Why cost and revenue will kill independent hospitals

Costs and revenue: This is the oxygen of any business, any organization. What are your revenue streams? How much does it cost you to produce them? Life is not just about breathing, but, if you don’t get that in-out equation right, there is nothing else life can be about.

Right now this enormous sector is turning itself inside out. It has turned the “transmogrification” setting to “warp.” Why? It’s all about the in-out. It’s all about increasingly desperate attempts to get that right — and the clear fact that we cannot know if we are getting it right.

Let’s do some school on the two sides of this equation. Let’s just go over the new weirdness, and the implications for you and your organization. Revenue first.

Hunting for true revenue

In traditional health care (the way we did business until about five minutes ago) the revenue side was complicated in detail, but simple in concept: You do various procedures and tests and services, and you bill for them. You bill each item according to a code. You bill different payers; each has its own schedule of payments that you negotiate (or just get handed) every year. There are complications, such as people on Medicare with supplemental insurance, dual eligibles on Medicare and Medicaid, and self-pay patients who may or may not pay.

That’s the basic job: aggregating enough services that reimburse more than their real cost so that you can cover the costs of services that don’t reimburse well. This is cost-shifted, fee-for-service management. Cut back on those low-reimbursement services; pump up the high-reimbursement ones. Corral the docs you need to provide the services, provide the infrastructure and allocate costs across the system.

The incentives all point in the same direction. The revenue streams are all additive. The more you do of the moneymaking items on the list, the more money you make.

Hybrid revenue streams in the Next Health Care. Fast forward to five minutes in the future, and the picture becomes not only complicated, but complex, in some ways irremediably so. Now you’re not just thinking about the revenue structure of a hospital; more often you are thinking about a system, with not just multiple revenue streams but multiple types of revenue streams. You may already have had clinics, labs, ambulance services, imaging services, primary care physician groups — in fact, a whole array of different businesses. What’s different now is how you get paid for things.

You may still mostly be working fee-for-service, but maybe now you have an insurance arm, and maybe some percentage of your patients are capitated through it: You have an incentive to provide excellent care, but any unnecessary emergency department visits or surgeries, any preventable heart attacks or diabetic shock episodes are now simple costs, while before they were revenue opportunities as well.

You may have developed a new set of revenue streams in per-patient, per-month prospective payments for “medical home” services but, the more you do that and the better you are at it, the more you keep people out of your ED and your surgical suites. That’s what those payments are for — to lower the overall costs by taking better care of the patient up front. And the costs you are lowering are your revenues.

Similarly, your primary care arm may have an at-risk contract like the Alternative Quality Contract from Blue Cross Blue Shield of Massachusetts, which literally pays primary care providers to keep patients from needing to use EDs or needing surgery or other high-end services, while holding them to quality standards that assure they are getting excellent care. It’s a revenue stream, but it’s at the cost of other revenue streams. Or it may not be your revenue stream. It may be an independent primary care physician group in town that has the contract, paid extra to deprive you of fee-for-service patients.

Or you may have dedicated clinics servicing specific groups on a per-patient, per-month basis (like, say, a spine and pain clinic for a company’s warehouse workers) in which working efficiently and well cuts into what otherwise may have been fee-for-service operations and imaging services.

Unknown factors. These scenarios lie against a background in which it is likely that actual fee-for-service reimbursement rates from Medicare and private payers will be held tightly in check. The future landscape has a number of new opportunities for revenue streams, but most of them make money by cutting into your (or someone else’s) more conventional business. But we cannot know by how much, or how the interaction between different revenue streams will play out over time.

In planning for the new environment, this tells us three things:

These systemic risks are not quantifiable, and so cannot be hedged. They are risks because we are entering new territory. We simply do not know how these different parts of the market will interact. Revenue estimates for most parts of the business have to be treated as “high-variance” projections, which were much harder to pin down in the past.

If some types of risk contracts make money by cutting into other types of business, you want to own that contract. If some organization is going to make money by costing you money, you want to be that organization. It may be cutting into your ED, surgery and imaging business, but at least you get the revenue stream for doing that. If you don’t, someone else will.

For any business that includes a hospital, bigger is better. At greater size, you can absorb more high-variance risk from a greater variety of revenue streams, and from different contracts serving different populations. You can spread the revenue base and try more alternatives. You have the space and breadth to try, fail forward quickly and try again.

