Accounting and Financial Reporting

3 Keys to Defending a Healthcare Organization’s Margins

June 26, 2018 11:14 am

As the healthcare industry continues its transition from volume-based to value-based payment, healthcare organizations must establish priorities regarding which areas of focus will best help them to succeed in this shifting environment.

The ongoing consolidation of the delivery market took a new turn in 2017 that has carried into 2018. Vertical deals that saw for-profits like Anthem and Optum acquiring delivery operations have raised anxiety to new levels.

Margin compression already was a fact of life. But the entry of nontraditional stakeholders into the mix has introduced the threat of a new kind of competition that will increase the pressure even more. With little hope for relief on the horizon, organizations both big and small need to develop their own roadmap to deal with margin compression. That challenge is further complicated by the transition to value-based payment models that is advancing at a varied pace in each market.

Overall, by adopting the following recommended tactics, organizations that are still largely in a fee-for-service (FFS) environment can improve current performance and also lay the foundation to assume risk in value-based payment models.

Understand Margin by Service

Historically, most financial analysis in health care has been at a gross level, so many providers can’t even see their cost structure—or what it costs to deliver a given service in terms of labor, infrastructure, materials, and equipment. From the smallest convenience store to the largest multinational corporation, for-profit enterprises operate differently. They know their margin on each product or service, and how it compares both historically and against industry benchmarks. Forward-leaning healthcare providers have adopted the same approach, because they need to understand and manage their cost structure differently.

As consumers shoulder more of the first-dollar cost due to high deductibles, they will shop more for healthcare services. Providing transparency around price (and costs) can become a way to distinguish an organization for consumers as well as for payers and employers. Furthermore, by obtaining greater insight into their underlying cost structure, healthcare organizations can gain greater control over their ability to compete.

As a starting point, organizations should define activity-based costs, which include materials, overhead and indirect costs, and the direct cost of the labor needed to deliver the service. Activity-based costing (ABC) techniques have been used for decades in manufacturing and other industries but have not typically been used in the world of health care. Moreover, providers’ attempts at costing have tended to be focused primarily on their biggest cost—staffing—rather than on evaluating and rethinking care delivery processes, which is what ABC enables in health care. With an understanding of the precise costs for individual encounters, procedures, and episodes of care, providers can focus in on specific drivers, including clinical, technical, and process elements—all of which make up the total cost of health care.

ABC also allows providers to perform accurate assessments of the profitability of individual service lines, provider relationships, and specific patient populations. Such information is crucial for making informed decisions about where to invest, especially for organizations interested in owning a niche to set them apart from competition.

Organizations with a deep understanding of their underlying cost structure can increase the value of their care, improving margins in both value-based and FFS models. Having competitive pricing will only become more critical as the market’s appetite for transparent price information grows stronger.

As more healthcare delivery organizations move to value-based payment and expand service coordination, executives must understand the cost of care beyond acute care facilities and physician practices, including post-acute facilities and in-home care. However, as a prerequisite, providers must first understand costing within the walls of their own institution. That knowledge positions providers to negotiate at-risk pricing with more confidence that they are market competitive and bottom-line safe.

Reduce Variation in Cost and Quality

One of the most important concerns for healthcare providers today is having the ability to manage variation in cost and quality. This concern is not just a technology issue that can be addressed by implementing new IT platforms and software suites. Rather, it represents a significant cultural issue that challenges the traditional assumptions about how health care is delivered. Today, healthcare finance administrators and clinical executives often struggle to address the problems of clinical and cost variation. Managing this variation effectively requires data that are credible from both a clinical and administrative standpoint and that are derived from an evidence-based approach to care, while taking unique patient needs into account. It also requires embedding accountability into key clinical and administrative roles.

Reducing variation in cost and quality is highly dependent on using evidence-based medicine to predict what treatments, services, and drugs will be required for any given procedure, and what outcomes to expect. At the heart of evidence-based medicine are predictive care paths. These care paths serve as the basis for analysis and elimination of variation that costs money and compromises the quality of outcomes. The increasing demand for predictable outcomes and costs has spotlighted the need to balance traditional physician autonomy in clinical decision-making with evidence-based medicine regardless of whether an organization is operating under FFS or pursuing risk-based contracts.

Once care paths are in place, organizations will require the analytic, process, and interpersonal capabilities to understand differences—including what they mean and why they exist—across clinicians in key clinical areas. Changes in roles, accountabilities, and skill sets also may be required so that clinicians and administrators working to manage variation in cost and quality can receive actionable, timely answers to questions about the nature and causes of that variation.

These capabilities will become even more important as the industry changes. As value-based payment models such as bundled payment and population health continue to create incentives to reduce resource use and improve outcomes, organizations will have no choice but to take a more disciplined approach to this task.

However, building the infrastructure and capabilities necessary for managing variation in cost and quality also will provide an immediate ROI for organizations. By performing a critical assessment of its clinical and financial data, a healthcare organization can identify gaps in processes and capabilities, prompting plans and actions not only to improve care delivery and reduce variation in cost and quality, but also to strengthen the organization’s bottom line.

Focus on Outcomes Measurement and Management

The importance of focusing on outcomes in healthcare delivery has been reinforced by the growing linkages between outcomes and payment, incentives, and penalties, including the following:

  • Financial penalties for so-called “never events”
  • The growing number of contracts between providers and self-insured employers for episode-based care that include quality and cost requirements
  • The growing availability of publicly reported cost and quality data intended to help consumers evaluate comparative cost and quality for the care they need
  • Federal reporting on hospital ratings and the linkage of those ratings to provider eligibility for participation in federal programs

For a given service, organizations should be able to clearly define what’s included and what’s not, and provide guarantees of quality irrespective of where that service is offered along the continuum of care. Organizations that can effectively manage the cost and quality of care within their own walls and build meaningful alliances and partnerships with like-minded external care providers will be best positioned to achieve these objectives.

Moving forward, differentiation will come from more effective execution of standard protocols, as reflected in new outcome metrics and the transparent presentation of specific economic and clinical value data. These data also can provide the basis for developing a clear value story that will resonate with different key stakeholders, including patients and health insurers. Patients will want to understand why any given provider is better than the competition, and insurers will want to see evidence of consistent outcomes and predictable costs. Provider organizations that don’t provide such economic and clinical data regarding value risk being omitted from consideration, losing out on potential patients.

A Difficult but Straightforward Path

The path forward is clearer than many realize. But it also undeniably is a difficult and strenuous journey—one that challenges traditional norms, requires new competencies, and introduces fundamentals that haven’t been the mainstay of the nation’s healthcare system. The payoff for those organizations that invest now will be significant, both in the short term and the long term.

Rita E. Numerof, PhD, is president, Numerof & Associates, Inc., St. Louis.


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