Despite saving millions of dollars through layoffs and administrative cuts, healthcare systems continue to struggle to keep overhead costs in line as they build integrated delivery networks.
Most systems have been evaluating certain centralized services with an eye toward reducing administrative expenses and stabilizing annual management fees paid by member hospitals to the system.
Each of the nation's more than 320 healthcare systems has a different story of the fight to keep a lid on administrative costs while acquiring hospitals, physician practices, home health agencies and management information systems that are the heart of integrated delivery systems.
"Integration takes time and money because of the change of the culture of the organization," says Peter Butler, Henry Ford Health System's senior vice president of corporate administration and hospital affairs.
"People are still questioning the integration strategy," Butler says. "Systems haven't proven yet that they have higher quality and patient satisfaction and lower costs. Those answers will come over the next several years as the changes play themselves out."
Detroit's Henry Ford is one of the oldest delivery systems and has served as a model for those working to pare overhead costs. Another leader of the integration effort has been Daughters of Charity National Health System, based in St. Louis, which experienced a small increase in corporate overhead costs in 1996 as many of its 44 hospitals demanded more centralized support services to pursue local integration strategies.
Overhead costs of affiliated Daughters of Charity hospitals, however, have gone down as the system has achieved savings from economies of scale at the corporate level, says Jerry Widman, the system's chief financial officer. He pointed to financing and management information services as examples of activities that can be handled more efficiently at the corporate level than by individual hospitals.
At Tenet Healthcare Corp., administrative costs are projected to rise slightly in fiscal 1997, two years after the 1995 mega-merger of National Medical Enterprises and American Medical International that created the nation's second-largest investor-owned chain, says Trevor Fetter, Tenet's CFO and executive vice president.
Fetter attributes the anticipated growth in overhead costs primarily to declining reimbursements from government payers. But he acknowledged that part of the increase will come from spending to integrate physician practices and home health services.
Mergers help. At the same time, however, mergers also are helping some systems gain administrative efficiencies. For example, Tenet, based in Santa Barbara, Calif., cut corporate overhead costs in half as a percentage of revenues the year after its merger by consolidating departments and contracting out selected support services, Fetter says.
Sutter Health System cut its administrative overhead costs by one-fourth as a percentage of total expenses after it completed its merger with California Health Systems in January 1996 to create Sutter/CHS. The Sacramento, Calif.-based system was able to reduce its corporate staff by 5% and renegotiate vendor and support service contracts.
Sutter/CHS plans to further reduce corporate administrative costs by decentralizing support services to its hospitals and physician groups and by making some services optional.
Not-for-profits like Sutter/CHS calculate administrative overhead as a percentage of total expenses because they believe it gives hospitals an incentive to reduce overhead expenses.
Investor-owned companies like Tenet, meanwhile, track expenses as a percentage of total revenues because they believe it gives a better picture of the relationship between costs and the volume of business growth.
Systems that are building integrated delivery networks can look to more established systems like Henry Ford for evidence that their efforts to achieve cost stability will bear fruit.
Henry Ford, one of the nation's most integrated systems, has kept its overhead costs stable the past two years despite spending time and money to further integrate its four owned hospitals, seven affiliated hospitals, 70 ambulatory-care centers and a 500,000-enrollee managed-care plan.
Corporate administrative expenses at Henry Ford were 4.5% of net operating costs in 1995 and are projected to remain the same in 1996, Butler says.
"We have spent a lot of money in the past to integrate our physicians and hospitals with managed care," Butler says. "Now, we spend more staff time in meetings and task forces to identify integration strategies. It's more opportunity costs (than capital costs)."
Within a year after the merger of Sutter and CHS, the company had cut corporate administrative costs to 2.5% of total expenses from 3.5% because it was able to spread costs throughout a larger organization, says James Farrell, the system's senior vice president of organization planning and development. With growth and acquisitions, Sutter/CHS' revenues increased to $2.6 billion in 1996 from $800 million in 1994, he says.
"It is very hard to measure administrative expenses when systems are merging, adding services and downsizing all at the same time," Farrell says.
Focusing on the real goal. Despite radical change and unanswered questions about their value, Butler contends systems are the best vehicle to accomplish what most executives believe is healthcare organizations' main objective: to improve the health of communities.
"We need better information to manage the business side, but it's more important to invest money that will benefit communities," says Widman of Daughters of Charity.
In 1996, Daughters of Charity's corporate overhead expenses increased to 0.5% of total operating expenses from 0.4% in 1995, Widman says.
"Over the short term we will have higher overhead as we invest in integrated delivery networks," Widman says. "It costs money to put together business arrangements. We are investing in the future and expect the paybacks to be down the road."
