3,000-6,000. FedEx charges a single rate, usually around $7.50. Says Detlor. “If that doesn’t convince you of the economics of this [program], nothing will.”

A New Economic Model

Not all products will see the same economic efficiencies. David Tiemeyer, Executive Director, Materials Management Services at Fairview, notes that for low cost, bulky commodities, traditional distribution fees may not be that much greater than FedEx’s fee. “Conceptually, this program works best with high dollar items where there is variable use per site,” says James Donnelly, R.Ph., Pharmacy Program at Fairview. “For needles and syringes, which are used in high volume and at predictable levels, the economics aren’t so clear.”

Still, behind AmHS’ new alternate site model is a new economic structure of distribution. Traditional alternate site distribution is a local service-intensive process, requiring a large number of local centers, each carrying a high level of inventory, to provide quick and convenient service to customers with small stocking capabilities. FedEx is able to serve the entire country on a next-day basis from a half a dozen regional centers, eliminating the need for either the hospital or the supplier to carry substantial levels of extra inventory.

The lower overhead and inventory levels, combined with acute care pricing and the replacement of traditional distributor margins with a lower, fixed delivery fee, radically changes the economics of supplying products to the alternate site. And in a managed care environment, argues Detlor, nothing short of a radical restructuring of costs is acceptable. “If we’re really going to get our costs down by shifting more care to the alternate site, we can’t simply build those costs [i.e., the $6,000 distribution fee] back into the system somewhere else. If we do that, we might as well keep care in the hospital.”

But someone will have to pick up the service levels that distributors typically provide. While most manufacturers already work with FedEx in shipping products internally, distributors provide other services besides product delivery, including order processing and the breaking down of bulk shipments into smaller, customer-specific shipments. That’s where distributors come in, such as Owens & Minor Inc. and Baxter International Inc. , who now serve the vast majority of AmHS shareholders on an individual basis. (Baxter is a corporate partner in its capacity as a manufacturer, not a distributor.)

Vendor Neutral

What AmHS has done is not to eliminate the distributor but to reduce its role to the simplest logistical functions. Anticipating the question, Detlor describes how the new distribution program works. “Once the manufacturer is set up to ship through FedEx, who’s going to label all of the different products and tie them together into an order? That’s where the manufacturer goes to Baxter or Owens & Minor and says, ‘We don’t want you to be a distributor who warehouses our product and takes title to it. We don’t need that anymore. What we need is for you to be a cross docker who does nothing more than take bulk inventory, break it down, re-label it, and move it on.”

Indeed, Baxter is one of three partners in the Fairview pilot. AmHS officials note that such distribution programs, while radical in their implications for distribution structure and economics, shouldn’t be all that new for manufacturers. Most already do cross docking and use FedEx to move products internally among different facilities and sites. Indeed, AmHS officials insist the program, as currently envisioned, is entirely neutral, both for AmHS and its manufacturer partners. “This is an open process,” says Detlor. “I don’t care who the manufacturers use as a cross docker, Baxter, Owens, or FedEx itself. Let everyone in the industry argue about who does that.”

Manufacturers should like AmHS’ new program for another reason: for those who have grown concerned that the added importance of distributors in serving the alternate site gives them an uncomfortable degree of control over the distribution channel, the AmHS program neutralizes the growing distributor clout. (See “Distributor Clout in an Age of Integrated Systems,” IN VIVO, October 1994.)

Detlor insists that even the large hospital supply distributors will like this program: they’ll get a percent or two for reassembling packages and won’t take the financial hit that comes with actually owning the inventory, something which should improve earnings for these two publicly-traded companies. “What do these companies need to make Wall St. happy?” he asks rhetorically. “A huge reduction in inventory and in the number of sites in order to free up capital. This mechanism fits that perfectly.”

Moreover, he says, it will limit the investment distributors have to make to get into alternate site distribution (at least as far as AmHS customers are concerned). Says Detlor, “The average doctor’s office spends $2,400 a year on products. That’s peanuts [to large distributors]. As their larger customers evolve toward integrated systems, they’re forcing distributors into something they’re not good at” because the economics are so different from traditional hospital supply.

Whether distributors are, in fact, pleased remains to be seen. O&M has already begun a program of its own that will mirror the AmHS program, serving a broad geography of alternate site customers from a limited number of distribution centers by utilizing FedEx and UPS to actually deliver products. Says one O&M executive, “It’s certainly a lower cost way of doing business.”

Still, the launch of an alternate site distribution program is a radical move not just for distributors, but for AmHS because AmHS has historically not played a role in distribution per se. Indeed, almost alone among the major national groups, AmHS has resisted signing national distribution agreements, and company officials insist that that approach has helped as it seeks to develop new strategies in distribution.

