Indiana Pumps Up the Volume on Savings

by David Yarkin

Office supplies, computers, copiers. These are the commodities most states tackle first when they begin a strategic sourcing initiative. While these categories showed up in Governor Mitch Daniels’ OneIndiana sourcing effort, a surprising area was an early focus: hearing aids.

Upon taking office, Governor Daniels created the State’s first Office of Management and Budget (OMB) to look for cost savings and efficiencies. One of the first functional areas on OMB’s radar screen was state purchasing. Cris Johnston, Executive Director of OMB’s Department of Government Efficiency and Financial Planning, explains the push for strategic sourcing. “Indiana had incurred annual operating deficits for many years. While other states had started to experience growth in tax revenue, our revenues still lagged, directing us to focus on expenditures.” With that in mind, he says, strategic sourcing was an initiative that the governor himself prompted OMB to undertake when he first came into office.

“We buy a lot of things from a lot of different vendors, but we weren’t knowledgeable buyers. We needed an assessment of who spent how much, on what, and from whom. We wanted to use our buying power for better prices,” says Johnston.

Indiana engaged Silver Oak Solutions (now CGI Spend Management Solutions) to perform an assessment, recommend commodities that lent themselves to strategic sourcing, and guide the State’s buyers in sourcing those commodities.

Hearing aids was a commodity that rose to the top of the list. A key indicator of a significant sourcing savings opportunity is the level of disaggregation within a specific category. Few commodities were as disaggregated as Indiana’s previous hearing aid procurements. “We were literally buying them one at a time,” says Sid Norton of the OMB government efficiency group.

The second indicator that there was ample room for improvement–and savings–was that the State had no visibility into the various components of the total cost of ownership of buying and using hearing aids. When a hard-of-hearing individual bought a hearing aid, the State received a bill that included the costs of the device, its accessories, and any and all future services associated with it. More often than not, none of those costs were identified individually. The State’s strategy would break out the costs of buying and dispensing the device and then use the power of volume aggregation, vendor consolidation, and demand management to reduce those two cost drivers.

Unlike commodities such as office supplies or hardware that are used by every agency in state government, hearing aids are purchased by a small group of agencies, primarily Vocational Rehabilitation (VR) and Medicaid, and to a lesser degree the State’s First Steps program that serves families with disabled or developmentally delayed infants and toddlers. Research into previous spending showed that VR, Medicaid, and First Steps purchased roughly 4,000, 3,000, and 200 devices respectively in Fiscal Year 2005.

As the State’s largest consumer of hearing aids, Vocational Rehabilitation, along with OMB and the
Department of Administration (IDOA), was the principle driver of the new procurement. In fact, it was VR staff who initially advocated that OneIndiana redesign the State’s hearing aid procurement process. Vocational Rehabilitation services are provided to Indiana residents who are seeking the State’s assistance in rehabilitating themselves for the purposes of obtaining gainful employment in the competitive labor marketplace. A large proportion of VR’s client base are individuals for whom hearing loss is their primary impairment.

Analyzing Old Processes

For as long as anyone in Indiana government can remember, hearing aids were bought just as Norton described it–one at a time. A Vocational Rehabilitation client would be examined by a hearing aid provider, often an audiologist, who would prescribe one of thousands of types of devices in the market. There were no controls placed on these providers. They could prescribe the most expensive hearing aids, whether or not there was a vocational need for all the device’s features. The device then was ordered by the hearing aid provider and he or she performed a variety of functions required to make it usable by the client: fitting and programming the device and training the client on how to use it.

When the client left the provider’s office, VR was sent an invoice for the bundle of products and services. The cost of the device did not have to be broken out, so the State did not always know how much it paid for the hardware. Since state and federal government sources were picking up the tab with little scrutiny, the providers had no incentive to negotiate with the device manufacturers for competitive prices. They also were free to throw in extras that would make most taxpayers furious. Often pricing from providers would include an unlimited number of follow-up appointments with an audiologist and a lifetime supply of batteries. This flew in the face of VR’s mission to support clients until the point that they joined the workforce, but not beyond it. In effect, Indiana taxpayers were subsidizing individuals who already had been vocationally rehabilitated.