If the revenue side is so hard to pin down, you need to create some space to try different options. The cost side can give you some of that space.

Getting our arms around cost

Compared with revenue, the cost side of things seems relatively straightforward. So why can’t we get our arms around it?

When we are talking about the costs of health care, we are talking about two different types of costs. One is the cost of doing things, such as: How much does it cost to do a complex back fusion operation? Think of these as internal costs. The other is the cost of producing an effect, such as: How much does it cost to reduce back pain? Think of these as system costs.

If you are at risk for a population (as in, perhaps you have a spine and pain center with a per-patient, per-month risk contract), then both kinds of costs are true costs to you. If you can satisfy the patient and end his or her back pain through medical management instead of surgery, you have dropped a bunch of money to your bottom line.

On the other hand, if you are in a fee-for-service environment, the back operation is not just a cost, it’s also an income opportunity, and only the internal costs are actual costs to you.

More unknowns. In any environment, then, reducing your internal costs improves your bottom line. The problem here is that we typically do not actually know what our internal costs are, or what we could do to reduce them.

Some things obviously reduce internal costs — better coordination, reduced duplication, more efficiency in moving the patient through the system (not adding the cost of an extra inpatient day just because someone neglected to sign off on the discharge form, for instance), or fewer mistakes and infections.

But beyond these efforts, to truly reduce costs we need to drive our analysis to the individual patient and case level, differentiating between the general system costs imputed to the case, or the average costs that such cases are thought to generate, or the sunk costs of the facility and equipment, and the actual incremental costs that this case generated: How much did it cost us to replace Mr. Herndon’s hip? Much of the costs attributed to particular types of operations are averages, or imputed costs representing the whole organization’s overhead. These obscure the costs that are particular to Mr. Herndon’s case.

Fine-grained cost analysis. Why do we need such fine-grained cost analysis? Because if the team who handled Mr. Herndon’s workup, surgery, post-surgery and rehab did something different that actually cost less and worked better — a different kind of wound dressing, say, or a more aggressive schedule of getting him up and walking afterward — more general cost analysis would not let us pick up that difference, track it and replicate it.

Further, we need to track the costs by activity (how much did the post-surgical care actually cost, say) and across the entire care cycle.

Similarly, we need to drive the cost analysis to the team level: If a given hip-replacement team is able to find ways of doing things that are better and cheaper, we need cost analysis that can pick up that difference so we can find out what teams are doing differently, try the improvement with other teams, measure the improvement and propagate it.

Two things make this currently impossible in most of health care: Our cost aggregation software is mostly designed for billing purposes, not for discovering actual costs. It doesn’t ask the questions to which we need answers. And typically in health care, we do not work in persistent, dedicated clinical teams. We rotate people through various assignments. When there are no persistent teams, it is not possible to notice which variations of practice actually cost less and get better results. Having no teams obliterates the possibility of learning.

Still, though tracking real costs to the patient, case and team levels is difficult, costs are ultimately more discoverable than future revenue streams. With the right strategies, one can drive down costs much more dependably than one can predict revenue.

Cost and revenue as change drivers

The struggle to get the cost-revenue respiration right is the prime driver of the enormous structural changes that we are seeing in health care. Recently, the head of health care for a major Wall Street bank told me that up to just a few years ago, mergers and acquisitions amounted to 5 percent of his practice. Today it is 67 percent.

Big systems, including for-profit systems, are expanding rapidly, acquiring hospitals and other health care services by the bunch. They see these acquisitions not as “revenue plays” largely, but as “cost plays.” The big systems believe they can create value and enhance their survival by mitigating the “high-variance” risks of the new environment through size and diversity, while wringing cost out of the services and hospitals they acquire through tighter coordination and more aggressive management.

These same factors make it increasingly difficult for small and rural hospitals to survive as independents. They need the scale, greater coordination, access to clinical excellence, ability to support experiments in driving cost and quality, and ability to rationalize high-variant risk across a larger system that only a partnership of some kind with larger organizations can provide.

The new era of costs and revenues likely spells the end of any notion of the hospital as a cottage industry. It is on the balance sheet and the cash flow sheet that the idea of “coordination across the full cycle of care” stops being a buzzword and becomes a structural reality.

Joe Flower is a healthcare speaker, writer, and consultant who blogs at Healthcare Futurist: Joe Flower

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