Some other groups, most notably VHA Inc. , collect administrative fees from both manufacturers and distributors, making it hard for them to implement programs that would exclude distributors, as traditionally configured, from the supply process. “Our way of dealing with distribution was not to make any commitments because we didn’t want to have any baggage,” says Detlor. “And that has proven to be very smart because if we carried that baggage, we’d face the dilemma of having one of our leading supply partners leaning on us not to do this.”

And Detlor believes the new model can be adapted for use by hospitals. “We’re starting small,” he says. “But if this works, it’s going to backward integrate. It won’t take purchasing agents more than a heart beat to see that if they can take a significant number of cases of an item on a flat rate basis through this mechanism right into the hospital, not only will their distribution costs go down but they won’t need as much inventory.”

A Standard Package

AmHS’ new distribution program has additional ramifications. One is the development of a standardized national package of products for outpatient procedures, modeled after the custom trays used in hospitals. The difference is that where custom kits have long been the bane of most national groups, as AmHS sees it, they become the key to lower costs in the alternate site in a managed care environment. The key: eliminating physician preference from the kits’ contents, thereby reducing the leverage—and pricing flexibility—of suppliers and creating a true fixed supply cost. “Under managed care, you can’t give the alternate site provider the whole catalog of products, as you do the hospital,” says Detlor. “[Alternate site providers] don’t need to hire staff to do complex surgical set-ups, so there’s no need to have 100,000 items to choose from.”

Instead, AmHS will use its leverage as a national supplier, having created, in effect, a national distribution channel through FedEx, to offer integrated systems a pre-established tray made up of a standard product list, a kind of alternate site formulary. “That means that throughout North America, I have one cost for [the products used in] that procedure. The only variable for the system when it goes to compete for a patient is its overhead. As far as the medical procedure is concerned, we offer a standard cost, no matter where the system is located.”

AmHS’ alternate site program is currently being tested in two pilot programs, SSM of St. Louis and Fairview in Minneapolis. Fairview is using the program to serve selected outpatient clinics among the 142 in its affiliated program, Fairview Purchasing Partners. If the pilots are successful, the new program will be launched nationally by year’s end.

Because the program is so new, key questions remain unanswered. Exactly how the cross docking role will work—how it will differ from traditional distribution—is one. Nor is it known yet whether alternate site customers will remain loyal to their traditional distributors. Notes Fairview’s Dave Tiemeyer, “Some clinics don’t like the program simply because they prefer the high service levels, hands-on twice a week delivery that independent distributors offer.” Moreover, adds Jim Donnelly also of Fairview, “In a complex environment like a clinic, which is likely to be thinly staffed, we have to be concerned about the costs and logistics of receiving and billing for the products.”

And then there’s the question of whether AmHS shareholders will offer the service as a value-added program to selected affiliates, or use it to reduce costs within their own system. “There’s a fairly wide range of applications right now, specialty clinics and primary care, small clinics and large,” notes Tiemeyer. “What we don’t yet know is how applicable it is to each. We may find out, when this is all done, that there are some types of [alternate site providers] who are better candidates than others. That’s what we’re testing now.”

More to the point is the question of how important alternate site distribution is to the clinic itself. Fairview is offering the program as part of a broader package of services as it seeks to extend its service network among affiliated providers in the upper Midwest. “They’re looking for a number of things from us: information exchanges, education programs, clinical pathways,” says Jim Donnelly. “This is just another thing they’re interested in. Is interest high enough on this? To be honest, it’s downstream. On a list of top ten priorities, this is somewhere between five and ten.” Adds Dave Tiemeyer, “As with anything we do, 20% of our affiliates love everything we bring to them, then they get progressively lukewarm after that. We’re clearly seeing more sensitivity to P&L among our affiliates and they’re looking for ways to help reduce their costs. But this alternate site distribution is, relatively speaking, a small issue for them.”

A GPO’s PBM

As currently configured, AmHS’ alternate site program is designed primarily for high volume medical/surgical commodities that account for the bulk of the alternate site product use.

What role pharmaceuticals will play remains to be seen. While many GPO alternate site programs are beginning with pharmaceuticals, Fairview’s experience is that drugs simply don’t justify a separate program. Certainly the program could easily be adapted to drugs, but most alternate site providers, with the exception of nursing homes, are low pharmaceutical users. Says Jim Donnelly, “Most primary care clinics don’t use much pharmaceuticals—they may have one bottle of Rocephinon hand. If they buy $300 a month worth of pharmaceuticals, it’s a lot.”

Specialty clinics, in oncology or orthopedics, are greater users of drugs, he notes, but there are existing distribution networks, such as those established by Axion/BMS, or Cardinal Health Inc. , which would compete with any program Fairview offers. “It’s not like we’re going into an area where there is a vacuum,” he goes on. “We have to make sure we could offer something these existing channels don’t.”

