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How To | Capital Finance

ENPR: A metric for comparing alternative and top-line revenue strategies to enhance strategic growth

How To | Capital Finance

ENPR: A metric for comparing alternative and top-line revenue strategies to enhance strategic growth


Jami Youmans

Kyle Hathaway

Ryan Smith, CFA

Health system CFOs today should be actively guiding their organizations toward strategic investments in alternative revenue sources that can strengthen the bottom line. A critical part of this effort is being able to assess the relative value of such investments.

The role of CFO continues to evolve — particularly as CFOs move beyond traditional finance functions and become more actively involved in financial transformation strategies. Among CFO respondents to a December 2018 McKinsey Global Survey, 44% percent said they directly oversee individuals leading a transformation. More than half of all respondents said the CFO has been actively involved in developing their health system’s transformation strategy.

“To be successful as we look forward, we’ve got to be thought leaders,” Lori Donaldson, CFO of UC San Diego Health, told HFMA in a 2019 article in hfm.[1] “We have to be innovators. We have to help our organizations find new ways of raising revenue. We have to be willing to look at other delivery models and consider partnering with entities we might not have considered partnering with before.”

The evolving CFO role includes taking the lead in identifying and pursuing reliable sources of alternative revenue. However, pursuing these strategies can require incremental capital investment and result in high opportunity cost. As pressure to maintain both margins and credit ratings continues to challenge financial leaders, competition for capital within a health system is likely to only intensify. The environment requires a clear, simple way to evaluate and interpret the impact of all opportunities under consideration by health system management teams.

It starts with having the right metric

CFOs require effective means to successfully identify, select and invest in attractive businesses that bolster patient care services and capture the value that is adjacent to a health system’s core business.

Absent the ability for organizations to assess the impact of alternative revenue strategies, capital deployment decisions are likely to have bias towards risk-averse or more comfortable options aimed at growing core clinical volume.

To counter this tendency, CFOs and leaders across health systems would benefit from an easy-to-understand metric that contrasts the profit impact generated from alternative investment strategies relative to that of the core business.   

An effective and relatable metric for this purpose is equivalent net patient revenue (ENPR).  Whether the potential alternative investment opportunity aims to increase revenue, reduce costs or achieve some combination of both, ENPR equates the profit generated from an alternative investment to the organization’s core clinical business in terms of net patient revenue, a traditional measure that's broadly understood across health systems. By focusing on the profit impact, ENPR alleviates health systems’ common bias toward weighting investment options based on revenue contribution alone when comparing investment opportunities with varying financial profiles. ENPR can be particularly useful for assessing alternative investment strategies that would leverage the health system’s existing infrastructure because it can clearly show why such an investment might be attractive, as discussed in more detail below.            

How to calculate ENPR

To calculate ENPR, the amount of projected return, or change in operating profit (OP), from an alternative revenue source is divided by the health system’s net operating margin:

total projected OP change (net proceeds) ÷ baseline operating margin = ENPR

This metric is primarily intended to serve as a forward-looking tool to make data-driven investment decisions. However, organizations also can use it to look back at previous investments to gauge overall financial impact.

A health system’s core business of delivering patient care typically has a narrow operating margin due to the wide range factors, including the need for:

  • Highly skilled labor
  • Complex machines and devices
  • A geographic footprint capable of achieving scale to properly deploy the organization’s assets

As such, alternative investment options that can expand the organization’s operating margin can accelerate profit growth. 

Sample scenarios

Consider, for example, that a health system with a baseline operating margin of 5% has the choice of investing in one of the following three options:

Investment option

Revenue growth per year

Margin expansion per year

1.     Core business revenue growth

5.0%

0 basis points (bps)

2.     Hybrid revenue growth/margin expansion

2.5%

25 bps

3.     Margin expansion

0.0%

50 bps

The resulting total revenue and operating-profit changes (i.e., margin expansin in basis points [bps]) over a five-year period are shown below. ENPR captures both the expected revenue and profit contribution and establishes that, when all else is equal, option three yields the highest ENPR and would be the most lucrative option to pursue over the five-year period. To attain the same level of profit growth achieved in option three, the health system would need to grow core revenue by 8.4% per year or by 50% in total over the five-year period (from $5 billion to $7.5 billion, as shown  in the exhibit below.

Application of the ENPR metric in three hypothetical investment scenarios

Note: Dollars are in millions.

  • CAGR = Compound annual growth rate
  • bps = Basis point
  • ENPR = Equivalent net patient revenue

Source: HealthEco, 2020

ENPR is used across the same three investment scenarios with differing amounts of upfront investment allowing for comparison between the different options, establishing ENPR per $1 of investment (total ENPR divided by total investment). The exhibit also shows option two yields the highest ENPR per investment based on required upfront investments of $50 million, $60 million and $100 million for options one, two, and three, respectively. Option three could be considered the least attractive option given the varying upfront capital requirements and the fact that investing in the core business to accelerate revenue growth requires less upfront capital. However, these examples illustrate the importance of understanding the profit impact of both revenue growth and operating margin capture generated from alternative investment strategies. ENPR is a tool that helps reconcile investments with differing financial profiles by translating profit impact into a relatable metric that allows leaders to make the most efficient capital allocation decisions.

Indexing alternative growth strategy with core revenue

In sum, ENPR uses both projected new revenue and the system’s operating margin to create a single metric that allows executives to compare alternative revenue strategies with core hospital and physician businesses. As such, it is a more reliable metric than ROI (i.e., comparison of net profit versus cost of investment), which previously was the primary metric used by health systems to determine whether an alternative revenue strategy was worth pursuing. The limitation of ROI is that it fails to provide a framework to contrast investments made outside of a health system’s core business. ENPR should not replace ROI as the sole metric, however. Rather, it is a good complement to ROI for helping organizations gauge the materiality of alternative revenue strategies.

Why measure ENPR?

Equating the financial impact of alternative revenue strategies by utilizing both revenue and operating profit better captures the holistic impact of the investments a health system makes. As organizations continue to pursue alternative growth strategies and revenue diversification, ENPR can serve as a guide to compare options in a straightforward, risk-stratified way.

The ultimate advantage of using ENPR comes from the increased visibility it provides to inform strategy and enable an organization to invest confidently in growth opportunities that will generate revenue adjacent to the core business lines. ENPR gives CFOs a new and unique perspective for assessing the extent to which investments in alternative revenue streams will deliver a direct financial impact to the organization. By pursuing these nontraditional investments, organizations can grow their profit, increase their borrowing capacity and ensure success during a time of continued financial uncertainty.

Footnote

a. Hegwer, L.R., and Hut, N., “The healthcare CFO of the future: How finance leaders are adapting to relentless change,” hfm, September 2019.

 

About the Authors

Jami Youmans, MHA,

is cofounder and a managing partner, HealthEco (jami.youmans@thehealtheco.com).

Kyle Hathaway

is a managing partner, HealthEco (kyle.hathaway@thehealtheco.com).

Ryan Smith, CFA,

is a senior investment associate, HealthEco (ryan.smith@thehealtheco.com).

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