Examined individually, the changes to purchasing, utilization and management practice in the pharmacy at Indiana University Health's Bloomington Hospital wouldn't appear to have earth-shattering consequences to the hospital's bottom line: Using an IV preparation of an anti-infective orally instead of using oral capsules will capture $50,000 in cost-savings annually. Drawing a 20-milligram bolus dose from the infusion bag instead of purchasing prepared bolus vials will save $40,000 a year. Using spacers to allow re-use of inhalers for asthmatics during their hospital stay will reduce annual drug spend by a similar modest amount.

However, says Michael Melby, director of pharmacy and clinical informatics at the hospital, taken together, the 50 cost-saving recommendations his department adopted after a comprehensive examination of medications and utilization will save the hospital $755,000, of which $375,000 will come in the first year. Many will not only save money, they'll improve quality of care, he adds.

With an annual drug budget of $12.5 million, that's a better than 3 percent savings in 2011 alone. If trends in health care reimbursement continue, the hospital anticipates a 30 percent decline in revenues over the next three years, so the pharmacy savings won't be enough to stave off deeper, more painful cuts. But it could have a significant impact in maintaining pharmacy support for clinical care.

"Will it be enough? No. I think we'll have to do more. But what I want to do is maximize the efficiencies I gain from my non-people cuts before I reach for my people cuts," Melby explains. "If you think about it, $755,000 equals seven pharmacists, so instead of cutting 10, maybe we only have to cut three."

The experience of the Bloomington hospital is an illustration of what is happening in hospital pharmacies across the country.

Challenges and Opportunities

With reimbursement cuts from Medicare, Medicaid and private payers looming, all hospital departments are facing close fiscal scrutiny, but the pharmacy poses specific challenges to the bottom line. Pharmacy costs make up 10-20 percent of the average hospital's operating budget. In addition, pharmacy is a department key to reducing medical errors and improving outcomes — central to health reform's reimbursement program. Not many hospital departments can play such a critical role in both cost and quality.

The pharmacy always has been an expensive operation because of the relatively high staff costs driven, in part, by the shortage of trained pharmacists, though the shortage has eased in recent years. But unlike other hospital departments, personnel costs represent only about 20 percent of the average pharmacy budget. Most of the remaining 80 percent of the operating budget is taken up by drug costs, which had been growing by 3 to 5 percent a year, and more for medicines used in such specialty areas as oncology. An annual review by the American Journal of Health-System Pharmacy indicates hospital drug expenditures are moderating and will increase by only 1 to 3 percent this year.

That doesn't tell the whole story, however. Newly patented specialty drugs and therapies offset cost savings generated by the economic downturn as well as the introduction of a variety of generic drugs to replace high-cost, frequently used medications. And drug shortages, which many say are the worst in 30 years, are driving up the cost of certain hard-to-find medications by as much as 4,000 percent.

Changes in regulations and accreditation standards over the past five years or so have added costs and complications to managing a hospital pharmacy, says Mike Brown, vice president of customer accounts management for Cardinal Health's pharmacy solutions unit.

The U.S. Pharmacopeial Convention's standards on compounding sterile preparations and modifications to accreditation requirements have led to changes in procedures and physical space that have added cost to the hospital pharmacy, although it may also reduce errors and add efficiency and patient satisfaction.

"But the biggest change we're dealing with today has to do with the [federal] health care rules coming down," Brown says. "And we're not sure how they are going to affect reimbursement."

Costs Down, Quality Up

Clearly, health care reform will focus even more attention on cost, clinical outcomes and patient satisfaction. And a trend in hospital management that has remained fairly constant for the past several years — the emphasis on bringing the pharmacist "out of the basement" and onto the patient care floor — can support a hospital's effort to meet the new standards in all three of those areas.

"When you look at pharmacy, you don't want to cut people. The big costs in pharmacy are in drugs, so it makes sense to focus on the drug therapies," explains Bruce Weiner, vice president with VHA Performance Services. "In order to do that, you want to have competent pharmacists who work closely with clinical staff in the patient care areas to assure safe, cost-effective drug therapies."

The stereotype of hospital pharmacists working in the basement is changing. "We're seeing pharmacists on rounds with physicians, assisting with drug therapy recommendations, working closely with other health care providers to assure optimal outcomes," Weiner says.

That's one main reason chief financial officers are looking at pharmacy now, says Todd Nelson, a technical director with the Healthcare Financial Management Association. "They realize there is a tremendous opportunity to partner with the clinicians in pharmacy to actually improve patient care and lower costs."

Some systems, like Scripps Health in San Diego, look first to organizational management as a tool to cut waste and standardize purchasing and other practices. As part of an overall restructuring announced in 2010, the system moved to a horizontal leadership structure aimed at standardizing operations across the five hospitals and 20 outpatient centers in the system.

The reorganization eliminated large variations in purchasing for software, drugs and supplies, created opportunities for shared staffing, and allowed a systemwide evaluation of both formulary and utilization practices, says Ed Jai, senior director, corporate supply chain management of pharmacy at Scripps.

The company says it saved $8 million in fiscal year 2010, bringing adjusted pharmacy patient day costs down to $90.03 in fiscal 2011. Between 2008 and 2009, those costs jumped from $93.49 to $98.40.

More importantly, Jai says, the added scrutiny the pharmacy received from management, including internal audits to help prepare for state inspections, has improved quality, with all five Scripps hospitals now ranking in the top 13 percent in California in terms of safety compliance.