But AmHS officials have other plans for bringing its pharmaceutical program into the managed care era, including the launch of its own PBM relationship. The prospect of linking GPOs with managed care organizations (MCOs), two market segments that, though driven by common market dynamics, have largely resisted efforts to come together, is an intriguing one. (VHA Inc., through its close links with SmithKline Beecham PLChas recently begun a four-way relationship with United HealthCare Corp. and PBM Diversified Pharmaceutical Services Inc. , an SB subsidiary, though VHA officials insist that, for now, the program is simply sharing data on utilization.)

The focus on pharmaceuticals is an important item on AmHS’ agenda. To date, only a handful of pharmaceutical companies—among them Glaxo PLC, Wellcome PLC,Bristol-Myers Squibb Co., Amgen Inc. , Johnson & Johnson , and Abbott Laboratories—are regarded by AmHS as corporate partners, and the alliance’s challenge is to get more pharmaceutical companies to come on board.

Indeed, while AmHS has always had what company officials call “good relationships” with the major drug companies, note that pharmaceutical suppliers themselves have historically been less willing to talk about contracting than medical/surgical companies. Says Lynn Detlor, “Drug companies haven’t wanted to discount their products. Med/surg companies have been doing it for years, and where a company was in both med/surg and pharmaceuticals, the med/surg companies pulled the drug companies in. But [pure play] pharmaceutical companies have stayed back.”

But a host of changes in the pharmaceutical industry, from Federal initiatives such as the Pryor legislation and Clinton’s early health care reforms to the growing clout of PBMs and moves by selected companies to embrace managed care—witness the acquisition of PBMs by Merck & Co., SB, and Eli Lilly & Co.—have, says Detlor, created a new mindset on the part of pharmaceutical companies. That new mindset, coming as the historic lines between hospital group purchasing and managed care are blurring as a result of the advent of integrated systems, is suddenly making national groups like AmHS very important to drug firms.

Critical to AmHS’s strategy in creating new partnerships with drug companies is to begin with a group of market leaders so compelling that, competitively, other drug companies will feel they simply can’t not participate. On the med/surg side, AmHS’ list of corporate partners reads like a Who’s Who of suppliers, part of a larger strategy to give hospitals access to suppliers they were already buying products from so that issues like conversion or vendor qualification become moot.

Asked what will happen if drug companies simply decide not to work with AmHS, Detlor says confidently, “We don’t think that will happen.”

The Challenge of Integrated Systems

AmHS is close to launching its PBM concept, which would represent a significant advance beyond traditional GPO strategies in its embrace of true managed care, not just in attacking pharmaceutical costs outside of the inpatient setting but also in assuming risk for the management of those costs. “The only issue we really have to figure out is the insurance piece,” says Detlor.

For AmHS, as for all national alliances, traditional ways of viewing their shareholders as hospitals—brick-and-mortar health care facilities—is changing. Today, AmHS officials talk of their alliance as an affiliation of integrated health systems rather than multi-hospital systems. And that means making MCOs, or systems that have strong managed care components, an important part of AmHS’ future constituents. “In some cases,” says Jack Bernard, AmHS VP of planning and marketing, “we’re going to be recruiting members that are primarily managed care systems that just happen to own a couple of hospitals.”

The shift toward integrated systems, with their strong managed care emphasis and focus on local markets, is challenging many national groups to create programs and structures to match. Industry insiders have argued for the last several years that AmHS is uniquely well-positioned to work with integrated systems because of its structure, which is essentially an alliance of local systems. AmHS officials agree. Says Detlor, “We’re in a better position than GPOs which only have free standing hospitals where you can’t always get agreement among all of the players. We’re a lot closer to managed care because our shareholders already have that system’s mentality. They’ve gone through that transition, psychologically, of being something other than an autonomous, stand alone hospital.”

A mandatory compliance program, instituted several years ago, which is the heart of the AmHS purchasing program, underscores AmHS shareholder’s ability to bring otherwise independent members into a cohesive program. But the current move toward integrated systems is challenging even the historic sense of what it means to be a system. Indeed, some shareholders, such as Henry Ford and Group Health of Puget Sound, already have clearly emerged among the country’s true local integrated systems. Others, such as Harris Methodist in Houston and HealthWest in Kansas City, are integrating managed care components into their offerings. Still others, such as Main Line in Philadelphia or Forbes in Pittsburgh are forging innovative alliances with other hospital systems to address the new marketplace.

That means that even for AmHS, the emergence of integrated systems raises questions about the role that broader national systems will play in serving local systems, particularly local systems under pressure to come up with unique, specific responses to local market conditions. Many manufacturers now believe that a prominent role by local systems will make national alliances obsolete because of the desire of those systems to act on their own. Typical is the response of one manufacturer. “Everyday I get a call from one of these local systems asking me to come in and talk to them about contracting directly,” he says, talking about groups in general, not AmHS in particular. “It’s getting harder for me to justify a strategy that focuses on national alliances when there seems to be less and less loyalty among the local systems.”

