Most health system executives who sit down to build the business case for a consolidated service center start in the same place. They open a spreadsheet, they model PAR, storeroom, and perioperative inventory reductions, they estimate the labor that can be consolidated out of hospital receiving docks, they quantify freight savings from replacing daily direct-to-hospital deliveries with consolidated fleet runs, and they add up what they find. The math is careful. The assumptions are defensible. The number that comes out the other end is real. And the business case that results is wrong.
It is wrong not because any line item is wrong. It is wrong because it is pointed in the wrong direction.
The CSC’s return on capital does not live inside your hospital. It lives upstream, in the manufacturer’s cost-to-serve. And until the business case is rebuilt around that reality, most health systems will hit the numbers they committed to at the board and leave most of the available return on the table. Worse, they will have trained their organization to think of the CSC as an internal efficiency project, when it is something categorically different.
The evidence, before the argument
Before I make the case, look at the numbers that make the argument unavoidable.
Healthcare manufacturers — pharmaceutical, biotech, and medical device companies — carry an SG&A burden of approximately 27 percent of sales. Their research and development expense adds another 24 percent. The combined indirect cost burden that sits inside the price of every product a health system buys is therefore roughly 51 percent. Half the price of every supply, device, and drug you pay for is overhead, selling, marketing, administration, and R&D. The product itself — the cost of goods manufactured — is the other half.
Now compare to peers. Consumer goods manufacturers carry SG&A of about 24 percent, but R&D is effectively nothing. Industrial equipment sits at 16 percent SG&A. IT hardware, 14 percent. Chemicals, 11 percent. Automotive, 7 percent. Aerospace and defense, 7 percent. Metals, 8 percent. Energy, 7 percent.
Healthcare manufacturers carry an SG&A burden roughly three to four times that of industrial and energy peers and materially higher than every comparable industry. This is not because healthcare is harder to make. It is because the conventional healthcare supply chain forces manufacturers to spend money on activities that manufacturers in other industries have long since offloaded to their customers, to their channel partners, or out of the system altogether. Market-share acquisition and retention costs are higher. Selling costs are higher. Distribution economics are worse, because the channel is fragmented and the intermediaries are structurally incentivized to take a margin on the inefficiency rather than remove it. Administrative overhead is higher, because the contracting is more complex, the pricing more variable, and the post-sale reconciliation more labor-intensive.
It is worth being specific about how that burden gets built, because the structure of the conventional supply model is the structure of the cost. The GPO sits between the manufacturer and the health system as the contracting intermediary. Its revenue is an administrative fee paid by the manufacturer, in the range of one to three percent of the sales price of every unit sold under the contract, of which roughly half to four-fifths is shared back with the GPO’s member health systems. That fee is built into the price the health system pays. The distributor sits between the manufacturer and the health system as the logistical intermediary. It does not actually buy low and sell high — it buys at dealer list price, sells at the pre-negotiated contract price, and is made whole by the manufacturer through a rebating and chargeback process that is itself an administrative cost on both sides. The distributor charges a cost-plus fee on every line of activity, and is paid additional fees by the manufacturer for sales tracing, channel usage, and early payment. None of these costs disappear. They are absorbed into the manufacturer’s SG&A, which is absorbed into the price of the product, which is absorbed by the health system at acquisition.
On top of that, the manufacturer maintains a parallel direct selling and marketing function to defend market share inside the GPO contracts it is paying to access — because GPO contracts are typically multi-source within a category, which means the manufacturer is competing against other contracted manufacturers for the same business under the same contract. The selling cost the manufacturer carries is therefore not the cost of selling to the health system. It is the cost of selling to the health system, plus the cost of selling to the GPO to get on the contract, plus the cost of defending the position against other manufacturers on the same contract, plus the cost of administering the rebate and chargeback machinery that allows the distributor to operate, plus the cost of the distributor’s fees themselves. All of it ends up in the price.
This is what the CSC is supposed to cut through. Not by squeezing the price further on a category-by-category basis — that is what the GPO has been doing for decades, and the SG&A numbers above show how successful that approach has been at addressing the structural cost. The CSC cuts through it by removing the structural cost itself: replacing the multi-vendor, multi-channel, multi-intermediary arrangement with a direct relationship between the health system and a small number of prime manufacturers, contracted under a Logistics Service Agreement that pays the manufacturer for a lower cost-to-serve and returns the savings to the health system either as direct funding or as lower net price.
