January 9, 2008
In 2006, the median hospital operating margin was 4.85 percent. This value, however, masked the well-known fact that there is wide variation around that level of performance. In fact, in that year, operating margins for the top quartile of short-stay, nonfederal acute care hospitals were more than 8.11 percent, and the bottom quartile had operating margins below 1.0 percent.
How do some hospitals perform so much better than others? An article in the December 2007 issue of Managing the Margin newsletter noted that to understand this issue, researchers focused on revenues and costs of 271 hospitals whose cost center and labor statistics had been standardized for the fiscal year 2006 using a proprietary national database.
The sample comprised short-stay, nonfederal acute care hospitals weighted to be nationally representative. All revenue and cost centers were studied on a per discharge basis and adjusted for both patient acuity mix and area wage index. The difference between the top and bottom quartile was examined to understand the drivers of operating margins.
Payer Mix and Size Don't Tell the Story
The characteristics of high- and low-margin hospitals were examined for occupancy rate, size of institution, case mix index (CMI), area wage index, and public payer mix. Surprisingly, the two groups are very similar. Both groups see about the same percentage of Medicaid and Medicare benefit cases.
In fact, the highly profitable hospitals have slightly higher acuity and higher prevailing wages in the community. To identify the drivers of operating margin performance, margins were decomposed into revenue and expenses.
Top-quartile hospitals yielded operating margins that were, on average, $1,418 per adjusted discharge better than bottom-quartile hospitals. Top-quartile hospitals recognized revenue of $7,760 per CMI-adjusted discharge, compared with $7,052 for lower quartile hospitals.
That $678 revenue advantage constitutes 48 percent of the total profitability advantage.
The remaining $806, or 52 percent, was due to lower costs per adjusted discharge. Outpatient services now account for a substantial portion of hospital revenue in both the high and low margin groups, with 38 percent and 36 percent, respectively.
However, the difference in performance cannot be explained by the percentage of revenue attributed to outpatient services. Interestingly, high-margin, lower-cost hospitals did not achieve such results by spending less on every component of care. Lower labor expense, both in salary and benefits, accounts for $328, or 40 percent, of the expense advantage.
Less bad debt accounts for another 17 percent of the advantage, followed by lower spending on nonmedical supplies (5 percent). Contract labor accounted for only 2 percent of cost advantage of high-margin hospitals. A large number of other expenses, each individually accounting for less than 2 percent of the variance, account in total for 35 percent of expense variation.
A surprising finding was that high-margin hospitals whose costs per adjusted discharge were lower than those of less profitable hospitals actually spent more on medical supplies, drugs, and lease or rent expenses. This finding supports the premise that some drugs and devices lower the total cost of care even if certain component costs are higher.
The finding also reinforces prior findings that hospitals that are early adopters of technology have a greater likelihood of being designated among the Thomson 100 Top Hospitals®—a designation that depends in part on clinical outcomes as well as operating margins and efficiencies.
Another interesting finding was that high-margin hospitals that had lower salary and benefits costs per case had a 6 percent lower staff per adjusted occupied bed (4.91 versus 5.22) but paid 4.5 percent more in salaries ($51,572 versus $49,199) even when normalized by area wage index.
Both the total cost advantage and higher wages have been identified in the Thomson 100 Top Hospitals database where winners have been shown to have lower costs and fewer staff per discharge while at the same time paying higher wages.
A New Way to Approach Benchmarking
The overall picture that emerges is that the success enjoyed by profitable hospitals is attributable to increased revenue and better productivity, rather than simply the luck of payer mix or across-the-board cost reductions.
This picture also suggests a more evolved way to approach performance benchmarks: When benchmarking performance against that of other hospitals, it may be more effective to target the performance of successful hospitals rather than just similar hospitals.
Source: "Revenue and Productivity Are Keys to Profitability," December 2007Managing the Margin newsletter. This monthly newsletter delivers strategies for increasing volume, reducing costs, and strengthening your organization's bottom line, as well as best practices that providers should keep in mind when benchmarking performance.
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If you have questions or comments about HFMA Wants You to Know, contact editor Maxine Harrison.
HFMA Wants You to Know ISSN: 1540-0697. Volume VII, Issue 1. Copyright 2008, Healthcare Financial Management Association. All rights reserved.