In addition, administrators are expanding automation, focusing on evidence-based treatments and are taking a very close look at cost and utilization of medications to lower costs and improve quality. In interviews with pharmacy directors, consultants and other experts in hospital pharmacy, a few prescriptions for meeting this dual test of cost and quality emerge.

Price x Utilization = Pharmacy Costs

The formula is simple but can be complex to put into use, explains Cardinal Health's Brown. More than 45,000 prescription drug products are on the market today, originating from about 1,400 different manufacturers. And data is collected by various departments of the hospitals, sometimes using computer software with inadequate interfaces. That makes it very complicated to keep track of what drugs are used and how.

Through group purchasing organizations and similar arrangements, even small hospitals can and do negotiate better prices for medications. But without an understanding of how the drugs are being used, it's difficult to calculate the true cost of the pharmacy, Brown says.

Cardinal helps client hospitals with targeted utilization initiatives to understand what drugs are dispensed to which patients and at what cost per dose, so that pharmacy managers can consider less costly, but equally safe and effective medications.

One 301-bed community hospital was able to achieve a 16 percent decrease in average cost per patient by analyzing utilization and working with medical teams to gain support for switching to lower-cost but equally effective drugs, according to Brown.

Utilization analysis, combined with effective communication of literature supporting the safety and efficacy of the lower-cost drug treatments, can lead to deep discounts if most physicians can be persuaded to switch. Even when physicians prescribe similarly priced drugs, standardization can lead to substantial savings, Brown says.

For example, 90-bed Cape Cod Hospital in Hyannis, Mass., has been saving money for years by combining its buying power with 10 other hospitals through a group purchasing agreement managed by Novation, a supply-contracting company formed by VHA Inc. and University HealthSystem Consortium in 1998. In recent years the hospital has built on that system by participating in a VHA shared services program that provides pharmacy expertise in formulary review, says Peter Scarafile, director of pharmacy for the hospital.

This year, the hospital discovered it could save more than $100,000 a year by switching most patients to generic sevoflurane from higher-priced, brand name general anesthetics. The pharmacist provided by VHA helps the hospitals recognize such opportunities for savings and then provides literature to support the safety and effectiveness of the medication to gain support of the hospital's Pharmacy and Therapeutics Committee.

"You want to encourage the anesthesiologist to use the generic, but you can't just go up to him and say, 'Hey, why don't you use the cheaper one?'" Scarafile says. "The VHA pharmacist must do the research, a comparison of all the gases and best practices, and pull out research articles and come up with a strategy to convince people to use these gases."

No one change in formulary is going to be a panacea when it comes to drug costs, says Scripps' Jai. "It is additive, rather than a single-shot wonder."

Track Everything

In addition to careful formulary management and keeping a close eye on purchasing, good accounting helps save money in the pharmacy by cutting waste and ensuring proper reimbursement, says HFMA's Nelson. Keeping track of costs means benchmarking cost against other similar-sized pharmacies as well as keeping track of how your own costs are moving over time.

Technology, such as robotics, bar coding and on-site medication dispensing cabinets, is effective for reducing medication errors and helps bring the pharmacists out of the basement and onto the patient care floor. But while it saves money and is essential for reducing medical errors, technology is only as good as the system it's plugged into, Nelson says.

With medication distribution cabinets on every patient care floor, hospitals often become overstocked with medications, which leads to expiration and waste. And billing errors often are caused by interfaces that don't track drug usage appropriately.

"You have to make sure you are accurately billing, and performing billing audits to make sure you are getting reimbursed what you're supposed to be," he says. "If I could give one piece of advice it would be to routinely run audit validation. There are a lot of medications being dispensed and if you're looking at a particular patient, it's hard to determine that you've got one or two drugs missing per patient. But if you multiply that by all the patients, several times a day every day, it obviously adds up."

Across the country, hospitals are demonstrating how revised formularies, evidence-based treatments, management realignment, and automation together can have a significant impact on cost and patient outcomes. These strategies all rely on the integration of competent, motivated pharmacy professionals into clinical care close to the bedside.

Working With Pharmacists

Fortunately for hospital CFOs, many pharmacists are well-trained for that role, and hospital administrators should make sure they work closely with them.

"Clinical pharmacists like the cost piece almost as much as the finance people [do]," Nelson says. "The pharmacy is so involved in the acquisition of the drug, with the supply and demand, that they're always thinking about that."

The "uniqueness," Nelson adds, is that "they're also always thinking about the clinical effectiveness of that drug. So they are truly marrying the financial and clinical piece of the drug for the best patient outcome."

Randy Edwards is a freelance writer in Columbus, Ohio.



Pharmacy Costs by the Numbers

As the numbers show, the pharmacy is a major cost center in U.S. hospitals, but it also plays a critical role in patient safety and quality of care. It is a complex environment for developing sound cost-containment strategies.

Cost of pharmacy operations as a percentage of the overall operating budget for average U.S. hospital.

80/20 ratio
Ratio of drug supplies to personnel as a percentage of the overall cost of operating the average hospital pharmacy.

Estimated annual percentage increase in prescription drug expenditures in hospitals and clinics, 2009 over 2008.

Estimated average cost each preventable adverse drug error adds to a hospital stay.

Annual savings in drug spend by 90-bed Cape Cod Hospital by switching most patients to generic sevoflurane from higher-priced brand name general anesthetics.

Estimated cost savings in first year of a pharmacy cost-containment program at Indiana University Health's Bloomington Hospital.

Amount pledged for technology upgrades, including robotics and bar coding, beginning in fiscal 2012, in the five Scripps' Health hospitals.

Source: H&HN research, 2011