This is the pool the CSC is designed to reach.
Where most business cases look, and why it fails
Most CSC business cases do not attempt to reach this pool. They are built on an internal-efficiency premise. The model goes something like this: we move inventory out of hospital storerooms into a central distribution center; we reduce the total inventory on hand across the system; we eliminate some receiving and put-away labor at the hospital; we consolidate freight; we centralize packing and sterilization for specialty supply categories. All of these produce real savings. None of them are large enough to justify the capital required to build and operate the CSC.
The numbers do not lie. In a typical implementation, inventory reductions of twenty to thirty percent are achievable, but they do not arrive in year one. They arrive over several years, and only if the CSC has earned the operational trust of the clinical staff. The mechanism is straightforward and almost always underestimated: as the CSC proves it can hold the right inventory and deliver it reliably, clinical staff slowly allow the CSC to own more of the primary and safety stock that today sits inside the hospital. The hospital storeroom and PAR locations are the easier conversation. The harder conversation is the perioperative inventory, which is the most expensive inventory in the building, the inventory that turns the slowest, and the inventory the supply chain organization usually does not actually control. Perioperative inventory is owned by the operating room staff and protected fiercely, because letting the wrong item run out triggers the wrath of a surgeon whose preferred device is missing — the dynamic that gave us the term physician preference items in the first place. Releasing that inventory to CSC ownership requires years of demonstrated reliability, not a project plan. Most business cases assume the perioperative reduction will be captured early. It will not be. Headcount reductions, similarly, do not actually appear on the financial statement the way the business case predicts. Hospitals like to be the largest employer in their city or state and are reluctant to let people go unless their financial survival demands it. What actually happens is reassignment: the receiving and put-away labor that the CSC displaces gets retasked to the OR inventory area, where the hospital’s most expensive and least efficient inventory is finally being managed by someone whose job it is to manage it. That is a real operational improvement, but it is not a P&L event in the year the CSC goes live. Freight consolidation matters but is rarely, on its own, worth the capital investment of the facility, the warehouse management system, the fleet, and the staff.
Add them all up and you get a business case that is barely above the line. The CFO signs it grudgingly, if at all. The board approves it with reservations. The go-live team executes against numbers that will feel tight the entire way. And when the CSC is operating, the organization looks at it as an expensive internal efficiency play whose benefits were smaller than promised.
That is the pattern. I have watched it repeat for twenty years.
The error is not in the math. The error is in the direction.
Where the savings actually live
The CSC is not an internal efficiency project. It is a commercial instrument.
Its purpose is to give the health system the operational discipline — the single ship-to point, the concentrated market share, the clean demand signal, the reliable payment terms, the predictable order cadence — that a manufacturer will pay for. The manufacturer will pay for it because the operational discipline the CSC provides allows the manufacturer to remove cost from its own SG&A structure. Market-share retention costs come down because the customer relationship is consolidated and long-term. Selling costs come down because the sales motion is simplified. Distribution costs come down because the manufacturer is shipping to one location in bulk rather than to dozens in small parcels through a distributor who is taking a margin to compensate for the fragmentation. Administrative costs come down because the contracting and reconciliation are cleaner.
The mechanism through which this transfer actually happens is the Logistics Service Agreement — the LSA. The LSA is a second contract that sits alongside the supply agreement. It is the instrument through which a portion of the manufacturer’s removed cost-to-serve is returned to the health system, either as direct funding to the CSC or as lower net product pricing, depending on how the underlying supply agreement is structured.
This is what I mean when I say the CSC is a monetization engine. Without the LSA, the CSC is a warehouse. With it, the CSC reaches upstream into the manufacturer’s SG&A and pulls a portion of it into the health system’s P&L. That is where the return on capital comes from. Not the storeroom. Not the receiving dock. The manufacturer’s cost-to-serve.
The health systems that have done this well and at scale report total supply spend savings averaging approximately nine percent as the model matures, with a maximum of eighteen percent reported by one health system. These numbers do not come from internal efficiency plays. Internal efficiency plays cannot produce nine percent on total supply spend. The arithmetic does not work. These numbers come from renegotiated economics with the manufacturer community, captured through the LSA, enabled by the operational discipline of the CSC.
