Alexis Levy
Jennifer Lawrence
David Shiple

Facilities, clinical and information technology, physicians, and service lines have all been critical investments for hospitals. In today's turbulent environment, hospitals need to refocus on maximizing these investments.


At a Glance

  • Hospitals should focus on optimizing performance in five primary areas of capital investment: facilities, IT, physician networks, service lines, and clinical equipment/technology.
  • Hospitals require a broad evaluation framework to help identify the key issues and concerns associated with each area.
  • Discipline is critical to this process, so that every area receives its due consideration.

The healthcare industry, once thought to be recessionproof, is clearly being hit hard by the recent economic downturn. Healthcare providers can expect a broad and diverse impact:

  • Access to capital will be limited (and for some hospitals nonexistent), and those that have access will find the cost of capital significantly higher than in previous years.
  • Investment returns will no longer subsidize operating performance; in fact, nonoperating income has gone from sustaining providers' income statements to dragging them down.
  • Prospects for philanthropy, including existing pledges, will likely dwindle.
  • As unemployment continues to rise, the payer mix will deteriorate as employees lose their insurance, and those who are employed will see their benefits reduced.
  • Patients will delay elective admissions, screenings, and tests.

The evidence of these effects is already being seen. A report issued by the American Hospital Association (AHA) this past November (Report on the Economic Crisis: Initial Impact on Hospitals) points to an 8 percent increase in uncompensated care in the third quarter of 2008 compared with the same quarter in 2007.

In the Nov. 19 news release announcing the report, the AHA also notes that "more than 30 percent of hospitals are reporting a moderate to severe decline in patients seeking elective procedures."

This environment is a stark contrast to the 6.1 percent average profit margin of one year ago. Given this operating climate, many hospitals are delaying new investments. Those that have the money to invest must adopt a mantra of, "What is the highest-i.e., most important-and best use of capital?" And before investing new money, hospitals must ensure they are making the most of the investments they have already made. These efforts must focus to a great extent on five standard areas of capital investments made by hospitals: facilities, IT, physician networks, service lines, and clinical equipment/technology. To this end, hospitals require a framework for evaluating the efficacy of past investments in these areas and for determining whether further capital is required. This framework should include the following key considerations for each area.

Facilities

Spending on healthcare facilities has more than doubled since 1999, rising to $30.6 billion in 2007, with almost half of that spending increase (i.e., $8 million) occurring between 2005 and 2007 (U.S. Census Bureau, reported April 4, 2008, by Healthbeatblog.org). Hospitals have invested significant capital in bed tower additions, emergency department (ED) and operating room expansions, and even full replacement. The objective for much of that construction has been to move to an all-private-bed environment to meet customer expectations and address competitive market positions. Expansions have increased capacity and allowed for the introduction of new technologies and programs. Some new facilities have been designed to allow for streamlined operations and patient flow. Unfortunately, many projects not carefully conceived in the early planning stages have led to increases in staffing costs and are failing to meet the targeted volumes projected in their business plans.

With the current conditions in the credit market, the limited access to capital may force near-term planned facilities investments to be put on hold. Hospitals will need to know how to do more with what they have by maximizing their available physical resources. If a recently completed project has not met volume projections, has not led to improvements in patient satisfaction scores, or has resulted in significant excess capacity, the hospital needs to review its current operations in order to correct its course and take full advantage of the newly constructed resource.

To maximize the return on facility investments, hospitals should consider the following steps.

Go "back to basics." One of the first steps toward maximizing new or existing physical capacity is to go back and review core patient throughput metrics to improve utilization. Although this step sounds simple, the favorable profit margins of past years have tended to shift hospitals' focus away from operating efficiency.

It is critical for hospitals to reduce length of stay where appropriate, ensure that times in the ED and imaging departments are within benchmarks, and scrutinize operating room block time more closely. Hospitals can improve their turnover times by reviewing environmental services and patient transport processes in a coordinated effort to push more volume through the same set of resources. If patient throughput and facility optimization are made a priority across the entire organization (from the C-suite down), the hospital can make considerable gains.

