Hospital Finances

How Do Hospitals Make New Equipment Purchases?

New technology is constantly improving healthcare delivery to patients. But new technology is expensive, whether it is a new MRI machine, a new surgical robot, or a new hip replacement implant. The processes that hospitals use to choose new equipment, supplies, and technology are complicated and hospitals can seem impenetrable to manufacturers new to the market.

Each hospital is different but in general, the more expensive an item, the more layers of approval are required. At the highest level of approval is the hospital board of trustees (or board of directors). These boards are largely comprised of non-physicians who bring outside expertise in business, finance, law, and community engagement. Decisions about new property purchases, new building construction, and major renovation will be made at the board level. These are decisions that involve long-term strategic planning for the hospital.

The next highest level of approval is the hospital CEO who generally makes decisions about major capital purchases, clinical program expansion, and moderate-sized renovation. Although the items approved by the CEO often require approval by the hospital board, most of the time, the board approval is merely a formality and the board generally accepts the recommendation of the CEO.

The next level of approval is the hospital administrative director. For medical centers with multiple hospital facilities, there may be separate administrative directors for each hospital, all reporting to the CEO. For smaller hospitals, the administrative director and the CEO are the same person. At this level, decisions are made about minor equipment purchases, minor renovation, and supply vendors.

The lowest level of approval is the individual unit managers. This can be the nurse manager of a patient care ward, the operating room manager, the emergency department manager, radiology manager, pharmacy manager, etc. These managers will typically make decisions about hiring and termination of individual staff and can make decisions about minor supply and equipment purchases, although such purchase decisions may require final approval by the hospital administrative director.

Academic hospitals can be even more complicated with the dean of the medical school and the department chairs having variable influence in the purchase decisions of the hospital. Some hospitals or medical centers will have a chief operating officer and/or a chief administrative officer in addition to a chief executive officer. Many hospitals will have a chief technology officer who can also influence purchase decisions. This variability in organizational structure from one hospital to another can result in vendors (and often the hospital’s physicians) being unsure who is ultimately making decisions.

Hospital medical directors generally do not have final approval authority for major purchases but they do have a great deal of influence in those purchases. Frequently, the clinical need for a new renovation, a new piece of equipment, or a new line of supplies will be initially identified by the physicians who then express those needs to the medical director who in turn makes recommendations to the administrative directors or to the CEO.

Understand the budget cycle

Every new purchase must fit somewhere into the hospital’s budget. Once again, every hospital is a bit different but budgeted purchases generally fall into one of three categories: major capital purchases, minor capital purchases, and annual discretionary spending. Each of these categories will appear on the hospital’s annual budget. Academic hospitals run on a budget calendar that is aligned with its university’s academic calendar, usually July through June. Non-academic hospitals more commonly run on a January through December business calendar.

For every hospital, there is an aspirational budget timeline and a reality budget timeline. Hospitals will aspire to start the budget process on the first day of the new business year and aspire to have final approval of the budget by the board of trustees or board of directors several months before the start of the next business year. The reality is that this rarely happens and the budgets often do not get final board approval until the last minute, and sometimes not until after the start of the next business year. A realistic budget timeline is as follows:

6-months before the start of the business year. The budget process generally begins about 6-months prior to the start of a new business year. For academic hospitals, this is January and for non-academic hospitals, this is July. At this time, the hospital will ask for budget item requests for the next year. Requests can come from a variety of people including unit managers, the medical director, or individual physicians. The requests will include the estimated cost of each item. Simultaneously, the hospital will begin estimating the amount of revenue that it anticipates in the next business year based on projected patient volumes.

4-months before the start of the business year. After all of the requests for new personnel positions, new equipment purchases, and space renovation have been received, the hospital administrative director must prioritize these requests. In some hospitals, the administrative director has unilateral prioritization power but more commonly, there will be a core group of hospital leaders who will prioritize the requests by consensus. Again, all hospitals are different but the core group may consist of the medical director, nursing director, hospital chief financial officer, assistant administrative director, etc.