Why most health systems cannot do this on their own
A health system supply chain team that understands its own costs can negotiate price. A team that understands the manufacturer’s cost-to-serve can negotiate the LSA. The second conversation is a different conversation, and very few health system supply chain organizations have the background to have it credibly.
This is not a criticism of health system supply chain professionals. It is a structural observation. Most have spent their careers inside healthcare, inside institutions whose supply chain sophistication is thirty years behind retail, automotive, and high-tech. They have been trained to negotiate against GPO-benchmarked prices on a category-by-category basis. They have not been trained to sit across from a manufacturer’s commercial team and dissect the cost-to-serve line by line — to know which selling costs the manufacturer is incurring that the CSC can remove, which market-share retention costs disappear when the commitment structure changes, which distribution economics shift when the ship-to point consolidates. That conversation requires fluency on the manufacturer’s side of the table. It requires having operated there.
This is the capability gap that most CSC business cases are built around. The teams building the case do not know where the manufacturer’s cost-to-serve actually lives, so they cannot target it in the model, so they default to what they can quantify — the inside-the-hospital savings — and call it the business case. They are not wrong about what they are measuring. They are measuring the wrong thing.
What a correctly-directed business case looks like
A CSC business case built in the correct direction starts from a different place. It starts from a mapped view of the current manufacturer community — who the top spend is concentrated with, what each of those manufacturers’ cost-to-serve likely looks like based on category and channel structure, what portion of that cost-to-serve is addressable through the CSC and LSA structure, and what the realistic capture rate is over a three-to-five-year period as the LSA program matures.
From that base, the internal-efficiency line items — inventory reductions, freight, consolidation — are added as complementary benefits rather than primary justification. They are real and they matter, but they are not the case.
A business case built this way will typically produce a savings number several multiples larger than the internal-efficiency-only version. It will also be more defensible in front of a board, because the mechanism is visible. The board is not being asked to believe that a warehouse will save the system money. The board is being asked to believe that the manufacturer community will pay for the operational discipline the CSC provides, which is a proposition with direct peer evidence — one health system reported nine percent savings on total supply spend in its first full year; another returned its entire capital investment in eighteen months — and a defensible economic logic.
The prescription
The prescription is simple to state and difficult to execute.
Do not build your CSC business case inside the four walls of the hospital. Build it from the manufacturer’s cost-to-serve backwards. Start with the SG&A burden that the conventional supply chain has taught healthcare manufacturers to carry, estimate the addressable portion of it, define the LSA program that will capture that portion, and treat the inside-the-hospital savings as complementary rather than primary.
If your team does not have the background to do this — and most do not — get help. But be careful about who you hire. The majority of healthcare supply chain consultants are neither CSC-versed nor manufacturing-versed. They are healthcare supply chain generalists who have read the same articles your team has read, attended the same conferences, and developed the same instincts. They will build you the same business case your own team would have built, just more expensively, and they will leave at go-live regardless of whether the model is producing what they promised.
The right advisor has two attributes that almost no one in this market actually has. First, direct operating experience inside a CSC — not consulting on one, operating one. The lessons that matter cannot be learned from a deck. Second, operating experience on the manufacturer’s side of the table, in healthcare or in another industry where the cost-to-serve dynamics are well understood. Without the first, the design will not work. Without the second, the LSA program will not capture what is available.
If you are about to commit capital to a CSC, the call to action is direct: do not commit until you have an advisor with both. If you have already committed and the model is underperforming, the call to action is the same. The fix is not more internal efficiency. The fix is rebuilding the business case in the right direction and renegotiating the LSA program against a cost-to-serve target the original team did not know how to reach.
That is where the CSC’s return actually lives. Everything else is a rounding error.
James Grieger is co-founder of Six Peaks Consulting, LLC, the firm behind All Things CSC. He has led more than twenty-five strategic CSC assessments and multiple implementations across the U.S. health system landscape. Prior to healthcare, he developed and operated a 25-center distribution and manufacturing network for a European industrial manufacturer and served as global strategic marketing vice president for two third-party logistics providers.
For conversations about CSC feasibility, design, the LSA program, or rescue of an underperforming model, write to James at jamesgrieger@sixpeaksconsulting.com or call (775) 351-8580.