Even AmHS seems vulnerable, despite—or perhaps because of—its structure and historic mandatory compliance program. After several years of winning local systems away from other groups, most notably Henry Ford in Detroit and the Lutheran General/Evangelical system in Chicago, AmHS has seen several systems slip away recently, including Christian Health Systems in St. Louis, which left to become part of Barnes/Jewish-Christian, HealthOne in Minneapolis (now part of Alina) and Samaritan in Phoenix. In each case, the former AmHS member merged with a system that belonged to a competing national alliance willing to give the new system more autonomy in decision-making, particularly in purchasing. AvMed Santa Fe, a Florida HMO, just left VHA to join AmHS, bringing with it three hospitals.

And there is even talk among some vendors that those shareholders who remain in AmHS are chafing under a national structure that sometimes seems to be less and less relevant to them on a national level. Says one manufacturer, “I think integrated systems pose a real challenge to AmHS. They have to do something to respond.” Adds another, “They’ve talked the talk about compliance for a long time; now we’re going to see if they can walk the walk.”

Playing Politics

Some AmHS shareholders havestruck a more independent stance, Yankee Alliance in New England, or Los Angeles-based UniHealth, which recently signed a capitated agreement with Baxter. Says one AmHS vendor, “The large national systems, AmHS included, have got to learn how to accept separate programs for their subsystems or they’re going to be in trouble. A number of their systems are asking for programs outside of the AmHS agreement, and we have to be prepared to give it to them. These systems are either going to get it from a corporate partner within the AmHS program or they’re going to get it outside the program.”

AmHS officials acknowledge that members are beginning to feel the need to create local programs, but they contend that concerns that AmHS’ historic compliance is cracking are overstated. “The premise that the development of local networks will hurt AmHS is really off the mark,” says Jack Bernard. “In virtually every major market we’re in, we have a very strong base with committed, compliant hospitals.” Adds Lynn Detlor, “If anything, we have more systems who would like to participate with us but don’t meet our criteria. It’s just wrong to say that our kind of structure is dead; we’re actually growing.”

AmHS officials say that the debate, largely centered in the manufacturer community, is driven by a political agenda. National alliances aren’t dead, says Detlor. “But a lot of manufacturers hope they are because they recognize that ultimately five or six of us are going to be very powerful forces and they’re trying to keep that from happening.”

In particular, AmHS officials claim that it isn’t AmHS corporate partners who are planting the seeds of dissent, it’s manufacturers who have been shut out of AmHS national agreements. “Who’s creating the problem?” asks Detlor . “It’s the vendor outside of the system who wants to break up AmHS to get access to these customers in a way that he can’t now because they’re compliant, so he offers a loss leader and says, ‘See what participating in AmHS is costing you?’ But would that company be willing to put that price on a contract at AmHS or Premier or VHA? No way.”

Reigning in Hospitals

One area where integrated systems will challenge national alliances is in contracting for high tech, physician-preferred items such as orthopedic implants—product lines that individual systems will have to get under control because of their high cost, but that national systems have largely stayed away from because of the difficulty of gaining compliance on such contracts.

AmHS was one of the first major alliances to sign a national orthopedic implant agreement, first with Smith & Nephew Richards in 1992, then adding Zimmer Corp., which is a division of corporate partner BMS, a couple of years later. Moving into these more clinically-oriented lines hasn’t been easy. There are rumors that five AmHS shareholders recently tried to bolt from the national agreement to contract directly with Zimmer, reinforcing the feeling at some manufacturers that national alliances like AmHS are most effective in lower tech, commodity product lines, but will have trouble contracting in more physician-preferred areas.

Detlor insists such rumors are unfounded, but does note that AmHS will have to be more selective in contracting for physician prefered products. “It’s an area in which we can be effective, maybe not by creating national agreements, but by targeting a much smaller subset of our membership.” In addition to orthopedic implants, which AmHS launched at just 300 hospitals, the group has recently begun to look at cardiovascular products as well.

Detlor argues that reports circulating that AmHS “lost” battles in which BJC and Samaritan bolted to VHA are wrong. “We didn’t lose anything,” he says. “BJC wanted to stay in our purchasing program and still be able to do its own thing. We said no. It’s not that they went to the VHA to access its purchasing program. They chose to be independent and we turned them down because we have certain rules. And we’ll continue to make that call. We won’t in any future scenario allow shareholders to participate on those terms.”