3-months before the start of the business year. Once requests have been prioritized, the request list then goes to the hospital CEO. In larger health systems and medical centers with multiple hospital facilities, there may be multiple request lists submitted from each of the hospital locations. The CEO must then create a master prioritization list comprised of budget item requests from all of the various medical center locations. This is generally done by having a group of high-level leaders vote on each of the budget items. This group may consist of individual hospital administrative directors, the health system’s CEO & CFO, the health system’s chief administrative officer, the health system’s chief medical officer, and the health system’s chief nursing officer. It is generally the CEO’s and CFO’s responsibility to determine how much money can be allocated for capital purchases for the upcoming year. Once that amount is determined, the prioritized items are approved by their rank until the total budgeted amount for all capital purchases is reached.

2-months prior to the start of the business year. Once the proposed budget is created by the CEO and CFO, it is then submitted to the hospital board for final approval. Once approved, the hospital administrative directors and unit managers are empowered to proceed with purchasing contracts, utilizing the hospital’s purchasing department and supply chain department.

The hospital administrative directors are also given an amount that they can use for discretionary purchases during the upcoming business year. In general, the hospital board will not want to be bogged down having to approve every new colonoscope for the endoscopy suite and every new instrument tray for the operating room. Therefore, hospitals will create a “threshold amount” above which requires approval by the board on the annual budget and below which is left to the discretion of the hospital administrative directors and the unit managers. It is up to them to decide the prioritization for these items that are below the threshold amount. The value of the threshold can vary from hospital to hospital and from year to year. Some amount is always held out for emergency purposes, for example to replace a broken ultrasound machine in mid-year.

Vetting new equipment and technology

Every item on the hospital’s capital budget has to be justified. “Because I want one” is not reason enough to buy a new surgical robot for a surgeon or to buy a new gamma knife machine for a radiation oncologist. For some items, the vetting process takes place at a committee level. For example, the decision about whether to stock a new drug for inpatients is commonly made by the pharmacy and therapeutics committee. The decision about whether to change to a different brand of suture is commonly made by the operating room committee. Many hospitals will have a “new technology committee” or similar committee to weigh the cost and benefits of new equipment prior to proposing that item of equipment on the next year’s budget. The biomedical engineering department usually needs to sign-off on proposed purchases to be sure that the item is compatible with the infrastructure of the hospital. There are several factors that are considered in this vetting process.

