• Sizing Up Economies of Scale

    Oct 31, 2012

    By Lola Butcherfeature-art-economies-of-scale

    One fast-growing health system is using economies of scale to standardize operations across dozens of hospitals while introducing an innovative model of care.


    In June, Mercy Hospital El Reno, a 48-bed hospital in central Oklahoma, went live with an electronic health record (EHR) system, an achievement that at one time seemed impossible.

    Until three years ago, the facility was called Parkview Hospital and it was staring at a $1.4 million estimated bill to meet the federal government's EHR/meaningful use mandate. "We had no idea where we were going to get that money," says Doug Danker, RN, the hospital's administrator.

    In fact, the hospital was struggling on many fronts. Sometimes the nursing staff worked short-handed because it could not fill positions. It was hard to succeed financially, in part because supplies were so expensive. Staff morale was low.

    In 2010, the public hospital, owned by the city of El Reno, entered into a lease agreement with Mercy, the sixth largest Catholic health system in the country. That makes Mercy Hospital El Reno one of 31 hospitals and more than 200 clinics in Mercy's four-state service area.

    Danker now has 38,000 Mercy coworkers, 90 of whom came to help when Mercy extended its EHR system to El Reno. "I had no idea resources existed like this until we became part of a large system," he says. "I truly believe that had we not been leased by Mercy that El Reno would no longer have a hospital."

    Mercy's View of the Future

    Since June 2011, Mercy has acquired three hospitals, added more than 70 clinic locations and grown by nearly 300 integrated physicians. With no hint of slowing down, the St. Louis-based system last year announced a plan for expansion over the next eight years that could amount to more than $4 billion. The money will be spent to advance Mercy's central strategy: success via economies of scale.

    "Managing the cost of care is vital to future success," says Michael McCurry, Mercy's executive vice president and COO. "When you have a concentration of facilities in a given geographic area, it's much easier to leverage your administrative and back-office functions, such as billing and purchasing, for scale to serve those facilities."

    Mercy has devoted the past several years to developing a model of healthcare delivery that is driven by that fact. As McCurry puts it: "Mercy has extremely robust back-office services that are highly automated in the way that they do the work. That gives us an opportunity to grow revenue without a corresponding increase in cost."

    Mercy provides clinical services in four states-Missouri, Arkansas, Oklahoma and Kansas-and it plans to continue to expand in those markets and adjacent markets if it makes sense. 


    "In the geographies that we currently serve, I would love it if we could have such a presence that you would rarely be more than 15 minutes away from a Mercy facility," McCurry says. "And if opportunities present that allow us to grow in adjacent communities where we could continue our contiguous presence, and grow larger than we are today, we would love that."

    He and his Mercy colleagues believe the transformation in health care today is driven primarily by three factors:

    • Technology that allows ever more patient care to move out of hospitals and into ambulatory settings
    • Heavy regulation that makes hospitals expensive to build and maintain, especially when inpatient demand is falling
    • Cost shifting to patients, prompting them to seek lower-cost options for health care or avoid services altogether

    To address these trends, Mercy is building a future delivery system that will meet the outpatient-centric needs of patients. "Given the common belief that there will be less acute care provided in hospitals in the future, we will be ready with a very robust presence in the ambulatory world," McCurry says.

    El Reno's Perspective

    Mercy Hospital El Reno, built in 1954, serves a rural county west of Oklahoma City. In FY11, the hospital handled 9,344 emergency visits, performed 400 surgical procedures, and provided outpatient services to nearly 20,000 individuals.

    Danker, who was named administrator in February, has been with the public hospital for nearly 24 years. He started as a paramedic and worked his way up to director of nursing before his most recent promotion. "This facility as a stand-alone was on a very rocky foundation," he says.

    In April 2009, the El Reno hospital entered into a management agreement with Mercy. The next year, Mercy leased the facility, changed its name, and opened an outpatient clinic. The city retains ownership of the buildings and equipment, but Mercy owns all operations, making it solely accountable for the hospital's quality and financial success. The system keeps any margin generated and is responsible for covering any losses.photo-mercy-nurses

    Despite its small size, the hospital is not designated as a critical access facility so it must survive on prospective payment system reimbursement rates. Since Mercy leased the facility, Danker says, the hospital has stabilized. "We're breaking even on our finances," he says. 

    Much of that is attributable to the economies of scale that come with being part of a large system, such as the following:

    • El Reno's business office, formerly staffed with about 20 FTEs, now has one staff member on campus because most back-office functions are handled at a central business office in Missouri.
    • El Reno has no local CFO; one Mercy finance leader is responsible for the system's rural facilities in Oklahoma.
    • Transcription is outsourced, eliminating two FTEs, and El Reno shares medical coding services with other Mercy hospitals.
    • Buying supplies through Mercy's in-house supply chain organization saves El Reno roughly 10 percent on supplies, Danker says.

