Originally Published MX March/April 2005
FINANCE
Making the Most of Company RevenuesTo meet the challenges of the medtech marketplace, revenue management is emerging as a strategic focus for medical device companies.
Van Diamandakis
Medical technology manufacturers continue to face a sometimes daunting market challenge: to manage accelerating competitive pressure in a consolidating industry while under heavy regulatory scrutiny. In fact, the arrival of the Sarbanes-Oxley Act has only intensified the government's interest in corporate internal practices. Another source of pressure for some companies is that the enterprise resource planning (ERP) and supplier relationship management (SRM) systems in which they invested over the past decade can now do little to further optimize the cost side of the business. And yet, many of these same device manufacturers leak millions of dollars in potential profits through gaps in their revenue life cycle.
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| Figure 1. A $1 billion company may leave nearly $40 million on the table annually through faulty management of the revenue life cycle. Source: Computer Sciences Corp. (click to enlarge) |
A 2004 survey of life sciences companies revealed that without a holistic approach to the management of corporate income from sales—all the way from the order to cash in pocket—revenue leakage in the form of price erosion, noncompliance to contract commitments, and inaccurate payment of settlements could cost life sciences companies annually as much as $40 million for every $1 billion in sales (see Figure 1).1
Aside from revenue loss, medtech company executives are increasingly concerned about government pricing regulations, such as those for Medicaid and Federal Supply Schedule (FSS) pricing, and the Sarbanes-Oxley compliance risks growing out of sales to both commercial and government customers.2–4
Companies that do business with the government on the Federal Supply Schedule must track pricing accurately on every offer and every order so that they can ensure that no customer prices will violate FSS thresholds. Government audits of FSS compliance have resulted in multi-million-dollar fines. And a fined company's error may have been only that it had no good internal mechanism for enforcing the pricing thresholds.
The problem with many current tools, if the company even uses them, is that they are detective rather than preventive. Unfortunately, compliance is a binary issue: either the company is compliant or it is not. This inescapable fact is driving medtech companies to focus on creating control systems that can prevent noncompliance with FSS pricing thresholds as a matter of routine.
That same preventive focus is apparent as medical device manufacturers undertake to implement Sarbanes-Oxley section 404 requirements pertaining to internal controls and reporting.4 Trends toward mapping the revenue life cycle and establishing in-house controls highlight the need for more-integrated approaches to managing the interplay among pricing, contract, and settlement processes that can ensure that regulatory compliance is maintained.
Since 2002, life sciences companies have paid more than $2.5 billion in regulatory fines for government price violations relating to Medicaid and the Federal Supply Schedule. The trend in 2004 was upward. While some high-profile cases of noncompliance involved a certain lack of ethics, noncompliance often was due simply to complex interrelationships of prices, discounts, and incentives lacking adequate visibility and controls. The new Sarbanes-Oxley requirements bring additional focus to the need to monitor critical business processes in the revenue life cycle.
As this article explains, revenue management software solutions now available can help medtech companies to cope with these increasing demands.
Revenue Management Challenges
The business processes that make up the revenue life cycle in a typical medical technology company are mostly manual and extremely varied. Many medtech manufacturers manage thousands of purchasing contracts across complex indirect channels, buying groups, and government agencies. The necessary tasks are typically delegated to departmental staff who employ spreadsheets; text documents; and in-house, proprietary systems. Increasingly, however, companies are realizing that the risks of exposure to revenue loss and regulatory noncompliance are too serious to allow such a fragmented and inefficient approach.
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| Figure 2. The traditional approach to revenue management, known informally as "throwing it over the wall," has been characterized by a lack of integral connection between pricing, contract management, and settlement processes. (click to enlarge) |
Effective management of the revenue life cycle is made more difficult by the fact that the cycle involves a series of complex operations spread through multiple departments and depends on many sources of information both inside and outside the company. Cross-departmental handoffs using traditional revenue management tools constitute a "throw it over the wall" approach (see Figure 2). In such a compartmentalized system, the inherent disconnections between pricing, contract management, and contract settlement can lead to deficiencies in regulatory monitoring, auditability, and documentation, as well as lost revenue and risk of noncompliance.
For example, pricing strategies, while often established by the marketing and finance departments, are executed in the field by sales personnel. Their implementation may vary across regions and with each salesperson. Sales teams often have limited access to a customer's full purchase history and few tools with which to analyze the profitability impact of a proposed offer, much less the potential impact that one contract might have on other commercial or government contracts. Often, this disconnection leads to price erosion, as discounts exceed their justification and lose touch with company pricing standards.
