News | June 16, 1999

Contract Administration: Questions and Answers

By: Richard Wells

As the materials manager or key individual responsible for the medical/surgical supply chain and budget of your organization, you've probably questioned the accuracy of the product price invoiced by the distributor. And if you haven't, maybe you should. In asking questions, you've probably realized that many business activities that comprise contract administration live behind the scenes.

Keep in mind that the overall industry pricing accuracy is probably greater than 97% and that the distributor, who ultimately generates the customer invoice, is very aware of this critical business issue. The problem is that any pricing errors contribute much pain (time and money) that the customer absorbs.

In this article, I'll provide you more understanding of the overall pricing/contracting dynamics in the healthcare industry. As a result, you'll increase the success of current and future contract awards.

Q:What is your definition of contract?

A: A contract is an agreement between the manufacturer and the customer (group) that conveys specific terms and conditions, including the contract cost for products for a specified time period. Generally, a contract compliance component will state the purchase volume commitment for the group or individual facility. The contract is then communicated by the manufacturer to the designated authorized distributors.

Q:What standard information is generally included in the contract that is sent by the manufacturer to the distributor?

A: This includes customer/group, manufacturer contract ID (which uniquely identifies the contract for rebating and compliance), effective and termination date, product catalog, description, unit of measure, and contract cost.

Q: Why is contract administration important to my organization?

A: You're receiving an economic benefit (through special pricing) to meet budget and to promote product standardization, which reduces or eliminates product overlap and associated carrying costs. What's more, as products covered under a special contract increase, your potential savings will also increase.

Q: What are the typical contract types?

A: Group and individual. The rest of this article addresses the group contract that is negotiated on behalf of a common group of healthcare providers that uses collective purchase advantages to obtain special pricing and services.

Q: Who is involved in the contract negotiations?

A: The group will take into consideration the desires of the members and initiate negotiations with potential manufacturers.

Q: How long is the negotiation process?

A: The initial bid request will occur three to six months' prior to the contract's effective date. This time frame allows for negotiation and granting the final contract awards. Keep in mind that if the customer requires 30-day advance price notification, the contract must be received by the distributor to allow for a reasonable process time.

Q: Is there a difference between price and cost?

A: A word may have different meanings to different trading partners. The price of the product is really a special contract cost that the manufacturer quotes to set the new net cost of the product, thus creating the rebate equation:

[distributor cost – contract cost = rebate amount].

This cost adjustment, or "special discount" occurs prior to any distribution fee or mark-up. Remember, if the manufacturer is quoting a price and a distributor is providing the product, there will be some fee or mark-up added by the distributor to the contract cost to cover distribution expense and profit.

Q:How does the rebate affect the customer?

A: The customer receives the benefit of a lower product price through the special manufacturer contract cost. The distributor receives the rebate from the manufacturer to compensate for providing the product at a special contract cost (net cost) that is below the normal cost to purchase the product for stocking purposes. Keep in mind that other customers will be purchasing the same product without the benefit of a contract that provides a discount to the stock cost.

Q: How was the product's price determined?

A: For a product contained in the group contract portfolio, the group would have completed a separate distribution agreement with the distributor. In this agreement, the distribution fee is set for the contract products. There are many possible ways to derive the price. One way is a simple cost-plus calculation where the distributor adds a cost- plus factor to the product's contract cost to create the price invoiced to the hospital (for example, contract cost = $100, cost-plus percent = 6%; price = $106). As a member of the group you'll probably be aware of the distribution fee.

Q: Why would a product's price change?

A: The answer should lie in the contract's terms and conditions.

Reasons may be that the contract terminated, renewed with a price change, included commitment tiers (multiple price levels) and a new tier was established, or eligibility determined by the manufacturer has changed. Whatever the reason, this is when the relationships with the distributor, group, and manufacturer are called into action to resolve the issue and to understand the outcomes.

Q: Why does it take so long to update the new contract price?

A: The contract business cycle involves multiple parties (manufacturer, group, distributor, and customer) who receive information at various times and at various levels. The multiple types and the volume of data on the contract information highway create traffic jams, detours, and dead-ends. The industry recognizes the opportunities that exist for streamlining this process and the Health Industry Distributors Association (HIDA)

is supporting such initiatives as Efficient Healthcare Consumer Response (EHCR). This initiative is aimed at standardizing procedures and driving costs out of the healthcare supply channel for the benefit of all parties. But you must be an advocate for your issues and find support through your key distributor, manufacturer, and group contacts.

Q: With the promotion of electronic data interchange (EDI), hasn't the contract-pricing problem been eliminated?

A: Progress has been made, but there are hundreds of manufacturers and distributors in the medical/surgical industry. Each one has unique systems that have been developed and activated for EDI transaction sets. The transaction from the manufacturer to the distributor of the contract data has been implemented only on a limited basis. The major problem is cross-referencing key customer and product information.

Q: What practical tips can improve my contract pricing performance?

A: Try these suggestions:

  • Understand the actions and responsibilities of the group, distributor, and manufacturer.
  • Know who will take ownership of issues.
  • Work to achieve your expectations by communicating with the principal supply chain providers. If a global issue involves all partners, target one partner to be the issue's owner.
  • Don't be afraid to ask about long-term solutions that will promote ongoing accurate contract pricing.
  • Create a checklist for key contracts. The list, by manufacturer, may be in order of importance or by termination date. Review as needed with the distributor account manager or the manufacturer representative to keep informed of future changes that will impact purchasing dollars and decisions.

The distributor, manufacturer, and group exist to provide service and support for you, the customer. Stay involved and help to mutually establish pricing and service expectations with the distributor. Above all else, you can help to communicate your issues through a greater awareness of the total pricing supply chain.

Richard Wells is found and president of Wellspring Consulting, Midlothian, VA. The firm provides consulting services designed to support contract administration. E-mail questions about contract administration to Wellspring Consulting at; 804-639-0095;