AmHS officials insist that manufacturers who see the new environment dominated by local systems making independent contracting decisions are placing their bets on the wrong horse. But it isn’t quite so simple. Widespread supplier defection, reflected in much deeper discounts being offered to local systems than to national groups like AmHS, VHA or Premier would, in time, become a self-fulfilling prophecy. It may be true, as AmHS argues, that national alliances still generate better savings opportunities than local systems can. But they do so only as long as manufacturers reserve their best pricing for national groups. Should manufacturers suddenly decide that local systems merit better pricing, the protests of all national alliances, not just AmHS, would fall on deaf ears.

That’s why AmHS officials are as likely to be critical of individual shareholders who break ranks as they are of manufacturers who encourage them. “Sure,” Detlor acknowledges, “there are some [individual shareholders] who feel they have to chase a better price. But once they get outside the national group, which way, over the long run, do you think their prices are going to go?”

The experience of one AmHS system, UniHealth, is a case in point. Having signed a capitated, risk sharing agreement with Baxter, UniHealth has been forced to renegotiate the terms of that agreement three times in three years, in part to keep up with declining prices, in part because the system didn’t really have a handle on its costs.

AmHS officials insist that sticking to the AmHS program would have driven much greater savings. Indeed, Detlor argues, local prices invariably drift up after time, if for no other reason than individual systems lack the national perspective or index against which to monitor their own pricing. In time, most systems come back into the fold.

Beyond Price

Rather than appeasing rebellious shareholders, AmHS officials argue that such systems bring as little to their national alliances as they apparently believe the national alliances bring to them. “I’d rather have every non-compliant system or hospital go to Premier or VHA,” he goes on, “because if I could push those systems to our competitors, the disparity between the national groups would widen. You look at the guys who complain a lot and we’ll always have a financial advantage over them because they have no discipline. We’re glad to let them go.”

Still, many manufacturers insist that it is the local systems, looking for exceptional programs to deal with local needs, who are undermining national contracts, not the other way around. Says one vendor, “We’re definitely being pushed by the local systems to do something innovative. If national alliances are to stay viable they have to embrace programs that are sometimes atypical and outside what they offer [nationally]. Their individual members are pushing vendors to do something creative and we either have to respond or we’ll see the business go to our competitors. “ Such trade-offs hurt AmHS as much as the vendor. “The key for them is to restructure their program so that when we go to an individual system with something special, they can accommodate it.”

AmHS is hardly alone. Implementation has historically been a stumbling block for all national alliances, particularly at the level of the individual hospital materials manager. Says one GPO executive, talking broadly of implementing a program, “You really have to sell this at the level of the CEO because often the materials manager has a personal relationship with [the non-contract vendor] and no amount of proof of savings can convince him to switch on his own.”

Implementation becomes even more difficult with the more strategic programs AmHS is launching. Vendors themselves often find obstacles when implementation moves down to the level of national account managers talking to more junior GPO executives. Says one national account executive, “Those [strategic] discussions take place between our senior management and their senior management. But when I go in to talk to them, the person I deal with looks at me cock-eyed when I discuss [these programs]. He simply wants to know if I can give them a lower price.”

The key for AmHS is to move beyond pricing issues and deliver services that have a value that is as radical in its revamping of the system as managed care is more broadly for its shareholders today. Argues Detlor, “The only thing you get with all of this talk about systems doing their own contracting is that everyone is back chasing nickels and dimes when there are dollars to be had.”

Wishful Thinking?

Detlor argues that claims by manufacturers that local systems acting independently will undermine national GPOs, represents a kind of wishful thinking. “The vendor community would like to see national systems go away so that they can go back and randomly price the local systems to get their margins up. They don’t want to get leaned on by organizations like ourselves.”

But it isn’t only wishful thinking. While some manufacturers would, without question, prefer to return to a time before national groups wielded influence, many feel the same frustrations that national GPO executives do about non-compliant members, especially those who try to use the group price to leverage a better deal. Says one product company executive, “A lot of these systems see the group price simply as a ceiling. They’re coming back to us and saying, OK, we have the group price, how much better are you going to do for us?”

The practice, a variation on cherry picking, isn’t new. But it comes with an added threat today when the cherry picker isn’t an individual hospital but an integrated system that can mandate compliance within a network that may represent 20-30% of a local market.

Lynn Detlor argues that manufacturers are too quick to respond to such demands. “Most [product companies] over-react,” he says. Despite years of working with national alliances, the first time they hear from a customer that a competitor is offering a lower price on a local level, they give in out of fear that if they don’t do something, they’re going to lose the business. “What they should be doing is reviewing for that customer what that relationship, through the national organization, has done for both of them over the last several years,” he argues.