Management of contract relationships is also a function that crosses organizational boundaries, in its case between the sales, operations, and finance departments. It often becomes complicated when individual customers have affiliations with or memberships in overlapping group purchasing organizations (GPOs). The sheer volume of contracts challenges the contracts and finance departments to manage pricing accurately in accordance with commitments or market share measurements embodied in purchasing agreements. Sales teams without knowledge of a customer's adherence to contract commitments (which the company's operations group may possess) cannot communicate effectively with that customer. There is no way for them to know if a competitive product is winning the business or to ensure that volume commitments are met so that the expected contract value can be realized. The absence of an adequate system for managing contracts usually limits a company's ability to implement negotiated terms such as built-in price increases or even to recognize when to stop offering discounted prices as a contract expires.
In addition, changes in customers' GPO membership and their eligibility across GPO contracts create significant issues for the accurate validation and payment of settlements to the distribution channel and of rebates or administration fees to the GPOs. Some medtech company customers belong to several purchasing organizations. This creates the further challenge of determining which contract is appropriate for a particular purchase. Often, multiple GPOs will claim fees for the same purchases, leading to overpayment of settlements.
Typically, information pertaining to each aspect of the revenue management process—pricing, contract management, payment of distributor rebates, and so on—is controlled in a separate departmental spreadsheet or in a custom system. The recent life sciences company survey found that 55% of participating companies kept their pricing data in spreadsheets, 58% had a manual contract approval system with a lengthy cycle, 45% experienced significant revenue loss due to contract noncompliance, and 58% believed they overpaid rebates and fees to more than a quarter of their contract base.1 Adding to the problem, each corporate department focuses on just one portion of the revenue management process, using tools that do not facilitate information sharing or collaboration among groups.
The resulting gaps that occur in the revenue management life cycle create the conditions for revenue loss and regulatory compliance risk. Price erosion stems from gaps in the enforcement of pricing guidelines, from discounts given that do not reflect customer performance history, and from missed contract expirations or renewals. Revenue leaks result from underperformance on contract discount terms; from inefficient management of commitments respecting multiple products; and from erroneous incentive, fee, and rebate payments. Even when initial contract pricing is effectively monitored, if commercial customers do not comply with performance terms, the manufacturer may inadvertently violate FSS pricing thresholds.
In fact, unless it implements industry best practices and installs an automated system specialized for revenue management, a medtech manufacturer will find it quite difficult to remain FSS-compliant for all of its contract offers.
Revenue Management Technology
Many medical technology companies have invested in customer relationship management (CRM) and ERP systems, but, as the cited survey indicates, few use them for effective revenue management. A proper strategic approach to revenue management would leverage industry best practices and integrated software applications to align systematically the processes of pricing, offer development, contract management, and settlements validation and payment.
For many medical technology companies, revenue management is emerging as an essential application category that is complementary to their existing enterprise applications. For example, while CRM systems typically comprise all customer-related processes from contact to contract, they lack critical information necessary to optimize the offer development process and prevent price erosion and revenue leakage. Revenue management can provide that essential pricing, incentive, product, and contract performance information; for example, customer history and single-customer visibility across multiple product lines or business units.
With access to software applications for revenue management, salespeople can gain several advantages. First, they can gather better pricing information with which to generate more-profitable offers. The automation of work flow and approvals that the system provides enables them to respond to customers more quickly. And being able to see more easily the historical performance of a customer relative to contractual commitments helps salespeople to maximize the value of each contract.
ERP systems, for their part, are said to manage the entire order-to-cash process; however, they really manage only the process stages from order to collection of cash. To get to net revenue (cash in pocket), a manufacturer needs to first reconcile settlement payments with business partners and customers. Gaps involving settlements processing, incentives validations, contract and program eligibility, price resolution, and improvements in net-price visibility remain to be resolved.
Revenue management applications complement an ERP system by providing support at two critical points in the order-to-cash cycle. The first is at the time of order, when the revenue management system can provide accurate pricing across multiple overlapping contracts. The second form of support is the validation and processing of distribution partners' and customers' settlement claims in order to give an accurate indication of net revenue in a timely fashion.
