Three Costly Pitfalls of Purchased Services Contracts

Purchased services are seen as the next great savings frontier in healthcare—and with good reason. Spend on purchased services accounts for approximately 30 to 35 percent of a hospital’s non-labor expenditures. Tapping into even a small portion of that spend can lead to significant financial savings. However, purchased services contracts are complex and the legal language can be difficult to understand. What seems like a competitively low price may actually result in unexpected charges and poor performance outcomes.

Over the past few years, I’ve worked with many hospitals and health systems on purchased services contracts and have seen my share of “the good, the bad, and the ugly.” What are some of the recurring themes? Some vendors bury language that is advantageous to their business. They omit key information and make performance management difficult for the hospital. While every purchased services contract is unique and every circumstance is different, it is possible to mitigate common traps and omissions that can lead to unexpected costs, poor performance, and no remedy when things go south.

Looking for service contract pitfalls to avoid? Check out my top three purchased services contract problem areas to gain the insight you need to improve the quality of services and drive savings across your organization.

Contract Problem 1: Poorly Defined Scope

Properly defining scope of work for purchased services is a huge challenge, but relying too much on the vendors to do this for you can put your facility at risk. Vendors frequently use templated scope of work language. Not only does this approach disregard a facility’s unique situation, it may favor the vendor by diluting their obligations and maximizing profits. This can lead to mismatched expectations that require additional work and unexpected expenses. Expanding the scope of services halfway through a contract can come at great cost.

To overcome this challenge, facilities need to take charge and define requirements upfront as precisely as possible. Every outsourced services contract should include definitions of the vendor’s responsibilities versus the hospital’s responsibilities. No detail is too small and no requirement too trivial. Don’t rely on assumptions when you can put requirements in black and white.

Outsourced housekeeping services is a good case in point. The contract should precisely spell out each step of the cleaning process, when it’s performed, and how often. For example, do you need the ice machine in the break room cleaned out once per week or twice per week? Which day? At what time? Who pays for cleaning supplies? Will the hospital provide a storage room for the environmental services (EVS) provider to store their equipment when not in use?

Getting this level of detail can be difficult and it is tempting to rely on the vendor for a scope of work template. Don’t give into the temptation! Work directly with the stakeholders in your facility to clearly define all expected vendor obligations. The service area directors/managers/supervisors are typically the experts who will be able to articulate the specifics of the services required for your facility.

Contract Problem 2: Excessive Price Escalation

Almost all of the purchased services contracts that we review include some type of price escalation clause. The most common are flat yearly increases or a variable rate linked to a Consumer Price Index (CPI) measure. Watch out for vendors that try to sneak in escalations past a reasonable CPI measure, or include confusing language that gives them too much wiggle room to increase prices in the middle of a contract.

A flat 3 percent yearly increase is typical. However, from 2012 through 2018, CPI-U average percent change was less than 3 percent for each consecutive year. So, accepting even the standard 3 percent increase could lead to unnecessary spending.

For larger multi-year contracts in highly competitive markets, we recommend negotiating for no price increases over the life of the contract. Many of our clients have saved $30,000 or more per year on housekeeping, hemodialysis, and medical gas contracts using this strategy. In competitive bidding scenarios, this is often one of the first concessions vendors will make. Locking in pricing for the life of the contract not only adds savings, it also simplifies contract management by reducing yearly tracking and auditing. If you successfully negotiate for no annual cost increase, watch out for other hidden fees, such as after-hours delivery or fuel surcharges that vendors may add to the contract in place of the annual increase.

Contract Problem 3: Lack of Performance Guarantees

Outsourcing services can be as much of a quality decision as a financial one. Monitoring and managing vendor performance are vital to a successful purchased services agreement. However, more often than not, contracts do not clearly define how to measure good performance, and do not include remedies for underperformance.

Every purchased services contract should define a set of Key Performance Indicators (KPIs) that will outline targets for the vendors to meet and alert you to potential service issues. KPIs don’t have to be complicated, but they should be specific to the service and easy to measure.

For example, a patient satisfaction score threshold is a useful metric for services with high visibility to patients, such as housekeeping or valet parking. For linen and laundry contracts, performance should be tied to turnaround times, fill rate targets, or on-time delivery rates. Regardless of the KPIs used, our SERVICEguide team recommends setting up quarterly or annual reviews with the vendor to monitor performance on a regular basis.

What should you do when the vendor fails to meet the contractual KPIs? Stiff financial penalties may come into play. For low margin services, a payment reduction penalty of 2 to 3 percent may be enough to keep the vendor in compliance. On the other hand, you can include incentive payment language into the contract to encourage vendors to go above and beyond. The carrot and stick approach can be an effective method to encourage the vendor to proactively monitor performance and remedy any potential issues that arise.

Key Take Away

As you can see, there is more that goes into a successful purchased services contract than just negotiating for an initial low price. Watch scope of service, price escalation, and performance measures closely. Keep these three problem areas in mind to help you navigate the contracting minefield of purchased services and help your hospital avoid potentially sticky situations. By making the contract work for your hospital’s needs, service quality and long-term success can become the cornerstone of each purchased service agreement.

Looking for more tips on how to get the most out of your outsourced services? Check out this free white paper, 5 Ways to Drive Savings on your Purchased Services.