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Cost Modeling and the Medical Industry

Cost Modeling and the Medical Industry

The medical industry is exceptionally large in the US and even larger worldwide. Nearly every individual comes in contact with this industry multiple times during their life span. From birth to death, from minor cuts and breaks to major illnesses, we all rely on some sort of medical intervention.  This is why the ideal target audience for Cost Modeling would be the consumers, but we all know that is not possible. So, who are the ideal customers?

There are numerous customers for Cost Models within the medical industry. The entire value stream should be considered potential customers. Let us start at the consumer. Since it would be impossible to train and implement Cost Modeling to the world population, we will start with the point of sale, hospitals and healthcare networks.

Hospital and healthcare networks have been experiencing healthcare reforms and are now under huge pressure to reduce their cost and maintain their profitability. This is the classic example of a need for Cost Modeling. However, on a more current and altruistic vantage point, what if healthcare networks could buy more for less? Let us assume a cost model gap of 20% (personal experience shows a much higher gap in this industry “because they can” charge more.) During the recent pandemic that would mean healthcare networks could have purchased 20% more personal protection, ventilators and all suppliers while maintaining their budgets and profits. Imagine the impact this would have had on the world.

The next layer in or potential customer is the Central Purchasing Organizations, CPO. Healthcare networks lean on CPO’s to assist for purchasing commodities. The idea with these CPO’s is to link and leverage multiple networks to drive down the prices of commodities. The issue here is that the typical contract between a healthcare network and CPO is not based on how much they save but the total amount purchased. As you can see, this is a formula that disincentivizes the CPO’s to reduce costs. What needs to happen is for the networks to revise their agreements with the CPO’s to reward them for performance. Regardless of this revision, it is still in the interest in CPO’s to work on cost modeling. The knowledge Cost Modeling will bring to them will assist in their negotiations.

CPO’s and healthcare networks purchase from OEM’s. Historically, these OEM’s have enjoyed unprecedented margins. Theses OEM’s have stated, “We print money here so what does cost matter?”, “We can charge what we want.” All the way to “It’s medical, people will pay.” Those days are fast coming to an end with insurance reforms and skyrocketing healthcare costs. The world is starting to or should be questioning why healthcare cost as much as it does. Again, during the recent pandemic we saw shortages of personal protection being backfilled by authorizing everything from “consumer grade” masks to home made ones. We saw ventilators that typically sell for $20,000 demanding prices near $50,000. When this happened, we saw major automotive companies tool up and produce ventilators in a matter of weeks, not years. We saw study after study conducted by colleges, startups and other industries challenge the notion of a $20,000 ventilator and come up with designs ranging from a few hundred dollars to maybe a few thousand. A far cry from even the initial $20,000 let alone the $50,000 the demand was driving. One potential positive that we can take from the pandemic is that although the medical industry has its requirements, others can get into it and rather quickly. This competition can and should drive down costs for the consumer and if the OEM’s want to maintain their margin, they need to start focusing on costs.

Most OEM’s are not entirely vertically integrated. For example, in 2019 OEM Johnson and Johnson sold off a large portion of it internal manufacturing to Jabil. This was to allow Johnson and Johnson and Jabil to each focus on what they do best. This seems to be a trend in the industry. For the OEM’s like JnJ to maintain the same margins with purchased materials, these now have to be at a much lower cost to now cover the Tier 1’s margins as well. For this reason, the next target customer for Cost Models in the Tier 1, 2’s and 3’s. Each level will force reduced prices and therefore costs down and open new markets for the Cost Modeling Industry.

One other area not mentioned here but equally important is the government. National and local governments also act as healthcare networks and CPO’s. Governmental agencies purchase medical supplies for their military, for their national, state or locally run medical facilities, hospitals, nursing homes etc. Again, during the pandemic we heard of country vs country, state vs state in negotiations with suppliers.

The Cost Modeling community has not only the ability to change the healthcare landscape, but the responsibility to the human race to make healthcare more affordable to all.

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