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Analysis: Hospitals target pricey medical devices for savings

By Susan Kelly

(Reuters) - When U.S. hospitals cut expenses as the economy slid into recession, they looked first to basic supplies like light bulbs and bandages. Next on the list: artificial hips and knees.

Implantable devices make up a sizable chunk of typical hospital budgets, and administrators are devising new ways to limit that cost as they brace for cuts to government reimbursement and treat more patients who can't pay for care.

That means methodically working through each category of device, from heart valve replacements and stents to spinal products, to see where they can negotiate lower prices. It also means creating databases of shared information on pricing between hospitals.

"We are pressing very hard on device makers because it is a big piece of the supply puzzle," said Michael Rosenblatt, vice president of supply chain management for SSM Health Care, a St Louis-based system with 15 acute-care hospitals.

Heart and orthopedic device makers have already seen their pricing power erode as patients forgo expensive treatments in the struggling economy, and the new push by hospitals will only intensify that pressure.

"Things are getting worse from a pricing standpoint. The big area of focus is the high-priced cardiac and orthopedic stuff. It's bad, and it's getting worse for everyone," said Mizuho Securities analyst Michael Matson.

Further hampering device makers are product portfolios full of mature technologies that make it harder to justify premiums. Drug-eluting stents are the most extreme example, Matson said, with annual price declines of 10 percent worldwide.

Prices also are falling, though not as dramatically, on pacemakers and defibrillators sold by companies such as Medtronic Inc, Boston Scientific Corp and St Jude Medical Inc, and orthopedic implants made by Stryker Corp and others.

"It's beginning to shift to where manufacturers understand that a lot of these products are really becoming more like commodities," said Christopher Baskel, supply chain director at Spectrum Health Hospital Group, a chain of nine hospitals based in Grand Rapids, Michigan.

Spectrum has found ways to cut costs in major device categories one by one, beginning with stents, then pacemakers and defibrillators, and recently spine devices. "We just got done doing orthopedic spine. We're starting on hips and knees next, after the first of the year," Baskel said.

To gain an advantage in negotiations with device makers, Spectrum is participating in an information exchange set up through its group purchasing organization, Novation, that allows members to see what other hospitals are paying for products. Company names are blinded.

"There is very little price transparency on these high-end sophisticated devices," said Baskel. "We've been working hard to lift the price transparency veil. We are not going to be satisfied until it's like Amazon.com."

CORRECTIVE MEDICINE

Americans pay far more for healthcare than patients in other developed countries but die earlier, according to the 34-nation Organization for Economic Cooperation and Development. They are among the top consumers of costly procedures including hip and knee replacements, MRIs and CT scans. For a graphic, see: http://link.reuters.com/pyr35s

Such statistics have put greater scrutiny on the role of device makers in driving unsustainable healthcare costs. The U.S. healthcare overhaul also gives financial incentives to hospitals and doctors to collaborate on cost savings while improving the quality of care for patients enrolled in the government's Medicare plan for the elderly.

"If you look at the healthcare system, the pressures are going to flow to those who can absorb them, and these guys have a lot of profit," Mizuho's Matson said.

Closer on the horizon, device makers face a 2.3 percent tax on their product sales beginning in 2013 to help pay for health reform. Stryker earlier this month said it would cut 5 percent of its workforce to help offset the device tax.

David Nexon, senior executive vice president for the Advanced Medical Technology Association (Advamed), which represents device makers, said some of the emphasis on cost is short-sighted. Devices such as artificial knees keep people out of nursing homes while new minimally invasive surgical techniques reduce the length of hospital stays, he said.

An Advamed-sponsored study found that medical device spending has remained constant at about 6 percent of national health expenditures over a 20-year period through 2009.

"If you look at price data, it doesn't suggest that we are a driver of higher costs, but certainly we've been a driver of greater value," Nexon said.

On the other side of the ledger, hospitals are caring for more people who rely on government programs or have no insurance at all as unemployment remains high. That is straining emergency rooms, which are required by law to provide treatment regardless of ability to pay.

The burdens brought by the struggling economy are making hospitals even more vulnerable to government efforts to reduce the national deficit by cutting the reimbursements they receive.

Premier Inc, a purchasing alliance for more than 2,500 U.S. hospitals, estimates that healthcare providers can expect cuts in reimbursement payments to reach 15 percent to 20 percent of current levels by 2017. So when hospitals look for places to cut, medical devices make even more sense.

DOING THE MATH

Hospitals are already losing thousands of dollars each time they perform one of the top dozen device implant procedures on a Medicare patient, according to Premier, which maintains a large database of patient claims and consults with its members on ways to improve their finances and quality of care.

For example, hospitals in a recent Premier analysis lost almost $15,000 on average for each cardiac valve replacement procedure performed on a Medicare patient.

Hospital administrators compare that with the robust profit margins traditionally enjoyed by medical device makers.

Operating margins for large medical device makers typically range from 25 percent to 28 percent, compared with 7 percent to 10 percent for publicly traded hospital operators, according to Thomson Reuters data. The spread on gross margins is even greater, with device makers in the 70 percent to 80 percent range compared with 35 percent to 55 percent for hospitals, according to analysts.

Hospitals such as SSM are working closely with their physicians, meeting regularly to discuss their brand preferences and encouraging lower-priced products shown to be just as effective, Rosenblatt said.

SSM also uses vendor-managed inventory, meaning its hospital shelves are stocked with devices that are there on consignment and not paid for until they are used.

As more hospitals combine to form larger systems, they are also joining forces to manage supply costs through group purchasing organizations such as Novation and Premier, and acquiring more independent physician practices.

Eric Hillenbrand, managing director of consulting firm AlixPartners, said it was once difficult to convince a doctor to switch to a cheaper device from a preferred brand. That is changing, in part because hospitals employ more physicians directly and have more influence on their choices.

The argument for cutting supply budgets is all the more persuasive given the alternative, said Premier Chief Operating Officer Michael Alkire.

"Our executives are very keen on getting all the costs down for the stuff before they have to really cut into the staff," Alkire said.

(Reporting by Susan Kelly in Chicago; Editing by Michele Gershberg and Steve Orlofsky)

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