Widman attributes the increase in corporate administrative costs to adding more corporate staff to support hospital development in areas such as home health, managed care and auditing.
"Our biggest increase in the national office last year was bringing internal auditors to the corporate office payroll," Widman says. "There should be corresponding savings (at the hospital level)."
Nationally, system hospitals' overhead expenses decreased for the fifth consecutive year to 33.9% of total operating expenses from 35.7% in 1991, according to HCIA, a Baltimore-based healthcare information company (See related story, p. 38).
After its merger with AMI, Tenet moved quickly in 1995 to reduce its corporate administrative expenses to 1.7% of total operating revenues of $5.6 billion, Fetter says. Tenet defines overhead as all costs above the hospital level, including payroll and benefits.
As NME, Tenet's administrative expenses were 3.5% of total revenues in fiscal 1995, Fetter says. Before the merger, NME's expenses already had declined to 4.2% of revenues in 1994 from 4.4% in 1993, the results of an overhead reduction program that included staff cutbacks, he says.
"We doubled the size of the company, and total overhead (as a percentage of revenues) decreased rather dramatically," Fetter says.
In addition, Tenet reduced its corporate staff during the year after the merger to its current level of 618 employees from a combined NME-AMI pre-merger work force of 1,062 employees, Fetter says. Savings figures were unavailable.
Tenet also cut corporate administrative costs by hiring Dallas-based Perot Systems in July 1995 to manage the company's information systems. And it saved by downsizing and contracting out work from NME's large construction and real estate department. Again, savings figures were unavailable.
Tenet operates centralized legal, accounting, finance, payroll and managed-care business development departments.
"We re-engineered our processes to stop unnecessary (labor) from being performed," Fetter says. "There is a realization that people can do certain functions better elsewhere, and we can save money."
But Tenet decided to buck the recent trend of hiring outside companies to collect patient bills and process payroll, Fetter says. "Each service has to be looked at on a case-by-case basis," he says.
Still, Tenet's corporate administrative expenses this year are projected to increase to 2% of revenues from 1.7%, Fetter says. The bulk of the increase is attributed to a reduction in revenues from government reimbursements. But overhead also increased somewhat as Tenet spent money to integrate physician practices and
home health services, he says.
"Integration costs shouldn't increase overhead and administrative costs as a percent (of revenues)," Fetter says. "New business lines should produce revenue that should more than offset start-up costs. Our plan is to grow the business."
With its recent acquisition of Nashville-based OrNda HealthCorp, Tenet now operates 127 hospitals in 22 states.
"As we grow, we expect administrative expenses to remain relatively stable as a percentage of revenue," Fetter says.
To pay for corporate expenses, hospitals owned by systems pay annual management fees to parent organizations. "If (hospitals) can reduce expenses, they also reduce their system allocation fee," Farrell says.
Staff costs drop. With layoffs, downsizing and job reassignments, systems also reduced staff costs to 46.8% of net operating revenues in 1996 from 51.4% in 1993, according to Hay Group, a Walnut Creek, Calif.-based compensation consulting firm (See chart, this page).
More diversified systems spent an average of 48.5% of net operating revenues on staff costs in 1996, compared with the 46% spent by less diversified systems, according to Hay, which surveyed 34 systems.
More diversified systems operate a greater variety of healthcare facilities such as nursing homes and physician offices; less diversified systems operate a higher ratio of hospitals to total holdings.
One reason staff costs are higher for diversified systems is they require more experienced executives and employ more physicians and managed-care executives who command higher salaries than hospital employees, Fetter of Tenet and Farrell of Sutter/CHS say.
Like many investor-owned systems, Tenet spends much less on staff costs than do not-for-profit systems. Tenet's staff costs are slightly less than 40% of net operating revenues, compared with several years ago when NME's were about 45%, Fetter says.
Henry Ford's staff costs remained the same in 1996 as in 1995, at 46% of net operating revenues, Butler says.
Daughters of Charity has trimmed staff expenses as it has downsized management. In 1996, its staff costs were 50.3% of revenues, down slightly from 50.7% in 1995.
"We are more diligent today with expense management," Widman says. "We use fewer people, and we've increased productivity and looked at benefits and cross-training. The bottom line is we need to save money."
But experts say one area where systems haven't done a good job so far is working with physicians and staff to reduce overuse of clinical services and streamlining patient care through the use of best practices.
"The real savings come through redesigning and standardizing care and eliminating unnecessary care," Butler says. "Clinical cost reduction will become even more important with capitation. If you can focus on managed care and per-capita costs, you can create a whole culture that can pull costs out of the system."