For most national groups, the struggle to keep in line independent members is a continuing battle. Organizations like Premier, VHA, AmeriNetInc. or United HealthCare Corp. have built their programs on the assumption that members didn’t need to participate or would do so only opportunistically, either because those members are large enough on their own to negotiate good deals or because a lack of ownership between hospital and group leads the hospital to take a more distant attitude toward the national group. Thus, programs are designed to be innovative enough to attract a large number of the group’s members, but flexible enough to allow for defections.

The $64,000 Question

AmHS, on the other hand, almost uniquely among national groups, has built its program on very different assumptions: that all members would comply and that the group was better not having members that didn’t participate rather than accommodating them. Even the corporate partnership program is, at heart, part of a broader philosophical impulse to get away from having to fight compliance wars so AmHS could focus on other issues. Says one industry executive, “Their attitude way back then [when the corporate partnership program was launched], was, Let’s not even bother with this. Let’s give the hospitals access to market leaders and take that issue [i.e., compliance] off the table.”

The trend toward integrated systems adds a new wrinkle to the challenge that Premier and VHA face, but doesn’t fundamentally change the way they have historically viewed their relationships with their members. For AmHS, potentially at least, it does. The irony, as AmHS officials see it, is that the very strategies that other groups are now adopting to deal with integrated systems have been part of its program for years. Says Detlor, “What’s the rage now—Compliance programs? We’ve had ours in place for eight years. Partnerships? I can remember going to a GPG (Group Purchasing Group) meeting and being the only one willing to talk about being partners with our suppliers. Now everybody wants to do that.”

Even the current trend toward member clusters and regional partnerships are, he says, a copy of AmHS local-systems structure, with the difference that AmHS’ local organizations are true systems, not alliances of otherwise independent providers. But even those local shareholders are beginning to recognize the tensions of a local market. Fairview has historically been one of AmHS’ most compliant members, one of the original AmHS shareholders. But ask Dave Tiemeyer what role national organizations play in helping Fairview deal with the demands of a market like Minneapolis, and he responds, “That’s the $64,000 question.”

Tiemeyer argues that AmHS will look different five years from now “because there does need to be some tweaking of our programs to fit better with the needs of those regional marketplaces.” The evolution of programs in alternate site distribution and pharmacy benefit management are part of that—an effort to address specific managed care needs of its shareholders. But he notes, “There will be integrated service networks carved out in local markets that have specific needs that can’t be addressed through a national program.”

In particular, where the new local system is formed by the merger of several different systems, compliance to any one national program becomes more difficult for the new organization. Notes Jim Donnelly, “I think what we’re going to see is organizations who believe that compliance is an appropriate goal for a national alliance, but we’ll have to back off of that commitment to compliance while they resettle. They may still see AmHS as an appropriate mechanism, but there’s going to be an interim period of adjustment. We’re not going to be able to fire down 15 lanes of the freeway and have everything fall right in line as we’ve been able to in the past.”

Still, Fairview tends, if anything, to see a stronger role for AmHS as it goes forward, not a weaker one. Part of that comes from the commitment of AmHS shareholders to see AmHS as a tool in accomplishing what they need to in their local markets. “You have to go back to the beginning of AmHS,” Donnelly goes on. “People tend to think AmHS started the day the compliance program was launched. But from the very beginning, we’ve built our program on the notion that when we sign an agreement with a vendor, we’re going to make a good faith effort to live up to it. Compliance is really only a report card, a leadership tool where we can say to someone, This is what we’ve agreed to do. You’re not there. What’s the problem?”

“Does AmHS serve a purpose?” he asks. “Yes, because it’s the shareholders who determine what AmHS is going to do next. When we commit to something it’s not because someone in San Diego thought it was a good idea but because we as shareholders have agreed we can make it work. [AmHS] represents the collective interest of the group, and as long as we as individual systems are involved in defining that, AmHS will be an important part of what we want to accomplish.”

That’s not to say there isn’t debate and disagreement within AmHS shareholders about where to go next. But says Tiemeyer, reports of dissension among the individual shareholders tend to be exaggerated. “There may be some shareholders who find the programs don’t fit with where they want to go. But I sit on the Materials Committee, and I see a lot of solidarity and commitment. There’s a lot more sharing of information and support for each other than I’ve seen before.”

A Sense of Change

“It’s my experience,” Tiemeyer goes on, “that in those meetings, we’ve gone from a spirit of ‘I’ve got a better deal than you,’ to one of real collaboration. And that’s going to be the true test of the future of AmHS: our ability to communicate and be open with each other.”

Jim Donnelly argues that while achieving compliance is more difficult given the emergence of local integrated systems, to back off high compliance demands simply makes matters worse by creating a vicious cycle. “Look at the groups who have taken that attitude with their hospitals that these aren’t real contracts and use us when you can and when you can’t that’s okay, too. For the last ten years, all they’ve done is encourage their hospitals to leverage those contracts” to get a better price.

