Financial benchmarking can improve hospital margins

If a healthcare organization is experiencing negative net margins, should it try to raise revenue 6 percent, or cut costs by 6 percent?

"Usually the response is raise your revenue 6 percent," said William O. Cleverley, chief executive officer of Ohio-based Cleverley & Associates, one of two co-speakers at an Healthcare Financial Management Association (HFMA) annual national institute presentation on benchmarking costs. But that is not necessarily the right answer.

In an era of declining reimbursements from both private and government payers, raising revenue is a tough proposition. "We have reached the point where, basically, the revenue machine is tapped out," Cleverley said.

Meanwhile, there remain opportunities for cutting costs. Cleverley noted that in 1970, the annual per capita expenditure on healthcare in the United States was just $356. It was $8,915 in 2012. By comparison, the Volkswagen Beetle he purchased for $2,000 in 1970 only costs $20,000 now. Other data has also suggested that spending growth is outstripping cost growth in healthcare.

That's why Cleverley believes that providers can continue to ratchet down costs and be able to at least break even.

Being able to do so, however, requires benchmarking. That not only includes comparing one's own healthcare organization's financial performance against another, but closely examining the per-unit costs of virtually every task that is performed. A general equation for doing so is encounters per capita multiplied by costs per encounter equal cost per capita. Cost per encounter can be determined by multiplying the number of services provided by encounter by the inputs per service and the prices of those inputs. The desired goal is a lower cost per encounter, with a focus on the intensity of care provided, compensation for staff and specific departmental costs.

Although benchmarking is fairly common at the hospital level, it tends to be tied more to quality than cost, with physicians often being paid bonuses based on hitting certain quality goals.

A survey by Cleverley's firm of hospitals in California concluded that low-cost facilities had an average margin of nearly 5 percent (compared to an average negative margin of 1.6 percent for the high-cost hospitals). That's despite the fact that net revenue per patient among the low-cost facilities is about 14 percent--or $1,504 less--than their high-cost counterparts. Expected mortality rates among the low-cost hospitals were also less than at the high-cost facilities.

Cleverley's co-presenter, Aaron Crane, chief financial officer for Salem Health in Oregon, suggested that hospitals looking at their cost structures create a business case template that includes a close look at all costs (including labor), as well as the anticipated benefit of making changes. Most importantly, he suggested, was to create a culture where reducing unnecessary costs was created throughout the organization.