    In addition, equipment service agreements are no longer needed. Several years ago, the El Reno hospital acquired a 16-slide CT scanner-and a service agreement that cost nearly $250,000 a year. "As a stand-alone, we had a service agreement on every piece of equipment we owned, but that's no longer the case," he says. "Our Mercy clinical engineering team out of Oklahoma City comes around and takes care of all of our equipment."

    In addition to those savings, Danker ticks off other benefits of being part of a large system.

    Readily available staffing support. Mercy El Reno shares a flex nursing pool staff with Mercy Oklahoma City and other nearby Mercy locations. "And it's not only nursing staff. Just last week, we had a couple people out of the lab, and we actually had lab techs from Mercy Hospital Oklahoma City working in our local lab," he says.

    El Reno is also supported by the system-level financial staff. "Before, if I needed a pro forma, I had to research, dig, and do all that myself," he says. "Right now, I've got a request out, and the financial team is doing that for me."

    An advanced EHR. Mercy's EHR system improves patient care in part because records can easily be reviewed by Mercy specialists at other locations. And its patient portal allows El Reno patients to connect with their physicians online, order medication refills, and pay their bills.

    Volume increases. Emergency department volume increased after Mercy signed the lease. "We put the name on the building and our volume immediately increased 20 percent," Danker says. "I think it reflects patients' confidence in the care that they are getting."

    Mercy's Financial Perspective

    Because of economies of scale, the substantial benefits that Mercy El Reno Hospital gets from being part of a large organization do not translate into commensurately big costs for Mercy. Indeed, according to an economic impact study that Mercy commissioned, the system invested $252,000 in direct capital expenditures in El Reno in FY11 and projected capital spending of $300,000 for FY12 and FY13, which includes the EHR implementation.

    But that is the most simplistic way of thinking about economies of scale in health care. In the years ahead, providers will increasingly be paid for population health management rather than utilization, and being able to manage the care of a large population of patients looks like a winning financial strategy to Tom Hale, MD, executive medical director of Mercy's Center for Innovative Care.

    "Rural facilities actually represent a very good opportunity because of their low cost structure," he says. "If you supply the specialty infrastructure through telemedicine and virtual medicine, these facilities will do very well in a population management or shared-savings model."

    Mercy's Center for Innovative Care is not a place, but rather a collection of activities that are key to the system's business model. The center operates the nation's largest electronic ICU, along with other telemedicine services. Through research studies, it identifies and disseminates best clinical practices to all its facilities, and it is building population management capacity throughout the Mercy system. This entails everything from increasing access by establishing quick-care clinics to providing team-based care through patient-centered medical home practices.

    "We're changing the paradigm of how we care for people into more of a preventive model and more of a predictive model," Hale says. "If a person is predicted to have an event in the future, we monitor that particular person, using case management and technology to track that patient and ensure that he or she has access to needed care."

    The considerable investment needed to offer population health management will pay for itself if projections prove out. Mercy commissioned an actuarial study of its population to learn how its costs and revenues would be affected by the implementation of telemedicine services, case management, and other population health services. The finding: when fully implemented, those services will decrease Mercy's cost of care for patients by as much as 9 percent.

    Specific Economies of Scale

    Many operational areas across Mercy support the health system's growth through acquisitions. Here are a few examples.

    Supplies and services. One point of efficiency for Mercy facilities is its ROi Supply Chain Services subsidiary. Among other things, ROi provides group contracting, pharmaceutical repackaging, custom procedure tray manufacturing, print operations, distribution, and transportation management. photo-roi-warehouse-picker

    When Mercy acquires or leases a hospital, all supply chain activities are fully integrated into ROi. "Supply chain costs typically represent 30 to 40 percent of a hospital's expense base. As a result, supply chain should be viewed as a highly strategic and an integral part of a health care provider's operating model," says Gene Kirtser, ROi's president and CEO. "Unfortunately, a lot of healthcare systems don't view supply chain in the same light, so they outsource it all and allow their fate to be held in the hands of others. That's not the path Mercy decided to take and it is certainly not the path we believe is best for the industry."

    The company even has its own private-label brand that includes more than 1,000 different products. "Because we have our own distribution assets and transportation assets and we can purchase container-loads of supplies directly from the manufacturers, we have significant purchasing leverage," Kirtser says. "With our manufacturing and private-label sourcing strategies, we can drive savings up to 30 percent in a product category."

    Technology. Recognized by Hospital & Health Networks as one of the nation's "Most Wired" healthcare systems, Mercy is among only 7 percent of hospitals nationwide with an integrated EHR system that can access and share medical records among multiple Mercy facilities in a four-state area.

