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September 2019
Spotlight: The Need to Adapt Operating Margin Strategies for Healthcare’s Future
©2019 Kaufman, Hall & Associates, LLC
The nation’s not-for-profit hospitals saw operating revenue growth of 5.1 percent, and expense growth of 5.0 percent for fiscal year 2018, according to recent reports from Moody’s and Modern Healthcare. Per Moody’s, “in 2018, not-for-profit hospitals saw revenue growth edge ahead of expenses for the first time since 2016, as a result of steady patient volumes, revenue cycle improvements, and M&A.” Meanwhile, profitability held steady, “with median operating and operating cash flow margins just below the prior year numbers.”
Referring to the traditional profitability equation of revenue minus expenses equals profit, one would expect profitability to remain steady—given that revenue growth only slightly exceeded expense growth.
This month’s Spotlight explores the ongoing validity of this equation in today’s dynamic healthcare environment, including Kaufman Hall analysis of various growth factors related to financial performance and healthcare consumer trends (see Sidebar). Analyses are broken down by Gross Patient Revenues, Total Expenses, and Operating Margins. Similar to the standard structure of the National Hospital Flash Report, growth factors are categorized by hospital type using the classifications of Bed Size and Region.
Overview
The data used in this month’s Spotlight were extracted from Kaufman Hall’s Axiom Database for the date range of FY 2017 to FY 2019. The data were analyzed on a monthly reporting basis, and a July to June fiscal calendar was applied. Under these data and time period assumptions, fiscal years 2018 and 2019 are showcased.
Kaufman Hall’s Axiom Database stores all of the budget and actual reporting data of hospitals that subscribe to Kaufman Hall’s budgeting platform. This includes about 715 organizations across the country, featuring hospitals and health systems of all types and sizes. While this is a sizable sample of organizations that generally reflects the greater population, these data represent a sample only—not all U.S. hospitals and health systems.
Sidebar: Analysis Assumptions and Data Background
Gross Patient Revenues
Total Expense
Overview
Operating Margin
Profitability Equation
Total Expense
Not surprisingly, hospitals across the country continue to experience rising expenses. Kaufman Hall’s analyses show that Total Expenses increased 1.35 percent and 1.68 percent overall for FY 2018 and FY 2019, respectively. Figure 3 displays the Total Expense growth rate for hospitals and health systems of various sizes.
Hospitals of 0-25, 200-299, and > 500 beds all experienced increases in Total Expenses in FY 2018 and FY 2019. Hospitals with 26-99 beds saw significant change in fiscal year-to-year growth rates, going from a growth rate of 6.13 percent in FY 2018, to -0.49 percent in FY 2019. This result is not surprising, given that these smaller hospitals typically are heavily involved in M&A transactions and, in turn, the re-allocation of expenses.
Hospitals of 100-199 beds experienced a decrease in their Total Expense growth rate in FY 2018, followed by an increase in FY 2019. Hospitals of 300-499 beds featured relatively stable expenses, with near off-setting growth rates of 1.5 percent in FY 2018, and -0.91 percent in FY 2019.

Figure 4 shows Total Expense growth by region, with the Northeast/Mid-Atlantic and West regions having the largest increases in FY 2019. The Great Plains and Northeast/Mid-Atlantic regions were the only regions to experience increases in both FY 2018 and FY 2019. The Midwest saw Total Expenses decrease -3.3 percent in FY 2019, the South saw a -4.5 percent decrease in FY 2018, and the West experienced a -1.33 percent decrease in FY 2018. Similar to with Gross Patient Revenue, the Northeast/Mid-Atlantic saw large increases in Total Expenses both years. This is to be expected, as a large number of hospitals in the region merged and therefore “grew,” which tends to drive sizeable increases in both revenues and expenses.
Gross Patient Revenues
Looking first at Gross Patient Revenues, the data show that hospitals in the sample group saw 2.75 percent and 4.62 percent positive growth rates for fiscal year (FY) 2018 and FY 2019, respectively. Figure 1 displays the Gross Patient Revenue growth rate for hospitals and health systems of various sizes.