Maximize highest and best use. Changes to specialty bed assignment may yield additional inpatient capacity and more profitable returns. Hospitals should ensure their bed assignment strategies do not deny more profitable service lines access to inpatient beds; beds will not be put to their highest and best use if less profitable service lines or programs are allowed to operate designated units with low utilization.

Utilization of inpatient beds for outpatients also is a reflection of suboptimal bed management. Because average reimbursement for an observation outpatient ranges from $350 to $640 per day (based on national unadjusted payment rates for ambulatory payment classification 8002 and 8003) compared with $2,000 per day for an inpatient (based on average Medicare payments for diagnosis-related groups most commonly related to one-day stays), alternative accommodations for observation patients can only help to maximize the return on the inpatient bed investment. At minimum, optimization of the observation patient throughput process is imperative.

Minimize the "mid-day effect."
If a facility has a significant number of one- and two-day stays, there may be substantial "mid-day effect" whereby effective bed capacity is reduced. When more patients are admitted during the morning hours of any given day before an equal number of patients are discharged, the average daily census taken mid-day will be significantly higher. The more discharge days (shorter length of stay) a facility has and the longer the duration of this overlap time, the more dramatic the impact. If the percentage of discharges before 11 a.m. is lower than 30 percent, focused performance improvement initiatives can increase throughput and optimize access.

Promote flexibility. Hospitals should determine whether their facility resources could be used more flexibly. Service areas that could potentially share physical resources, for instance, could be placed adjacent to one another.

To illustrate, consider the ED. Given the current economic conditions, the volume of ED visits is expected to rise. The conditioned response to this growth is to expand the ED, despite the ED being the most expensive option to build or operate for a huge majority of visits.  Hospitals should examine other options, such as placing functions adjacent to or near the ED that could be utilized in the evening hours to handle peak demand, or offering care alternatives such as after-hour clinics, retail clinics, or urgent care.

As an example of other opportunities, capacity in a new surgical prep and recovery area (perhaps built to meet 2020 volume projections) could be utilized in the near term to care for outpatient observation patients. Such available capacity can present short-term solutions that allow hospitals to maximize their facility resources or bridge the capacity gap when expansion projects are put on hold.

IT

IT has been the second largest capital investment area for hospitals, after new facility contruction. As hospital margins improved in the early 2000s and with a mandate to improve quality and safety, IT investments for clinical and enterprise class systems dramatically increased. Yet many hospitals have not realized the ROI originally planned, and the additional support costs, maintenance fees, and depreciation expense for these IT investments are actually forcing them to increase their IT budgets. Many health systems have seen their IT expense increase by a full percentage point of their overall expense budget.

Especially given today's financial challenges, hospitals and health systems should consider the following measures to manage their IT costs.

Make IT decision making work. IT optimization begins with an IT decision-making body led by clinical and business leaders who are familiar with the IT systems' benefits and risks. This group should include not only executive leadership, but also every manager who oversees an operational budget and who benefits from IT investments. Often, organizational leaders and managers participate only in the initial decision to select a vendor for a large-scale IT investment, deferring to the IT department to manage the process. Instead, these leaders should remain engaged in IT decision making at every stage-from capital allocation to project prioritization to benefits realization.

Extract value from IT investments. Once sound IT decision making is in place, a disciplined benefits framework should be used to realize offsets (increased revenue or decreased costs) to IT investments. Without a methodology to define, measure, and achieve success, substantial benefits will likely remain elusive.

Key parts of the benefits framework should be to demand measurable performance improvement from areas with new IT systems and to hold relevant directors and managers responsible for achieving these metrics. Examples of performance improvement metrics include reductions in adverse drug events, supply spend, practice variation, and time spent in nursing shift changes. Using a disciplined approach, a hospital can reasonably expect a 50 percent offset toward the costs of most IT investments.