Structuring Reform

Indiana’s forthcoming procurement would focus on three levers to drive savings. First, establish pricing directly with hearing aid manufacturers and high-volume resellers. By committing the State’s volume to a small handful of suppliers, instead of buying devices one at a time through audiologists, the State was confident it could see per unit cost reductions. Second, create greater central coordination and control to eliminate or at least greatly reduce the number of high-end devices prescribed and encourage the purchase of more reasonably priced yet clinically appropriate devices. Third, use classic demand management techniques to eliminate clinically unnecessary extras while still meeting VR’s mission.

Much like a solicitation for office supplies, Indiana’s RFP for hearing aids aimed to drive the majority of the spend through a market basket of devices that it called the Primary List. The Primary List was broken into several tiers based upon technical attributes: the number of channels, bands, and listening programs available on a device, and the style and shape of the device. Bands are volume controls that can be set to address the client’s hearing range impairment. Listening programs allow the device to adjust to different environments, like noisy rooms or soft conversations. Finally, there are four different shapes of hearing aids for which pricing was solicited: behind the ear (BTE), in the ear (ITE), completely in the canal (CIC), and in the canal (ITC).

In all, suppliers were asked to give firm, fixed prices for 91 different configurations of the above variables. Pricing was to include a two-year warranty and all shipping and handling costs.

Since the State knew that there would be occasions, albeit rare, when an audiologist believed that a client had a true vocational need for a hearing aid that was not available on the Primary List, it asked suppliers to provide a discount off list prices for every additional device in their catalogue, or what the State referred to as its Secondary List.

A dozen proposals were received, mostly from original equipment manufacturers (OEMs). Unlike most procurements, none of the respondents were incumbent vendors since the State VR never had bought directly from manufacturers in the past. An evaluation committee was established to review proposals consisting of representatives from the major using agencies: VR, Medicaid, and First Steps, as well as the IDOA and OMB. To give the committee deeper subject matter expertise, an audiologist from the Health Department joined the team as well.

While the evaluation committee had planned on a round of Best and Final Offers (BAFOs), the prices came in so low that they decided to forgo BAFOs and accept the prices that were offered. Awards were made to four manufacturers: GN Resound, Siemens, Phonak, and Oticon, and one wholesaler, the American Hearing Aid Association (AHAA).

While the prices for devices on the Primary List came in significantly lower than the prices that the State had previously paid, VR knew that those savings would never materialize if the audiologists and the other dispensing agents did not routinely prescribe hearing aids from the Primary List.

Applying U.S. Supreme Court Associate Justice Louis Brandeis’ quote, “Sunlight is the best disinfectant,” VR required audiologists to file an extensive justification to VR for items on the Secondary List. Approval had to be granted not by a low-level bureaucrat, but by the director of VR’s deaf and hard-of-hearing program. In contrast, the more reasonably priced items on the Primary List require no approval from VR. State officials expect that this extra scrutiny will prevent audiologists from prescribing high-end devices with functionality beyond what is medically necessary.

To further ensure that the vast majority of prescriptions would be from the list of aggressively priced devices, VR sent their dispensers only the Primary List. The hope, of course, was that by giving audiologists a list of only reasonably priced options, they would stick to it unless there was a vocational need for an alternative.
Vocational Rehabilitation officials explained their rationale at a recent training for the hearing aid dispensing community:

“We purchase equipment for people for what their employment needs are. We purchase for necessity and not for convenience. If an individual cuts grass and they can walk around, we buy them a push mower and not a riding tractor. It may take three hours instead of 20 minutes as on a riding mower, but that would be a convenience not a necessity.”

Fine-Tuning Implementation

From a total cost-of-ownership perspective, the costs of hearing aids included the cost of acquiring the device and the cost of dispensing it to the client. The first half of the puzzle was solved through a combination of volume aggregation, buying directly from manufacturers and wholesalers, and ensuring that the dispensers prescribed vocationally appropriate devices rather than ones with unneeded functionality and cost.

For the second half of the equation–dispensing the devices to the client–VR and the OneIndiana team decided that savings could not come and would not come from a vendor consolidation effort. The State was simply too large and there were too many VR clients dispersed across Indiana to force all clients to be served by just a handful of audiologists. Instead, the State allowed every audiologist to apply to dispense hearing aids. However, it set the dispensing rates.