For hospitals with 0-25 and 200-299 beds, Gross Patient Revenue growth largely remained steady from FY 2018 to FY 2019, while hospitals of 300-499 and >500 beds saw declining growth rates over the same period. This is due to the high volume of merger and acquisition (M&A) transactions involving these larger organizations in FY 2017 and FY 2018, and corresponding growth, which skewed the data for those years. Even so, overall growth remained positive.
As noted in Modern Healthcare, “about 93 percent of most metro hospital markets are highly concentrated, which means fewer choices for potential M&A partners.” Due to the declining number of potential partners, hospitals and health systems may need to explore other investment-based sources of revenue to increase their top line.
Figure 2 shows Gross Patient Revenue growth by region.1 Most regions—except the Midwest and South—featured positive year-to-year growth for FY 2018 and FY 2019. For the Great Plains and West regions, year-to-year positive growth remained relatively steady. The largest growth was seen in the Northeast/Mid-Atlantic, due to the region’s high number of metropolitan markets, which continued to experience higher-than-average volumes of M&A transactions.
Operating Margin
Figure 5 displays the Operating Margin growth rate for hospitals and health systems of various sizes. With the exception of 26-99 bed hospitals, hospitals of most sizes experienced overall negative Operating Margin growth rates in FY 2018, and positive growth rates in FY 2019. Hospitals of 26-99 beds featured positive growth rates both fiscal years, but growth slowed significantly in FY 2019.
The Operating Margin results vary significantly when calculated by region. For example, the Great Plains and Northeast/Mid-Atlantic experienced positive growth rates in both FY 2018 and FY 2019, while the South and West saw negative growth in FY 2018 and positive growth in FY 2019, and the Midwest saw positive growth in FY 2018 but negative growth in FY 2019.
Overall Operating Margin demonstrated a negative growth rate of -2.97 percent in FY 2018, and a positive growth rate of 18.43 percent in FY 2019. For hospitals and health systems that are not involved in mergers, acquisitions, financial turnarounds, and other drastic operational changes, the average margin typically rests in the “low single-digits” (for example, 1-3 percent). With this in mind, growth rates expressed as a percentage may seem large, as a slight change in year-to-year Operating Margin typically equates to a large percentage change.
In the past, as revenues, expenses, and operating margins stabilize, hospitals and health systems typically would target patient volumes, patient mix, and payer mix to enhance their revenues and profits. Patient mix is changing, however, and the number of inpatient visits relative to total visits is declining. The September 2019 Moody’s Medians report concluded that “median growth rate in inpatient admissions continues to trail outpatient volume.”
Putting the Profitability Equation Together
Figure 7 shows Kaufman Hall’s analysis of the Inpatient/Outpatient (IP/OP) Adjustment Factor from FY 2017 to FY 2019. The results support Moody’s conclusion, as the orange line represents the upward trend of the IP/OP Adjustment Factor.

As outpatient volumes have increased, Total Equivalent Discharges have decreased, demonstrating growth rates of -1.82 percent in FY 2018 and -1.18 percent in FY 2019. Putting these metrics together, hospitals are experiencing both a greater share of outpatient visits, and fewer overall patient visits (both inpatient and outpatient).
Kaufman Hall’s analyses presented here support Moody’s findings that revenue growth is edging ahead of expense growth—but hospital and health system leaders cannot afford complacency in this fact, which likely will soon prove fleeting. For hospitals looking to increase profitability, the traditional reliance on volume adjustments is becoming increasingly obsolete. The current healthcare environment is changing rapidly, making patient- and volume-based strategies riskier than ever before.
As stated in Modern Healthcare, “many health systems are exploring alternative revenue sources related to venture capital, commercial real estate projects, and other investment avenues. This could hold some potential long-term gains, but they should be pursued with caution.”
An ongoing trend seen in the monthly National Hospital Flash Report has been hospitals’ ability—and often inability—to budget and shift expenses relative to fluctuations in volume. While having revenue growth rates greater than expense growth rates may provide some flexibility for now, organizations need to act quickly to develop effective strategies for the new healthcare era. Those hospitals and health systems that can best manage expenses relative to volume fluctuations will be the most agile and able to navigate evolving market conditions.
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1 Note: For a reminder of the states included in each region, please refer to the About Data section of the National Hospital Flash Report.
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Gross Patient Revenues
Total Expense
Overview
Operating Margin
Profitability Equation
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