Reduce IT demand. Demand for new IT systems can be reduced by ensuring business and clinical leaders are willing to commit to measurable improvement before further IT investments are made. The most pointed form of commitment is to reduce departmental budgets in anticipation of improved performance. Allocating IT costs back to operational cost centers so that hospital managers have a direct incentive to manage IT expense as part of their profit and loss can also lead to more discriminating IT purchasing.

Standardize and consolidate IT. A persistent goal for any healthcare provider should be to standardize and consolidate IT systems. Reduced variation in IT systems leads to economies of scale, process standardization, and comparable information, and presents opportunities for consolidation of areas such as business offices, human resources, laboratories, and imaging.

Consolidation and standardization do not mean discarding all existing systems and replacing them with a common system. The solution can be as simple as using one e-mail system instead of three, one kind of network switch, or a common lab system instead of one per hospital. One measure of successful IT standardization and consolidation is a year-over-year decrease in the unit cost of providing IT services (for example, one person required to operate IT rather than two).

All four of the above measures involve changes in management practices, cultural norms, and operational processes; therefore, they are not easy to implement. However, the current economic climate is a strong catalyst for change. Just as many other industries used the economic downturn in the early 2000s to improve their business processes and the performance of their IT departments, so too can health care in response to the current economic crisis. Indeed, many in other industries would say it was only the economic difficulties that produced a favorable climate for IT-enabled process improvement.

Physician Networks

In the worsening economic climate, hospitals will likely see an increasing number of physicians seeking employment as they find the private practice model difficult to maintain. In the past, physicians have been able to offset cuts in professional fee reimbursement by investing in facilities and equipment to access the technical and facility revenue. However, Stark laws are limiting these opportunities, and the credit markets have restricted capital available for these investments. Many established physicians who have seen their retirement funds impacted by the stock market will delay retirement, but may not want the day-to-day headaches of running a private practice (and there are fewer younger physicians with the desire or capital to buy them out).

Employment of physicians is a significant capital investment for hospitals. There are the costs of acquiring the current practice of established physicians, as well as the temporary costs needed to allow new physicians a ramp-up period before they are fully productive. Although physician employment on its own is at best a break-even proposition, owning a physician network can produce significant benefits. These benefits, as well as the concomitant risks, should be fully evaluated before investment in physician employment is made. Hospitals should give particular attention to the following questions.

What alignment approach is most appropriate? Employment creates the closest alignment of hospital and physician incentives, but it is often the most costly option. Hospitals should evaluate if there are other means-such as EMR assistance, recruitment assistance, or clinical comanagement-that could be used to meet the physicians' needs and create closer alignment.

Do we have the capabilities to manage employed physicians? Managing a network of physicians requires a different skill set from that required to manage a hospital. Although a physician network can be a valuable tool, hospitals should ensure that they have the human capital to manage this business and the appropriate infrastructure (e.g., IT systems, billing systems) to support it. The infrastructure expense should also be factored into the investment equation.

Can we go beyond providing stability (income for physicians and volume for hospitals) and influence physicians' behavior so they become committed to delivering higher quality and lower cost care to the community? The ultimate benefit of an integrated system of hospitals and physicians is in the alignment of incentives to improve quality and lower cost. This value imperative will be increasingly important as patients bear more of the cost of their health care and reimbursement is based on quality.

Service Lines

Hospitals have invested in and organized clinical care into service lines for a variety of reasons, including to improve quality, attract physicians, and enhance the hospital's brand and market recognition. The significant financial and human capital investments that hospitals have made to reap these benefits include investments in physician recruitment, equipment and technology, new facilities, and marketing.

Although the service line model is attractive in theory, most hospitals have fallen short of realizing its full potential and are not seeing the market growth or the cost savings expected. Indicators of low service-line ROI include:

  • Lack of improvement in market share 
  • Flat outpatient volume 
  • A continuing increase in variable costs Investment by physicians in competing services
  • Poor scores, with no signs of improvement, in quality of care indicators

There are several steps a hospital can take to reevaluate and improve service line performance. Hospitals should implement these steps in the early stages of service line development.