  1. Does it do what they say it will do? One of the catch phrases in healthcare is “evidence-based medicine”. This generally means having publications in medical journals proving that a piece of equipment is safe and effective – preferably from a randomized, double-blind study.
  2. Does it improve patient care? Hospitals are in the business of improving the health of patients. Does the new equipment provide a more effective cure for disease? Reduce the risk of a patient dying? Relieve patient suffering?
  3. Will it save money? For example, if a new chemistry analyzer uses less reagents and requires less manpower to operate, it can reduce the clinical lab’s costs to perform chemistry tests. If the analyzer costs $600,000 but will lower operating expenses to perform tests by $700,000 every year, then it saves money.
  4. Will it bring in new income? For example, by purchasing a hyperbaric oxygen chamber, the hospital’s wound center would be able to begin billing for hyperbaric wound treatments. This represents a new billing opportunity for the hospital.
  5. Has a fair market analysis been performed? Radiation therapy machines are not reviewed by Consumer Reports or Wire-Cutter. It can be difficult for hospitals to know whether the price they are being quoted is fair. Sometimes, it takes calling leaders at other hospitals to find out what they paid for similar equipment.
  6. What is the cost of consumables? For example, does a new laboratory analyzer require that the lab switch to more expensive reagents? Or, does a new surgical robot require the robotic instrument arms to be replaced  with new arms after a certain number of uses? What about the cost of cleaning and storage? These are all hidden costs that can make a seemingly inexpensive piece of equipment be quite expensive in the long run.
  7. Does it improve patient safety. For example, a new point-of-care ultrasound in the intensive care unit may not bring any new revenue to the hospital but by using it, the physicians can perform central venous catheterizations with fewer complications. This can translate to better metrics on publicly reported safety measures and reduced costs of treating those complications.
  8. Does it improve patient experience? For example, if a program to purchase hand-held tablets for inpatients to use to access their medical record and to view health instruction videos improves patient satisfaction, that can result in higher scores on the HCAHPS survey.
  9. Does it improve staff satisfaction/safety? For example, if new security cameras in the parking lot make staff feel safer going to and from their cars at night, this can create greater satisfaction and improve the hospitals workplace-of-choice ratings. As a result, it can be easier for the hospital to attract new employees.
  10. Does it integrate with the hospital’s IT system? For example, a point-of-care ultrasound device that can directly upload ultrasound images into the hospital’s electronic medical record has greater value than one that requires images to be printed and then scanned into the EMR.
  11. Does it allow the hospital to provide a unique service? For example, if a no other hospital in the area has a surgical robot, then by purchasing one, the hospital can promote its robotic surgery program as an example of its use of cutting edge technology to differentiate it from other the other hospitals in advertising campaigns.
  12. Does it reduce length of stay? For example, if a new model of a mechanical ventilator allows patients with respiratory failure to be extubated 1 day faster than the previous ventilators, then patients will have a lower ICU length of stay, thus reducing the hospital’s cost to care for those patients.
  13. Does it improve operational efficiency? For example, purchasing “workstations on wheels” that nurses can take into different patient rooms to do charting (rather than charting at desktop workstations in a central charting area) can improve nursing efficiency.
  14. Does it replace personnel? For example, if a central video monitoring system eliminates the need for individual one-on-one sitters for confused or suicidal patients, then one staff member can do the work of several, thus reducing personnel costs.
  15. Does it avoid a disruption in patient care? For example, when remodeling our cardiac catheterization lab, we leased a mobile catheterization lab housed in a trailer that we placed in the hospital parking lot. This allowed us to continue to do cardiac catheterizations on inpatients during the months that the regular cath lab was closed down.
  16. Is the vendor reliable? For example, in the past, as the manufacturer provided good customer service? Timely installation? Prompt repairs?
  17. Are there additional downstream costs? For example, if a new cardiac MRI machine requires the hospital to recruit and hire a new technician trained in using the machine and hire a new cardiologist who has done a cardiology MRI fellowship, there can be considerable costs over and above the machine itself.
  18. What are the environmental specifications? For example, do the temperature and humidity thresholds require modifications of the HVAC systems in the area that the equipment will be located in? New alarm sensors? New electrical wiring? Higher water pressure? This is where the hospital’s clinical engineering department can be helpful.
  19. Is the manufacturer willing/able to guarantee profitability? For example, if a new software program for patient bed placement advertises that it can reduce waiting times in the emergency department for patients being admitted, is the company willing to reduce the price of the software if the promised waiting time goals are not met?
  20. Who pays for maintenance and repair? For example, colonoscopes frequently break and need to be repaired – will the manufacturer cover these repairs or does the hospital have to purchase a separate, expensive repair contract? Does the manufacturer supply loaner colonoscopes when a colonoscope is out for repairs?
  21. Does the manufacturer provide staff training? For example, a surgical robot requires not only specialized physician training but also specialized training for surgical assistants. A manufacturer that provides free training and certification courses or on-site training can save the hospital money in the long run.

In a disaster, the purchasing rules change

Budgets are fine when the future goes as planned but when the unexpected happens, the normal purchasing process is too laborious. Fires, floods, tornados, pandemics, and other natural or man-made disasters require immediate acquisition of equipment, supplies, and other resources. For example, when the COVID pandemic hit, our hospital had to acquire a mobile outdoor drive-up testing unit that was made from a converted transportation container and we also had to purchase new lab analyzers to perform hundreds of COVID tests each day. When a broken water pipe flooded our kitchen, we had to lease a mobile kitchen trailer that we parked by the loading dock to prepare inpatient meals. These were purchases that needed to be completed and installed within hours or days and that could not wait until the next month’s board of trustees meeting. Sometimes these expenses are eventually covered by insurance but frequently the hospital has to draw from its “days cash on hand” funds to cover costs. These funds are held as emergency resources to cover expenses that cannot be covered by the much smaller amount budgeted for more minor emergency expenses on the annual budget.

Decisions about these emergency purchases are generally made by the hospital executive director, CEO, or CFO. With no time to go through the usual channels, the decision is often based on recommendations from individual physicians or staff members. Frequently, hospitals will have a “disaster team” to manage the hospital’s response to a disaster. Equipment and technology purchase recommendations will often be channeled through the disaster team to the administrative leader who is authorized to make those purchases.