Still, notwithstanding the implicit accommodation in the way shareholders like Fairview view AmHS, the sense of change at the national level is strong. The arrival of a new CEO, Robert O’Leary to replace Monroe Trout, has fueled speculation among AmHS’ corporate partners that changes are coming, especially given O’Leary’s history, which includes stints as the head of American Medical International Inc. (before its merger with National Medical Enterprises Inc.) and VHA. AmHS officials insist that early signals suggest no fundamental change in strategic direction by O’Leary. Still, as one industry executive noted, “When have you ever seen a CEO come in and not make changes?” (O’Leary declined requests to be interviewed for this article.)

Given its historic focus on compliance and partnerships, the challenge for AmHS is clearly to prove the value of its programs to individual shareholders who, in an era of managed care, are increasingly seeking local solutions to local pressures. That means convincing them that the tangible savings from volume-driven discounting are best accomplished at a national, not a local level, where the greater clout of 40 combined shareholders will, in the long run, exceed any immediate opportunistic deals local systems can sign with worried vendors.

But even beyond these hard savings, AmHS must find ways to make real the benefits and savings realizable from more strategic programs, such as alternate site and PBM, that local systems can’t create on their own working with individual vendors.

That’s why it’s important that the alternate site program, in its connection with FedEx, is not just a new way to distribute products, but also delivers demonstrable savings. Perhaps not surprisingly, some of the more innovative initiatives will be offered as elective, not mandatory, programs. Says Lynn Detlor, “I want to start with a small universe of our members and then watch as the others look at what they’re accomplishing and say, ‘Why aren’t we doing the same thing?’ What we want to do is to set some targets and then let others follow because in today’s environment, you can’t bring everyone up to the same level at once, nor should you try to.”

Still, as managed care fundamentally changes the economics for health care providers, AmHS officials are more likely to stress the need for radical new programs and new ways of doing things that, just as fundamentally, change the economics of the services they deliver to their shareholders. “There will always be [shareholders] searching for that extra penny off a price in the belief that it has an impact on their overall costs,” says Detlor. “But though the industry plays up to it, cherry picking on price really does very little. Changing the distribution mechanism, changing key strategic initiatives can do a lot because they establish a new floor.”

And that means fundamentally changing what AmHS does as well. In one respect, Detlor agrees with critics who charge that the advent of integrated systems threatens national alliances, not because of their national structure per se,but because of the need for those alliances to reinvent themselves in the new environment. “I can’t say for sure whether national alliances are going to survive or not,” he says. “Certainly, simply being a national alliance is no guarantee of anything.” The ones who do make it, he argues, will be those who have the strategies and vision to create the kinds of radically different solutions that managed care calls for. “The question is, what exactly is the group planning for? And how will those plans deliver value to their shareholders? The national alliances that survive are the ones addressing those issues now.”

Corporate Partners as Resources

Radical in the way it redefines the distribution channel to non-hospital providers, AmHS’ new alternate site program is innovative in another respect: the way it utilizes the capabilities of its corporate partners to create programs that often have nothing to do with the products those corporate partners traditionally supply.

Tapping into the expanded resources of partners such as General Electric, Du Pont, 3M, and Kodak, AmHS officials are as likely to see these partners as providers of skills or technology as of products. AmHS’ first venture in this area: last year, it worked with Baxter and Du Pont to create a new exam glove.

One challenge in creating these kinds of alliances: getting over the “not-invented-here” syndrome of most companies. “Initially there’s the attitude that if they’re not doing it in their own shop, they don’t want to be involved,” says Lynn Detlor.

A related and even stronger issue has to do with competitive turf battles. “There are a lot of turf issues even when both sides think it’s a good idea,” he goes on. “Sometimes that turf issue becomes like a steel door.” But AmHS officials argue that partners who can look beyond such issues will see even greater rewards. “When we brought in the pharmaceutical companies to talk about the PBM, the message was clear: you may be weak in one area, but by having your competitor as part of this program, you no longer have to worry about that. Sure there are turf issues. But if they can get past that, there are some real opportunities here in terms of dollars to be made. But I need them to help me bring everyone together.”

For the corporate partner, such alliances not only help an important customer address new needs, they also can open the door to new contracting opportunities. “Partners who don’t have a full line, have an opportunity for them to work with someone else to bring in products to complement their offering,” says Detlor.

Creating standard kits in the alternate site is one way of bringing corporate partners together to create a new product offering; AmHS is also talking with pharmaceutical companies about pre-packaging different products in a single unit and with other partners to develop new med/surg products. They’re also working with partners like Du Pont to develop new materials in packaging to lighten shipping loads and lessen the environmental impact.

