Worse Before It Gets Better

Healthcare is a trailing indicator of the economy. Mass layoffs and credit tightening have devastated other industries, but hospitals typically show the effects of an economic downturn a little later as people scale back on elective procedures and even preventive care. That means, even though the stock markets and the economic outlook are finally showing some signs of life, the healthcare sector may still be in for a rough short-term ride.

A recent survey by Thomson Reuters backs up that notion, showing cracks in hospitals' generally razor-thin margins. The trouble in this downturn is that hospitals are more exposed than ever to the vagaries of the economy, as more of their revenue dollar comes from consumers and, in recent years, as more hospitals depend on their investment portfolios to pick up the slack. Those two areas are having a pretty drastic effect on hospital margins, the survey says, as about half of hospitals are operating in the red on total margin.

Gary Pickens, chief research officer for the Center for Healthcare Improvement at Thomson Reuters, says that data is unprecedented, historically. "If you go back in the 2001-2002 [dot-com crash], basically their investment income dried up but it didn't impact total margins because there weren't any serious losses or writedowns," he says. "The opposite has happened here and we can all relate personally by looking at any savings or investment returns we have. We've seen not just unrealized but realized losses in those assets."

Cutting construction

Pickens predicts that hospitals will have to cut back on developmental projects and focus on the core business, something that's already happening en masse, even with stronger systems like Atlanta's Emory HealthCare System, which recently mothballed a $1.5 billion expansion and replacement hospital project. Emory is far from being alone in curtailing capital expenditures in these uncertain times.

Pickens says healthcare IT falls into the same category, although cuts in planned expenditures there don't necessarily make the headlines like cancellations of multibillion-dollar construction projects. He suggests that IT money in the American Recovery and Reinvestment Act will help, but hospitals still may have a tough time committing to large investments even if the government is footing a large part of the bill.

Many suggest that hospitals are going to have to focus on their core business—trying to get more out of the people they have now and achieve savings through a reduction in contracting expenses.

"They are going to have to look for the pennies on the margin to get through this," Pickens says.

Trouble is, I've been writing about how hospitals have been looking for those pennies for years. And while focusing on the core business and getting out of business lines that aren't in their core competency has helped many of the hospitals I've profiled, there just isn't a gold mine there. There's no getting away from the fact that all of the operational engineering in the world won't save you from a cratered economy.

Just ask Toyota, the king of operational efficiency and a model that many hospitals have adapted to their own business to great success. Perhaps the world's most respected carmaker, Toyota is cutting back all over the place—even stopping construction on a Mississippi plant that was set to build its vaunted Prius.

Layoffs won't move the needle

Despite the constant drumbeat of news about hospital layoffs, Pickens says cutting staff just doesn't deliver the bang for the buck that many hospitals need, so he doesn't see it as a major way to add to margins.

"The average hospital operates at maybe 3% to 4% total margin, which is life support," he says. "Of course there are some hospitals that do much better and some that do worse. But they are pretty much already running lean and mean. So, I don't think there are a lot of nonessential workers to cut."