My first hospital CFO had a plaque on his desk that read, "no margin, no mission." This popular business phrase is more relevant today than it was back in 1989, as we are faced with healthcare costs that are out of control and consumers that are reaching the point of price inelasticity. Hospitals have never had a more pressing economic imperative for hospital margin improvement, but cultural issues must be addressed in order to achieve success in developing a margin improvement program.
Why Should Leadership Care?
As we discuss margin improvement, there are two core measures to consider. The first is operating margin, or operating income, which measures how well your organization is managing the business of patient care and compares patient care costs to patient care revenues. Net margin takes patient care expenses and revenues and also includes revenues and expenses from non-patient care operations such as income on investments, philanthropy or cafeteria sales.
A recent Thomson Reuters analysis concludes "that about 50 percent of U.S. hospitals are losing money, and that total net margins for U.S. hospitals declined last year. The worst-performing hospitals had net margins of negative 7%, while the best performing hospitals' net margins topped 4.5%. This dragged down the median total hospital margin to near zero for all hospitals and left approximately 50 percent of hospitals in the red."
When we compare these total margin statistics with historic data, we find that medians this low have not been observed before.
Some alarming trends are driving the decline in hospital margins. These trends include: healthcare cost inflation that is advancing at two to five times that of the consumer price index; reimbursement that does not keep pace with cost increases; declines in payer mix; businesses shifting more costs to workers; supply chain cost increases in pharmaceuticals, implantables and devices; increasing demands for high technology and clinical information systems; outdated competitive strategies that use capital investments in new buildings or technologies to attract patients; defensive medicine; and a lack of evidence-based medicine to ensure the best care standards. These trends and the rapid decline in hospital margins create a real threat to the mission of many hospitals. If these alarming trends continue, margin improvement could become the most critical skill set for healthcare leaders in the 21st Century, and those without this capability will not likely hold C-Level positions in the future.
Altruism, Practicality and the Cultural Aspects of Margin Improvement
"Culture eats strategy for lunch" is a very true statement and the cultural aspects of a margin improvement program cannot be overemphasized—particularly because healthcare is an industry made up of people with a "calling" to help others. Whether the "calling" requires the use of spreadsheets or care plans, most healthcare workers are here because they want to help people. For this reason, the cultural and ethical aspects of "what we do" cannot be overlooked in any discussion of margin improvement or in the way it is approached.
While corporate culture differs from client to client, the basic wiring of healthcare people does not. This is why it is critical to remain cognizant of putting margin improvement objectives in the broader context of mission and help people appreciate the need to be better stewards of our limited resources. It is the aspect of stewardship—effectively managing the resources with which we have been entrusted—that is at the heart of sustainable margin improvement. Stewardship should therefore be the link used to connect a person's "calling" with their method of operation.
By engaging physicians and clinicians based upon their "calling" to serve others and using stewardship as the practical enabler that will allow them to better apply their altruistic values to patient care, results achieved can be far superior to traditional "turnaround" approaches. After all, physicians are highly educated, data-oriented people who respond well to clinical quality improvement, efficiency enhancement and improved methods. Unfortunately, too may hospital leaders try to engage them solely on the basis of economics and fail to help them see how the best quality of care is often the least wasteful and most economical.
A few years ago, we worked with a chairman of orthopedic surgery on a major supply chain project. According to the staff in hospital administration, the chairman was "uncooperative," "in bed with the vendors," and "wasting millions of hospital dollars on knee and hip replacement appliances." Their approach was to take spreadsheets to him and point out the money the department was losing in order to engage him to change his ways. In short, they had no success with this approach.
When I met with the chairman, I quickly realized that we both shared a passion for excellence in care. When he sensed that we were on the same page and had the same "calling," he wanted to know if the rumors that his department was losing the hospital a lot of money were true. I explained the economics of the situation, the impact of physician preference items and current vendor contracts on the hospital margins, and how these losses negatively impacted departmental funding. After some education, he became a champion for improved orthopedic "stewardship" and ultimately helped reduce orthopedic supply costs by more than $4 million per year by supporting contract negotiations, changing policies and procedures, and requiring clinical justification from faculty before approving preference items.
Practical Advice on Margin Improvement: A Success Story
In addition to considering the cultural aspects of margin improvement, it is critical to establish reasonable goals that are based on long-term solvency, capital for plant and equipment refurbishment, recruitment, maintenance of employee benefits, and similar organizational benefits. Whatever the hospital's tax status, margin improvement needs to be about more than profits or retained earnings. It has to have a strategic and ethical context that helps people fulfill their calling. Too many times a hospital leadership team waits until a bond covenant is tripped or their losses threaten their ability to effect change in a methodical manner. At that point senior executives are fired and a "turnaround" firm or management company is brought in. In contrast to the "turnaround" approach, margin improvement should be thought of as a proactive management tool rather than a last resort.
One example of a successful values-based margin improvement program comes from the University of Mississippi Medical Center. By 2006, UMMC had realized significant operating losses four out of the prior five years, was faced with significant morale issues, and lacked the funding needed to invest in capital improvements and hire enough clinical staff to meet increasing patient care demand. The organization was also faced with recruiting and retention challenges due to prior employee layoffs that had been implemented by the hospital's outsourced management firm. Based on the limited success of management outsourcing, UMMC leadership decided to hire a proven CEO and change direction. The new CEO quickly initiated a three-prong strategy of culture change, leadership change, and engaged us to assist him with a large-scale margin improvement program. The overall program covered three major phases starting with assessment and road map development and concluding with implementation and monitoring.
Over the first 28 months of implementation, the UMMC margin improvement program achieved the following results:
- $144 million in sustainable operating margin improvement
- Thomson Top 100 Hospital Award
- Volume growth of 4%
- The hospital no longer has to receive subsidy from the Medical Center and is now able to contribute to overall mission areas such as expanded education and research
- Medical education was expanded with a one-third increase in medical student admissions and UMMC is now able to help the state address physician shortages
- UMMC is investing more than $50 million of its margin improvement in new clinical information systems
The margin improvement program combined the values of patient care quality and stewardship and provided a comprehensive strategy for helping hospital leaders simultaneously improve patient care quality, patient satisfaction and operating margin. It has resulted in significant improvements to the institution and has created the capital needed to take the organization to a higher level of healthcare service quality, clinical quality and fiscal stewardship. Based upon these results, the margin improvement program should be considered by other institutions as a positive response to the strategic economic challenges of healthcare reform, the need for capital investments in new technology, and as a management tool for ongoing process improvement and effective long-term leadership.
Kent Giles is a Partner at CSC in Atlanta. He may be reached at kgiles4@csc.com.
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