If the past couple of years have proved to be a bumpy ride for providers, the road ahead portends to be full of even more challenging twists and turns.  

In this Q&A, John Johnston, vice president of the strategy and leadership practice for Brentwood, Tenn.-based Quorum Health Resources, discusses the impending changes of health reform and specific cost-cutting and strategic initiatives hospitals can use to prepare for the rough journey to come.

Q: What are some of the changes that will be taking place as a result of healthcare reform that have the most potential for affecting a healthcare organization's bottom line?  

A: We have studied the reform bill extensively, and we see five main "categories" where the change is most significant. The first is an expected increase in demand for primary care, which will be a driver for increased hospital care, as well. This will affect a hospital's primary care practice employment strategy. Second, we expect that this growth and demand for services is not going to be met with a corresponding level of increase in net revenue. There's not enough money going into the system to keep reimbursement where it is on a per patient basis. Third is value-based purchasing. Payment models are shifting from pay for volume to having a significant component tied to outcomes, whether it's quality or some other metric. The fourth category is a gradual shift from a focus on managing illness to managing the health status. This is where accountable care organizations and medical homes enter in. There's more responsibility for a hospital to assess what's required outside hospital care and making sure patients have access to that care. Finally, there are going to be bundled payments. All the silos from across the care continuum-primary care, specialists, hospitals, home health, skilled nursing, rehabilitative-will be jointly responsible for care, and payment for that care will be bundled together.

Q: Are there certain types of hospitals-rural, community, independent-that will gain the most or the least from such changes?  

A: Generally speaking, we do not believe anyone automatically comes out ahead financially. Take an example of a large safety net hospital in a major urban area. The first reaction is: Safety net hospitals could really benefit from reform because their patient populations are going to have insurance. But, those patients are also going to have other care options, and they may not want to go a safety net hospital. They may choose a more boutique type of hospital. So, there's increased competition for those patients. We don't really believe that anyone comes out ahead; reform creates new strategic challenges for everyone.

Q: In light of the impending changes, where should hospitals focus their cost-cutting strategies?  

A. One of the main areas for cost-cutting focus should be physician management. Hospitals have been ramping up their employed physician base. A stand-alone hospital that eight years ago might have employed one or two primary care practices may be employing 40 to 50 physicians today, but often, there's no operational approach to managing the performance of those practices. Now is the time to operationalize management of physician practices. You may not expect those practices to generate a positive bottom line, but you want to minimize their losses. So, you have to look at that practice's revenue cycle, patient throughput, and physician compensation to make sure the physician is incentivized to drive enough business. We see a lot of hospitals that want to pay at the MGMA [Medical Group Management Association] 75th percentile because they're convinced that that's what it takes to recruit to their markets. Yet in five years, when you look at productivity, that physician may be only producing at the 50th percentile. That's a balance that has to be adjusted.

Another area to pay attention to is labor costs. The opportunities in this area are more a result of volume changes caused by the recession than changes coming from reform. Nursing shortages that were in effect five years ago aren't so critical now. So, depending upon the market, the premium pay model that it took to maintain a nursing staff can be revisited. Look at areas such as built-in overtime and staffing levels. You have to be discretionary, because there's still competition. Hospitals should also review ancillary departments, such as physical therapy or wound care centers, where volume is driven more by scheduling than urgent need. Does the hospital really need to keep those departments open at the same level of hours? By changing hours of operation, it might be possible to eliminate a couple of positions.

Overhead is another area to focus upon. It's hard to correlate patient volume to workload in areas like human resources, accounting, and IT, but the reality is that volumes are down and revenues are down also. So in our hospitals, we evaluate overhead costs as a percentage of total operating revenue. There is no single benchmark, so you can't say it needs to be at 'x' percentage. Hospitals should review the last couple of years of financial data to see where net revenue has moved, then look at overhead costs. Today, most hospitals have net revenues that are flat, but costs in departments that are purely overhead have continued to rise at more traditional rates-about 5 to 10 percent a year. So, hospitals should determine: What is the appropriate amount of our net revenue that should be consumed by the overhead function? One simple solution may be to consolidate managerial and clerical positions in small departments to eliminate redundant staffing. There can be a lot of opportunities for improving efficiency in large departments, like IT. Implementing an electronic health record requires a lot of investment in staff and consultants, who are often kept on longer than necessary. Once software products are developed, what are the developers focused on? Sometimes there doesn't have to be a reduction in staff, but a reallocation of skill sets, which can reduce outside consulting costs.

Q: What else can healthcare organizations do to better position themselves financially?  

A: Look at their core service lines. Hospitals need to get a fresh handle on the cost of care in a given service line to determine, no. 1, do they need to eliminate the service line, or No. 2, are there operational changes that can improve the financial performance of the service line, or should they refocus their managed care contracting strategy in that service line, which is in and of itself becoming more difficult because payers are so afraid of the losses that they're going to incur. Then, there's the volume piece. If my orthopedics program is losing money, but I believe orthopedics is a strategic service line, how much of that loss can be mitigated by growth in volume? My fixed costs stay the same, but my revenue grows, and so my fixed costs per case decrease. Making the margins you need to make in your core service lines requires a combination of volume growth plus cost management and efficiency.

Q: What's a good starting point for creating an action plan?  

A: Hospitals should continue to closely monitor key indicators. Element no. 1 continues to be current operating margin. Is your current operating margin what it needs to be? I want to see a hospital with [earnings before interest, depreciation, taxes and amortization] at 10 percent or more. If you're not there, then you've got to work on some of these other things I've talked about. Also, if there are bond covenants, make sure you are operating well above those targets.

Review the organization's service lines-see what can be eliminated or improved. On the revenue side, make sure the revenue cycle is tight. I'd look at documentation-clinical and physician documentation-and I would look at improving upfront self-pay collections.

Also, review the makeup of your medical staff. Be sure to include all of your active physicians, not just employed physicians Do you have the appropriate mix of primary care funneling your programs and specialists? Do you have the right number of specialists? Ask your specialists, "When do you refer your patients to my facility, and when do you send them elsewhere? What do I need to do to improve to increase referrals?

Overall, hospitals need to think about the strategic changes that need to occur, not just the operational changes. Strategic and operational changes are very intertwined, and both types of changes are required to either get a financially underperforming hospital back on track or move a well performing hospital to the next level.

Publication Date: Tuesday, August 10, 2010