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| Figure 3. Process-based approaches to a market opportunity are designed to manage and integrate business processes throughout the revenue life cycle. A revenue management system is an essential linchpin between CRM and ERP systems. (click to enlarge) |
A spreadsheet is not suited to fill the strategic gap that exists between the major enterprise applications of CRM and ERP, although that is how most organizations try to manage the critical business processes that constitute revenue management (see Figure 3).
Beyond Contract Management
Traditional vertical approaches to contract management, with functions generally restricted to the buy or sell side of the process, leave large gaps in the management of the revenue life cycle, as do point solutions that focus on pricing or contracts or settlement payments alone. An integrated revenue management system, by contrast, is designed to be an end-to-end solution, automating both the business process for each function and the interplay between pricing, contracts, and payment of settlements. All of its elements are based on a single technology platform.
The revenue management approach is horizontal in that it tracks with the revenue life cycle. Thus, it is more effective than the vertical or point approaches of the past. A revenue management focus brings a high degree of automation to the business processes of pricing, contracts, and settlements that have historically been disconnected manual operations. In addition, the new horizontal approach provides better integration of people, processes, and information from various functional areas.
Revenue management is distinct from, but complementary to, existing ERP applications for medical technology companies. In fact, many of the companies pioneering revenue management technology implementation integrate the systems into their core enterprise applications. Revenue management software often becomes the system of record for real-time price resolution, contract term setting, establishment of audit trails, and settlement processing and approvals. Problems common in the ERP order-to-cash process, including longer than desirable periods of sales outstanding that are due to invoice reconciliation issues, are resolved because the ERP system interacts with the revenue management system.
Additionally, next-generation revenue management solutions use robust Web-based architectures for fast, low-cost deployment. They feature shared services, such as pricing engines, catalogs, alert systems, and data management tools, that, besides improving process integration across applications, facilitate collaboration among users.
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| Figure 4. An integrated revenue management system includes applications that link pricing, contract, and settlement processes throughout the revenue life cycle. (click to enlarge) |
To be satisfactory, a system should consist of applications that may be implemented either individually to solve a specific problem or together to address broader revenue and compliance-exposure issues. A comprehensive revenue management software system should include applications for optimizing and executing pricing strategy, for automating the contract management and compliance processes, and for accurately processing distributor rebates, incentive rebates, and service and administrative fees in real time. Its integrated structure makes it likely that the company will maintain full regulatory compliance while also leaving less money on the table (see Figure 4).
An integrated-technology approach based on a single next-generation platform and a suite of end-to-end applications that unify the entire revenue life cycle can enable a medtech company to carry out strategic revenue management–related business processes with efficiency and full visibility. Core functions in any best-in-class system would be:
- Pricing strategy and execution.
- Contract management and compliance.
- Settlement of payments.
Vendor offerings should be evaluated for the integration of their approach to revenue management. Applications should run on a robust, shared-services platform that automates both core processes and the interplay between them.
Pricing Strategy and Execution. This application allows pricing managers to define and publish accurate price lists, discounts, and incentive programs, including setting up tolerances and thresholds in the system generally or by customer or product segment. Pricing managers can also use the system to track price history, performance, and program results in order to develop and improve pricing strategy. In addition, they can look up real-time pricing directly, with the ability to resolve overlapping contract, membership, and pricing combinations automatically. Price execution becomes the system of record for pricing, driving accurate pricing at the transaction level for the order-management or ERP system.
Contract Management and Compliance. This application enables contract administrators to create and manage not only contracts, but also associated approvals and administrative tasks, with closed-loop integration to pricing and settlement applications. Contract compliance automates tracking against customer contract commitments and monitors performance at multiple levels. Alerts and reports can help determine when contract terms are broken or FSS pricing thresholds are violated.
Settlement of Payments. With this functional module, pricing and contract compliance data flow into the rebates payment and validation process, allowing analysts to process indirect sales data and validate against contracts and terms, and to manage approvals, resubmissions, and reversals. Incentive programs can be created easily, and sales claims can be received and validated. The system should make it easy to determine eligibility, track incentives, perform net revenue calculations, automate approvals, and better manage recalculations and reversals. Finally, a system should process sales data for the calculation, validation, and analysis of fees due to third-party organizations such as GPOs for value-added services.
Next-Generation Technology Platform. Transparent to users, but critical to integrated revenue management, a single, shared technology infrastructure must power the system. This infrastructure should consist of supporting applications and data and integration server layers that support the functionality of the applications. This approach provides the configurability, extensibility, and end-to-end process integration that are essential for optimal revenue management.
