• Determining the Value of a Service Line

    Oct 23, 2012

    An academic medical center used a strategic framework to decide the futures of a service line and a business unit-one profitable and one that was losing money-as detailed in this excerpt from a recent report.

    By James W. Blake, Brian S. Channon, Mark E. Grube, and Jason H. Sussman

    Analysis of the viability of hospital and healthcare system business units and service lines must address total value of the entities to the strategic and financial goals of the organization. A business/service line analysis framework provides insights for business leaders on using resources wisely while serving community needs. 

    Analysis Framework Considerations 

    The framework should consider mission, nature of operations, market environment/competitive position, financial performance, and compatibility with new-era needs and competencies.

    KH Guide Figure 8

    The following are full descriptions of each framework element. 

    Mission. Considerations include: 

    • Benefit provided to and support provided by the community
    • Whether a void would be created if the business/services were not provided
    • Whether other organizations would appropriately fill that void

    Nature of operations. Considerations include:

    • Whether patients/customers flow across the businesses and services or whether the operations are detached and separate
    • The extent to which the business/service functions as a stand-alone operation (i.e., systems, management, funding of operations, utilization of shared services) 
    • The alignment of associated strategic requirements and financial incentives with the core operations of the organization
    • The downstream or upstream implications of eliminating this business/service

    Market environment and competitive position. Considerations include:

    • The attractiveness and demand for this business/service
    • The key industry drivers and requirements for success of this business/service 
    • The intensity of competition and the organization's ability to differentiate from others 
    • Whether the organization has a competitive position that is relevant and sustainable in its market

    Financial performance. Considerations include:

    • The historical financial performance of the business/service
    • The level of financial performance generally achieved within the industry for this type of business/service
    • Future capital requirements and the level of performance that can be expected
    • The estimated valuation of the business/service
    • The impact divestiture would have on the overall credit profile and the financial position of the organization
    • The impact development of a new business/service or acquisition would have on the credit profile/financial position of the organization

    New-era compatibility. Considerations include:

    • Whether the business/service supports longitudinal patient management across the continuum of care
    • The business/service's impact on the organization's brand and image
    • Whether this business/service has a material cost structure advantage or disadvantage relative to competitors
    • Whether the organization can be an essential provider of this business/service with sufficient scale of operation to succeed

    Categories Define Analysis Approach 

    Ultimately, discussions related to an organization's businesses and services must openly address total value of the business to determine if it is the best use of scarce resources available to meet community needs. The following figure provides an appropriate evaluation matrix, with four categories of businesses and services-core, achievers, nonstarters, and prodigies-as defined along strategic-position and financial-contribution axes. Tough decisions will need to be made and implemented by hospital and health system boards and executive teams.

    KH Guide Figure 9

    Medical Center Decides to Divest Two Businesses

    Given the significant capital investment requirements of its new business model, one academic medical center evaluated its options in the changing landscape. The evaluations started with the development of a financially oriented business plan for each service line and business unit currently owned and operated by the organization. The medical center owned a home health business and a reference laboratory business, among other entities.

    Each business plan was supported by fact-based assumptions about volume, revenue, expense, and associated capital costs going forward. Sensitivity and scenario analyses were completed for the key drivers to understand the range of possible outcomes. Each plan was integrated into the organization's long-term strategic financial plan in order to understand the impact of the businesses on the organization's strategic and financial success going forward.

    Home health business. The academic medical center needed access to high-quality post-acute care in order to manage patients' health following discharge, thereby minimizing readmissions. But the economics of its home health business were difficult. Competition was intense in its market. The business was not profitable, and its losses were expected to increase. The medical center was concerned about its ability to sustain the business in the long run and provide the necessary capital and resources to maintain ongoing quality services. It decided to divest the home health business to one of the major players in the market, which could continue providing quality services more effectively and efficiently in the community. The divestiture would mitigate the medical center's losses and enable the organization to redirect capital capacity to initiatives in its core competency and mission-driven areas.

    Reference laboratory business. The academic medical center's reference laboratory busi¬ness, on the other hand, was very profitable, having been significantly capitalized over the years. But the business did not meet leadership's criteria for core services. Two large laboratory companies, which already provided services in the community, proposed to purchase the medical center's business to increase their market penetration. The medical center decided to divest its reference lab business and use the proceeds to build its balance sheet in support of core strategic initiatives.

    Analysis Framework Aids in Decision Making

    When deciding the fate of a business line or service, paying attention to a single consideration could result in faulty decision making. A business/service line analysis framework that includes many considerations and a service evaluation matrix assists hospital and health system leaders in taking a holistic approach to determining the value of a business/service and making judicious decisions.

    James W. Blake is managing director, Kaufman, Hall & Associates Inc. (jblake@kaufmanhall.com).

    Brian S. Channon is senior vice president, Kaufman, Hall & Associates Inc., and is a member of HFMA's First Illinois Chapter (bchannon@kaufmanhall.com).

    Mark E. Grube is managing director, Kaufman, Hall & Associates Inc. (mgrube@kaufmanhall.com).

    Jason H. Sussman is managing director, Kaufman, Hall & Associates Inc. (jsussman@kaufmanhall.com).


    This article is an excerpt from a Guide to Strategic Cost Transformation in Hospitals and Health Systems, published by Health Research & Educational Trust and Kaufman, Hall & Associates Inc