State officials first assembled the list of services that the dispensers would be expected to provide: taking an ear mold to properly fit the client; meeting with the client to tune the device and adjust the bands, channels, and listening programs for optimal performance; and educating the client on how to use, clean, and store the device. For all these functions, the State determined a fair market value by multiplying the number of hours required to perform these functions times the average wage rate of audiologists in the State and adding in the overhead costs.

Staff from VR and OneIndiana allowed clients to return to their audiologist for four follow-up visits. The costs of these trips were to be included as well in the lump sum dispensing fee.

One of the keys to the success of this procurement was that the rates and the process used for determining them were not established behind the walls of the Statehouse. As CGI’s Matthew Lewis explains, there was significant outreach to the vendor community to get feedback and to validate the process. “Before the State published the rates, they held a town hall meeting with dealers and audiologists. They vetted the prices and explained how they set them,” says Lewis. “Low rates are useless unless the dispensing community would be willing to dispense at these prices. It was important to them to cap the number of follow-up visits as it eliminated some of the uncertainty and the risk. It helped that the State could show that its prices were higher than other states we benchmarked.”

Once the rates had been set, Indiana sent out a letter to the dispensing community, listing the dispensing fees for four different permutations: monaural/analog, monaural/digital, binaural/analog, and binaural/digital. All providers who completed and returned an enrollment form, accepting the published dispensing rates and providing proof of licensure in Indiana, would become authorized to provide services to VR’s clients. As of this printing, more than 200 licensed hearing aid providers have enrolled in the program. The large number of authorized dispensers ensures VR’s clients that they will have the convenience of having multiple providers in their geographic area.

Tallying Success

The key to success in the era of strategic sourcing is understanding all the components of the total cost of ownership. Indiana’s previous system of buying hearing aids made that impossible. When an audiologist sent an invoice to the State, it usually did not break out how much the device, or the services associated with dispensing it, cost.

Indiana’s new procurement does just that. It breaks out the hearing aid cost and reduces it dramatically by buying under a statewide contract through manufacturers and a wholesaler. It then sets a fair market price for the services that include vocationally appropriate services, but does not cover services that always should have been the responsibility of the client.

By effectively applying the strategic sourcing tactics of vendor consolidation (for purchase of the devices) and demand management on the types of devices and length of services provided, Indiana’s Vocational Rehabilitation department and the OneIndiana sourcing team are protecting the interests of both the VR clients and the State’s taxpayers. In all, the sourcing of hearing aids has generated roughly $4.3 million in annual savings for Vocational Rehabilitation alone. State officials are optimistic that the overall savings figure will rise exponentially if the Medicaid and First Steps programs utilize the new contract and processes as well.

OMB’s Johnston is optimistic that the gains made in hearing aids and other OneIndiana initiatives will be sustained into the foreseeable future. “Strategic sourcing was a key piece to getting Indiana to a balanced budget for the first time in eight years. But we still have budgetary pressures. Strategic sourcing still will be critical to us to continue to instill sound fiscal discipline within state government. Sourcing elevated purchasing to a strategic function and raised its visibility. It is critical that we continue to buy smarter for years to come.”

About the Author

David Yarkin, former Deputy Secretary for Procurement in Pennsylvania’s Department of General Services, is President of Government Sourcing Solutions, LLC. Contact Yarkin via e-mail at [email protected]

While a number of stories have been written in recent months about strategic sourcing at the abstract level, few provide the tactics involved in sourcing a specific commodity.

“Sourcing in the States,” a Government Procurement column by David Yarkin, covers state and local strategic sourcing methodologies. Until recently, Yarkin served as Deputy Secretary for Procurement in Pennsylvania’s Department of General Services and led the State’s successful strategic sourcing initiative.

In each issue, Yarkin will detail how his colleagues in other governments have generated value for their taxpayers through an individual sourcing project. This month, “Sourcing in the States” explores how Indiana’s success with vendor consolidation and demand management for the sourcing of hearing aids helped the State achieve a balanced budget for the first time in eight years.

If your government has taken a particularly innovative approach to strategic sourcing, e-mail Yarkin at [email protected]

To read archived “Sourcing in the States” columns, visit the article archive on www.govpro.com.

David Yarkin is the President of Government Sourcing Solutions, LLC.