Group Health: A Different Kind of Shareholder

One of AmHS’ oldest shareholders, Seattle-based Group Health of Puget Sound, is leading the redefinition of AmHS’ core constituents as the national alliance enters a managed care era. Indeed, at first blush, Group Health “looks like a traditional staff model HMO,” says David O’Brien, Group Health’s CEO. It owns two acute care hospitals, five specialty physician groups, and 30 community medical centers. Virtually the only patients receiving care at these facilities are Group Health enrollees.

But increasingly Group Health is contracting outside of its own facilities to provide care for its covered population, both because Group Health’s network of owned facilities isn’t large enough to provide care for all of its covered lives and because that existing structure doesn’t cover a wide enough geographic area.

Implementing that expanded coverage is one of Group Health’s prime challenges. “It’s one thing to work with those providers where you have high penetration in a concentrated market,” says O’Brien. Developing programs and extending opportunities to them are relatively easy. But it’s tougher for those providers for whom Group Health enrollees represent only a tiny fraction of their patient base.”

As it expands its own network, Group Health is wrestling with how to make the efficiencies of its system work for physicians and physician groups outside its own providers. Says O’Brien, “We have to make sure that we’re providing the same opportunity to patients who go to providers outside of our own staff model as we are to the ones who go inside our system.”

And that means extending the opportunities AmHS brings to Group Health’s staff model to independent practitioners and providers. “As we develop relationships with other hospitals and specialty clinics and even family practice clinics, we want to be able to extend to them the benefits we get through our contractual relationship with AmHS,” says O’Brien.

Indeed, where other MCOs might take the attitude that extending such benefits is not their business—i.e., providers outside the system who accept an MCO’s rates are at-risk to make sure their costs are in line—Group Health sees it as part of its mission to help providers outside its system lower their costs. “If their costs are excessive, we won’t get from them the kinds of capitated rates we need to provide cost-effective care to our patients,” O’Brien notes.

O’Brien acknowledges that compliance gets tougher as Group Health tries to extend its program. “As we go outside our staff model, that’s going to adversely affect our ability to mandate compliance. We’re not always going to be serving physician offices that have all of their patients coming from Group Health. We’re going to run into more and more physicians who see 95% of their patients coming from outside our system.”

Still, O’Brien insists that as Group Health creates new programs to expand its local market coverage, he tends to see AmHS as more relevant, not less. Even as he acknowledges that the nature of Group Health’s relationship with AmHS is different today than it was five years ago, O’Brien argues that Group Health is more likely to be compliant rather than less. His response to product suppliers who see national groups as irrelevant as integrated systems wrestle with local problems: “That’s not our experience.”

In fact, he says, “Our challenge is to take those cost-effective supply services and make them available in any setting where one of our patients gets care. We need to reduce costs not just for providers within our staff model, but for all providers within our network.”

O’Brien notes that Group Health’s role as a staff model provider and the time it has had to develop its managed care program has made it easier for Group Health to adopt the compliance and standardization programs AmHS’ committed contracting requires. “Other systems who are trying to put together their own local networks may not have that same discipline right away, in fact, they may never get it.”

One area of potential opportunity for Group Health to marry local initiatives with the national programs offered by AmHS is in disease management. A recognized leader nationally among local systems in disease management, Group Health has identified 8-12 disease states that it is currently developing clinical pathways for, including cancer, particularly breast cancer, cardiovascular, diabetes, and hypertension. “This isn’t just diagnosis and intervention,” says O’Brien, “but the full continuum, from education, prevention, and follow-up.”

The program also includes products. “In a number of these areas, we’re just now beginning to define ways that appropriate supply use is relevant,” he goes on. “We’ll bring in select suppliers on a preferred basis and credential them to be part of the program.” For instance, in its diabetes management program, it may mean bringing in their insulin and needle and syringe suppliers, not just to provide products, but to help with creating educational programs.

And one critical supplier credential: status as an AmHS corporate partner. Indeed, when it sought help with a lipid-lowering program to treat cholesterol, it turned to AmHS corporate partner, Bristol-Myers Squibb.

Increasingly, integrated systems like Group Health will be driven more by the managed care component of their service mix than by the imperatives of their bricks and mortar structure. “We used think of ourselves as a bricks and mortar system, but that’s not where we’re heading. We’re going to be more bits and bytes than bricks and mortar,” says O’Brien.

In particular, information systems hold the key to Group Health’s ability to manage in today’s managed care environment. The same holds true for AmHS. As AmHS takes on new and different kind of shareholders, organizations that don’t necessarily define themselves in terms of traditional bricks and mortar measures, such as number of hospitals beds or outpatient visits, but in terms of covered lives, managing traditional group purchasing-type programs becomes a challenge. Says O’Brien, “It’s not only harder to drive compliance with that kind of shareholder, but harder to track it and even measure its relevance to that kind of provider.”