Emerging Best Practices
Medtech manufacturers that have filled gaps in their revenue management life cycle by deploying integrated applications for pricing, contracts, and settlement payments have seen improvement in several key areas of revenue management.
Price Management. Revenue management can be leveraged effectively to ensure that pricing guidelines are followed both during the offer development process and at the time of order. One medtech company known to the author has implemented a revenue management system to provide gross margin and impact analysis for its salespeople to use when developing offers. Sales staff can easily gain access to relevant sales history to ensure that volume commitments for a particular customer reflect achievable levels. The revenue management system is the pricing system of record. It provides real-time pricing to both the customer call center and the ERP application used to process orders, automatically resolving pricing across multiple contracts and incentive programs. The system can also recognize items appearing in orders and automatically adjust pricing to implement promotions such as procedure-based product combinations. This capability helps the company serve customers better, as well as sell more of its products.
FSS Compliance. In addition, by adopting revenue management best practices and a next-generation technology platform and suite of applications, the same company has eliminated noncompliance with FSS pricing guidelines. The revenue management system enforces FSS pricing by controlling the company's pricing matrix and by providing a record of the approvals workflow and a complete audit trail. It continually tracks FSS price thresholds against commercial contracts in real time and provides timely notification of FSS price violations if any occur during the offer development process. This prevents government noncompliance and thus potentially steep fines.
Contract Compliance. Revenue management can ensure a medtech manufacturer's compliance with contract terms, GPO regulations, and performance milestones. An end-to-end system can identify customer accounts that are noncompliant with contract commitments and also prevent overpayment of administrative fees.
Another leading medical technology company recently deployed revenue management applications across several divisions to automate its processes for pricing, contract development and management, and monitoring of customer contract compliance. The new system can both determine the proper price to charge a customer on any particular order and, on a different level, judge whether a customer is in compliance with contractual commitments. The upshot of these wide-ranging system capabilities is that the company has a streamlined, auditable means for the management and operational control of the entire revenue process, from predeal analysis through the placement of orders against customer contracts.
In addition, the revenue management system ensures that customers meet the terms of negotiated contracts. Its decision-support functions allow national and field sales operations personnel to isolate accounts that are not compliant with commitments. Using these compliance analytics, sales staff can make more-informed decisions about revenue exposure and possible price increases based on customer performance.
Distributor Rebates Management. Given the high volumes and time pressures involved, as well as issues regarding data cleansing, management of distributor rebates poses quite a challenge for medtech manufacturers. More than 20% of rebate sales lines are treated manually as discrepancies, according to the recent survey of life sciences companies.1
When revenue management technologies and best practices were deployed across this second company's sell-side business, real-time price resolution became available to augment the order management capabilities of ERP and to process transactions based on electronic data interchange and e-commerce. By extending ERP in this way and automating the rebates life cycle—sales line validation, error correction, approvals, payments, and adjustments—the company was able to reduce distributor discrepancy rates from near the industry average of 15–20% to around 1%. As discrepancy rates fell, so did overpayments to distributors. Meanwhile, dollar-volume throughput related to distributor processing could increase significantly without any increase in staff.
Conclusion
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| Figure 5. An on-line worksheet enables medtech manufacturers to calculate the potential impact of implementing an integrated revenue management system. The worksheet calculates a company's total revenue opportunity (left) and illustrates what types of revenue management effort will have the greatest effect (right). The worksheet is accessible via www.modeln.com/impact. (click to enlarge) |
Optimizing net revenues and profits in an increasingly competitive and regulated industry is top of mind for medtech executives. However, the management tools at their disposal have been inadequate in many cases, being either antiquated manual processes and spreadsheets, home-grown systems, or point solutions that address only part of the revenue management life cycle. Revenue management—which transforms the revenue life cycle by bridging gaps between business processes—presents a large opportunity for driving company value and reducing the risk of government audits and fines (see Figure 5).
Medical technology manufacturers can improve top-line revenue and profits significantly through automating and linking elements of their revenue life cycle. Revenue management occupies an important place between CRM and ERP, where there has been a need for software applications to coordinate and streamline pricing, contracts, compliance, and settlement payments. This new solution provides the integrated, horizontal business approach that neither CRP nor ERP alone can manage.
References
Van Diamandakis is senior director for corporate marketing at Model N Inc. (South San Francisco, CA), a provider of software solutions for revenue management.
Illustration by Artville
Copyright ©2005 MX