    The EHR technology is key to Mercy's business model, which depends on providing population health management to a growing number of patients. The system conducts research to identify best practices, which are disseminated to all facilities through the EHR's clinical decision support functions.photo-mercy-safewatch

    "The ability for us to actually manage at a patient-level, a panel-level, and a population-level has had a tremendous impact," says Will Showalter, CIO. "We use it for our pathways and our registries, and we have been extremely successful with programs such as early management of sepsis and management of congestive heart failure."

    Because it has interoperability technology, Mercy can easily share patient images and other data to clinicians throughout the Mercy system as well as to those outside its network, Showalter says. And the EHR is fundamental to its strategy of delivering virtual care through telemedicine.

    Telemedicine. "Mercy has the ability to give care without borders, and the ability to support the local community without having to duplicate a tertiary care-level hospital in every town in the country," Hale says.

    Through its SafeWatch electronic ICU program, physicians and nurses in St. Louis can monitor up to 450 patients who need intensivist care at more than 20 Mercy facilities in four states.

    The system also has more than 60 specialty-consult telemedicine programs-pediatric neurology, adult headaches, pulmonary medicine, perinatology, and others-already implemented or in the works.

    And it is just getting started. The big expansion announced last year includes $70 million to build a virtual care center. That center will be the hub for a full spectrum of telemedicine services including e-ICU, e-hospitalists, an e-skilled nursing facility-and eventually a hospital-bed-at-home program.

    Mercy's e-hospitalist program will help alleviate the physician shortage in small communities where a hospital's census may average less than 10 patients. "If four or five inpatient beds can be monitored by an e-hospitalist, that can take the pressure off the local primary care physicians so they are not getting called all through the night," Hale says. "Their lifestyle is better so you can keep those physicians in the community much longer."

    The big expense of telemedicine programs is in the staff and monitoring technology at the hub. Thus, when the virtual care center opens, Mercy will place mobile carts for two-way communication in all its hospitals. "This is the perfect part about economies of scale," Hale says. "The staff is already in place and they can take those extra calls without even missing a beat. In the future world, everybody gets that technology."

    Challenges and Lessons Learned

    Despite the benefits that economies of scale bring, the growth strategy has many challenges. Most obviously, it is expensive to add facilities and physicians.

    When affirming Mercy's Aa3 bond rating in late 2011, Moody's cited the health system's stable operating performance as a strength. However, the rating service identified some potential negatives for Mercy, including the amount of physician hiring. "Continued growth in the number of employed physicians currently is affecting system profitability negatively," the agency said in its report.

    Other challenges facing Mercy and other large health systems include the following.

    Service line changes. Stand-alone hospitals that seek to be managed, leased, or acquired by a large system often have operational or financial problems that have to be addressed to put the hospital on a strong footing.

    While Mercy has not eliminated any service lines in El Reno, that tactic is necessary in some situations. For example, shortly after it entered into a management control for Kingfisher Regional Hospital, a critical access hospital in Kingfisher, Okla., Mercy recommended that its obstetrics department be closed. The rationale: The hospital had only 70 deliveries in the past year, which was not enough to justify the expense of round-the-clock coverage by physicians, anesthesiologists, and nurses. In addition, that level of activity is insufficient to ensure best-quality care.

    Disruptions to staff. Mercy Hospital El Reno has eliminated nearly two dozen non-clinical staff positions since Mercy leased the facility. Except for one worker who opted not to take the placement, all were assigned to other jobs in the Mercy network. So they did not lose pay, but they did have to change jobs.

    Chain of command. When a hospital is leased or acquired by Mercy, its supply chain staff becomes integrated with ROi, which is Mercy's supply chain services company.

    The upside is that supply chain staff members have more opportunities for training and career growth within the system's supply chain; the potential downside is that those staff members become matrix-managed by both ROi and the local hospital administration. "Those situations can be challenging and conflicting at times," Danker says. "Usually the problems stem from miscommunication. If you sit down and collaborate with all the stakeholders, we can have the same message."

    A Growing Trend

    Traditionally, many stand-alone hospitals have rebuffed the loss of autonomy that comes with affiliation with a large system. Today, however, Mercy has more opportunities to acquire stand-alone hospitals than it can handle, McCurry says.

    "It's hard for me to imagine a time when there would be no stand-alone hospitals, but I certainly think that it will be much tougher in the future for stand-alone hospitals to exist," he says. "What I am certain of is that there will be tremendous consolidation over the next 10 years."

    Lola Butcher is a freelance writer and editor based in Missouri.

    Interviewed for this article (in order of appearance): Doug Danker RN, is administrator, Mercy El Reno Hospital, El Reno, Okla. Mike McCurry is COO, Mercy, St. Louis. Will Showalter is CIO, Mercy, St. Louis. Tom Hale, MD, is executive medical director, Center for Innovative Care, Mercy, St. Louis. Gene Kirtser is president and CEO, ROi, St. Louis.