System hospitals are cutting overhead expenses and staff costs to improve profitability as their systems integrate operations with physicians, managed-care organizations and other specialty providers.
Overall, system-affiliated hospitals reduced overhead expenses as a percentage of total operating expenses by almost a full percentage point in 1995 to 33.9% from 34.8% in 1994, according to HCIA, a Baltimore-based healthcare information company.
System hospitals have cut overhead expenses each year since 1991, when overhead averaged 35.7% of expenses. The exceptions are investor-owned systems, which saw overhead increase slightly in 1995 as a percentage of total operating expenses, HCIA says.
System hospitals also cut staff costs to 47% of net operating revenues in 1995, compared with 52% in 1992, according to figures from Mecon, a San Ramon, Calif.-based healthcare data services company.
Overhead costs include general administration, operations, supplies and capital expenditures. Staff costs are payroll and employee benefit expenses. The two categories make up about 80% of a healthcare organization's annual budget.
"The struggle to lower costs is continuing because of the pace of acquisitions and mergers and the need to assimilate what organizations are trying to acquire in order to integrate and deliver services in a growing capitated marketplace," says Bill Murin, a consultant with Hay Healthcare in Los Angeles. Under capitation, where providers receive fixed payments per patient, management of overhead costs becomes even more critical to the solvency of provider operations.
About two in five of the nation's nonfederal hospitals have been involved in merger and acquisition activity in the past three years, MODERN HEALTHCARE research indicates. Transactions in 1996 involved 768 hospitals, up from 735 in 1995 (Dec. 23-30, 1996, p. 37). In addition, hospitals have acquired physician practices and home health agencies and entered joint ventures with specialty providers and managed-care organizations in unprecedented numbers.
"We have witnessed a considerable number of consolidations in the VHA system," says Daniel Bourque, senior vice president for information and research for the Irving, Texas-based hospital alliance. "In every case, administrative costs are the first issue to be dealt with in a merger. There is compelling evidence that (overhead) savings can be found on a system level."
Murin says systems and individual hospitals have reduced overhead expenses through a combination of work redesign, outsourcing and group purchasing of supplies and services at discounted prices. They have reduced staff costs through layoffs, downsizing and employee reassignments.
Freestanding not-for-profit hospitals, enjoying the lowest overhead costs at 33.1% of total expenses in 1995, also saw an increase in average margin to 5.1% in 1995 from 4.3% in 1994, according to HCIA. At freestanding investor-owned hospitals, overhead costs dropped to 35% of total expenses in 1995 from 35.8% in the previous year. Margins increased to 8.9% in 1995 from 7.2%.
For the first time in at least five years, however, investor-owned system hospitals in 1995 experienced an increase in average overhead expenses to 36.5% of total operating expenses from 36.2% in 1994. But those system hospitals still posted total profit margins of 9.8% in 1995, up from 7.8% in 1994, according to HCIA.
Not-for-profit system hospitals' average overhead costs dropped to 33.5% of total operating expenses in 1995 from 34.6% in the previous year, HCIA says, while margins increased to 5.6% in 1995 from 5% in 1994.
"It doesn't surprise me that investor-owned hospitals have higher overhead costs and nonprofit freestanding hospitals have the lowest overhead," says Jerry Widman, chief financial officer for Daughters of Charity National Health System, St. Louis. "The more centralized a system is in management approach, the more likely you are to pay higher corporate fees (to the home office)."
Another reason overhead expenses are traditionally higher for investor-owned system hospitals is they spend significantly more money than not-for-profit system hospitals on capital improvements, a major component of overhead, says Suzanne Zueschner, an HCIA analyst.
In 1995, investor-owned system hospitals spent 9.3% of total operating expenses on capital improvements, while not-for-profit system hospitals spent 7.7% on capital proj-ects, according to HCIA. Capital spending includes acquisitions, information systems and construction.
As expected, freestanding not-for-profits spent the least on capital costs, averaging 7.2% of total operating expenses.