Evaluate what programs are classified as service lines. Many systems do not have meaningful criteria for what constitutes a service line. As a result, all programs and services become service lines by default, which causes duplication of resources. The service line criteria should include opportunities for quality improvement, operational efficiency, and volume growth.

Get physicians involved. Successful service line models involve physician leadership, which is critical for establishing physician buy-in to service line quality, cost, and volume initiatives that will generate a return to the organization. A physician leader should be invited to work closely with a service line administrative leader to manage the line of business, while other physicians should be encouraged to serve on other service line committees (such as quality improvement, business development, and operations).

Think outside the walls of the hospitals. As care continues to migrate to an outpatient setting, it will be important for hospitals to extend the service line model beyond the inpatient arena. Patients will tend to seek the most cost-effective arena for care as they become increasingly responsible for their healthcare expenses.

The service line model also should address preventive and disease management aspects of the clinical area (e.g., a cardiac service line should include programs that address congestive heart failure, coronary artery disease, and hypertension). To this end, the service line model will need to include physicians (both employed and independent), home care, and long-term care entities.

Collaborate with payers. As payers feel the effects of the economic downturn, they will become more interested in care models that promote prevention and disease management and reduce the incidence of hospitalization and intervention. Hospitals should seek to partner with payers in programs that involve measuring, tracking, and rewarding improvement in clinical outcomes. And, if possible, hospitals should seek to share any benefits accrued with physicians involved in the service line.

Clinical Equipment/Technology

With advances in diagnostics and treatment and investments in clinical programs/service lines, hospitals must routinely make capital decisions regarding the purchase of clinical technology. With purchase prices in the millions of dollars, many of these investments are now being put on hold, or at the very least are undergoing increased scrutiny in the planning process.

The following decision-making criteria can help in the capital allocation process.

What is the decision-making process for the technology investment? Most hospitals are adept at creating a pro forma to estimate the ROI of a capital purchase, but it is important that the decision-making process not be left to the finance department alone. Clinical equipment purchase decisions should involve a cross-functional team that can give advice on the implementation and potential uses of the new technology and determine if there are other applications and benefits to its use.

What is the true benefit of the equipment investment? Improved quality of care is an inherent benefit of investing in the next generation of technology. But unless the technology currently being used is so out of date that it is compromising patient care, the hospital also should expect other benefits from investing in the new technology. Other considerations include whether the investment will provide a market differentiator that leads to volume or market share gains and whether the equipment can justify higher levels of reimbursement.

Is the technology aligned with the hospital's patient base? Hospitals should ensure that their patient/acuity mix justifies the technology purchase. For example, a community hospital that performs only basic cancer and cardiac care may not have the volume to justify a 64-slice computed tomography scanner and should seek out a partnership with a tertiary or academic center for more complex patient care.

Is the equipment tied to a particular physician? Can the equipment be used as a recruitment tool to attract and retain physicians? If the technology is being advocated by one physician, particularly if he or she is a pioneer in the field, it is important to understand the impact if the physician were to leave the hospital. Even if the technology is launched with just one physician, the hospital should look to recruit other physicians interested in the technology or train existing physicians on its use.

A Disciplined Approach

The foregoing framework briefly lists what should be hospitals' primary considerations and initial steps in determining the highest and best use of capital. The disciplined and creative use of such a framework for evaluating key investment areas (both past and future) will be critical to weathering the financial downturn and ensuring the long-term success of the organization.


Alexis Levy is associate director, healthcare strategy practice, Navigant Consulting, Inc., Chicago, and a member of HFMA's First Illinois Chapter (alevy@navigantconsulting.com).

Jennifer Lawrence is associate director, healthcare facilities planning advisory, Navigant Consulting, Inc., Chicago (jlawrence@navigantconsulting.com).

David Shiple is associate director, IT provider services, Navigant Consulting, Inc., Boston (dshiple@navigantconsulting.com).

Publication Date: Sunday, March 01, 2009

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