The Joint Commission requires hospitals to perform at least 2 emergency response exercises (disaster drills) every year. I have participated in dozens of of these exercises over the past 3 decades. Each disaster drill simulates a different scenario. We have had a simulated plane crash at the Columbus airport, a simulated bombing at the state fairgrounds, simulated  terrorist mass shootings, a simulated tornado striking downtown, and simulated communicable disease outbreaks. In an ironic twist of fate, we had a simulated “super-flu” outbreak for an emergency response exercise 2 years before the COVID pandemic – it is eery just how closely the simulation foreshadowed the actual pandemic. During these simulations, the disaster teams ask themselves questions such as: what would we do if we needed… a portable morgue, 30 additional mechanical ventilators, 50 additional ICU rooms, or 5 more operating rooms? From these disaster drills, hospitals compose lists of equipment and vendors so that in the event of a true disaster situation, the hospital already knows who to call.

What can the hospital do when it cannot afford to purchase a new item?

Advances in medicine and technology happen at break-neck speed. Just like personal computers, automobiles, and cell phones, next year’s medical device models promise that they can do more and do better than last year’s models, whether that device is a CT scanner, a bronchoscope, a surgical robot, or a telemetry monitor. When the hospital decides it really needs one of these items but cannot fit it into next year’s budget, there are options.

  1. Negotiate a better price. Member-based supply chain analytic organizations can provide data on equipment pricing and can allow for group purchasing. For example, Vizient, Inc. is an organization whose members include 97% of academic medical centers and more than half of all U.S. acute care hospitals. Vizient member hospitals can benefit by purchasing equipment and supplies from vendors using Vizient-negotiated prices.
  2. Rent it. There are a number of ways to acquire the use of equipment without buying it outright. There are lease-by-month/year contracts, lease-to-own contracts, and pay-per-use contracts. An advantage of these options is that the annual cost of the equipment will then often fall below the annual budget “threshold amount” and thus give the hospital administrative director latitude to acquire the equipment without having to go through higher authorities.
  3. Buy used. Many times refurbished used equipment can adequately fill the clinical needs of the hospital. This can be especially true if the equipment will be only intermittently used.
  4. Buy last year’s model. When the next year’s cars come out, car dealers discount the previous year’s models to clear their lots. Medical equipment manufacturers do the same thing. Frequently, the new model of a piece of equipment will have features that are not essential to the clinical needs of the  hospital and the previous year’s model will suffice at a lower cost.
  5. Depreciate accurately. Knowing the life expectancy of a piece of equipment is essential in determining its true cost. For example, a CT scanner that costs $1.2 million that can be depreciated over 10 years is less expensive in the long run than  CT scanner that costs $1 million but is depreciated over 5 years.
  6. Get a demonstration unit. As a medical director, I was frequently asked by a physician to buy a particular piece of equipment. If that physician is particularly eloquent, particularly vocal, or particularly influential, then I was not always sure if the hospital really needed that piece of equipment. That concern can often be settled by arranging for the equipment to be brought in for a demonstration period by the vendor to determine if the equipment would really be used as much as was said. This can avoid making costly purchases of devices that go unused. Several years ago, one of the physician groups at our hospital insisted that they HAD TO HAVE a $500,000 piece of equipment in order to provide standard of care services. They gave me projections on the annual number of procedures that they would use it for and how many years it would take the hospital to recoup the investment. I successfully lobbied senior leadership and the hospital purchased the equipment. Four years later, that physician group had not used the equipment a single time and I’ve regretted that purchase ever since.

Hospital purchases are unique

Major equipment purchases made by hospitals are different from purchases made by other organizations, companies, or individuals. The value of a piece of equipment is judged differently than in any other industry. Benefits in patient length of stay, hospital throughput, and patient satisfaction from equipment or technology can often be just as valuable as increased revenue from equipment or technology. Moreover, physicians have considerably more clout than rank and file employees in other organizations or companies. Knowing how to define the true value of equipment or technology is the key to making wise and informed purchases.

November 11, 2022

By James Allen, MD

I am a Professor Emeritus of Internal Medicine at the Ohio State University and former Medical Director of Ohio State University East Hospital