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June 2019
Spotlight: The Challenges of Managing Softening Volumes in Large Institutions
©2019 Kaufman, Hall & Associates, LLC
Hospitals and health systems across the country continue to face the challenges of flat-to-declining volumes, and the residual impacts on revenues, expenses—and ultimately, hospital margins. The repercussions are particularly acute for the nation’s largest legacy providers.
An analysis of the data over the last 12 months shows that hospitals and health systems with 500 beds or more are disproportionately affected by fluctuations in volume. The results indicate that it is more difficult for larger hospitals and health systems to adjust their expenses according to shifts in volume, compared to small- and medium-sized organizations.
Recent months, however, have shown signs of potential improvements, as larger organizations are beginning to see incremental increases in persistently tight margins. While it is too early to say whether this upward movement will continue, a closer look at the relationship between these margins and various volume and expense metrics can help healthcare leaders better understand how to manage in times of softening volumes.
A Look at the Data
The Challenges of Size
The Challenges of Size
These analyses clearly indicate how heavily the nation’s largest hospitals and health systems continue to rely on volumes to maintain margins. Historically, they have benefitted from high volumes and revenues, which in turn allow them to support relatively high expense structures and inefficient operating models. They become more exposed, however, when revenues and volumes flatten or decline. By contrast, small- to medium-sized organizations have become more adept at flexing expenses to adapt to changes in volume. They are better able to tighten supply and labor expenses as volumes soften.
Much of this contrast can be attributed to the general structures of these different-sized organizations. The nation’s largest organizations include multi-hospital systems and academic medical centers that serve as the tertiary providers of care for large swaths of the population, often drawing patients from multiple states and across regions. Academic medical centers have added challenges, as their mission includes subsidizing their affiliated medical schools to support teaching and training for the next generation of physicians and other medical professionals.
These organizations traditionally have seen higher volumes and market share, because they provide the subspecialized services not available at smaller facilities. As such, they receive referrals from near and far. They are not as accustomed to flexing their variable staffing levels, because—historically—they haven’t had to.
Because of their massive size, larger organizations also have a larger percentage of fixed overhead costs, such as sizable human resources, revenue cycle, and finance departments. These larger fixed structures make it harder to adjust expenses in those areas. Smaller facilities, however, have more fixed populations and a limited set of services, and therefore can be more agile. They are more accustomed to continuously shifting staffing levels and expenses based on fluctuations in volume.
A Look at the Data
Data in the May issue of the National Hospital Flash Report showed that the nation’s largest hospitals experienced a rise in margins for the first time in several months (note that margin improvement does not necessarily mean hospitals are achieving sufficient margins; also, margins of individual hospitals within a system do not necessarily reflect margins of the system).
These results likely were linked to strong productivity management, with Full-Time Equivalents per Adjusted Occupied Bed (FTEs per AOB) for this cohort declining nearly 3 percent year over year. This continued in this month’s report, with Operating Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) Margins for the cohort up about 25 basis points over June 2018, and FTEs per AOB again down 3 percent year over year. Continuing this performance has the potential to help counter some of the long-standing margin challenges at these large organizations.
Figure 1: Variable Importance of Selected Metrics to Operating Margin
Source: Kaufman Hall proprietary data
A regression analysis was conducted to better understand the links between hospital margins and other key performance indicators. It found that the metrics most closely linked with margins vary somewhat when looking at a national sample of hospitals and health systems of all sizes, compared to those with 500 beds or more (Figure 1).
The metrics with the most significant impact on both an organization’s Operating Margin and its EBITDA Margin for the national cohort are Emergency Department (ED) Visits, Net Patient Service Revenue (NPSR) per Adjusted Patient Day, and Drug Expense per Adjusted Discharge.
Looking at the 500+ bed facilities, however, fluctuations in Operating Margins were most closely linked to Average Length of Stay (LOS), Discharges, Total Expense per Adjusted Discharge, and the Inpatient/Outpatient (IP/OP) Adjustment Factor. Changes in EBITDA Margins were most closely linked to Total Expense per Adjusted Discharge first, followed by Average LOS, Discharges, and IP/OP Adjustment Factor. These represent the most significant metrics to consider when attempting to manage margins in large hospitals.
Despite widespread talk of healthcare’s move toward a more value-based business model, these analyses show that legacy hospitals and health systems—particularly the country’s largest organizations—continue to function in a fee-for-service environment.
This heavy reliance on volume and revenue to determine Operating and EBITDA Margins is risky, because organizations have limited control in driving growth in these areas. The opportunities to control expenses are much greater. To effectively manage expenses across large systems, healthcare leaders need to make it a routine, daily focus of management.
Larger footprints require more resources to tackle costs. A 250-bed community hospital with 10 nursing units, for example, requires less resources to implement performance improvement initiatives compared to a large, regional medical center with 40 or more nursing units. Legacy providers with 500 or more beds need dedicated resources, such as a results management office, or a process improvement department. To manage costs amidst declining or stagnant volumes, the nation’s largest healthcare providers need to be willing to invest in the resources needed to build a true culture of change. The goal should be to make performance improvement an integral part of the organization. Such efforts must have the support of top leadership to gain broad buy-in and the ability to drive continuous improvement into the future.
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A Look at the Data
The Challenges of Size
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