When Rex Hospital dared to take on a percent-of-premium contract offered by Healthsource North Carolina in early 1995, the Raleigh, N.C., hospital got stung.
Unexpectedly, the HMO lowered its price and expanded geographic coverage, leaving Rex holding the bag for covered services. Because of those losses, the 534-bed hospital was forced to restate its earnings from $14.2 million to $10.5 million for the year ended Sept. 30, 1995.
The 10-year contract remains in place but with modifications. For example, Rex no longer serves as Healthsource's exclusive provider for Wake County, an HMO spokeswoman said.
As more hospitals begin to tinker with pricing strategies to boost the bottom line, there are bound to be missteps. If it happens to the best of corporate America, it can happen to hospitals.
Consider recent price bungling by McDonald's Corp. and America Online. This spring, the Oak Brook, Ill.-based fast-food chain pulled its nostalgically priced 55-cent burger deal, saying customers didn't understand that they also had to buy a drink and fries at regular prices. Many franchisers reportedly griped about the financial drubbing they were taking by virtue of the corporate fiat.
And last year, when America Online rolled out its flat-rate plan for unlimited AOL and Internet access, subscribers responded in such overwhelming numbers that the service provider couldn't meet demand. Some customers also complained that they didn't receive sufficient notice before being switched to the new plan, which in some cases was more expensive than their existing contracts. The company's stock took a beating, and AOL entered a settlement agreement with attorneys general in several states over the pricing switch.
Pricing neophytes. When it comes to setting prices, hospitals are no more immune from mistakes than other corporations. Many, in fact, are neophytes.
Blame it on cost-based reimbursement. Before managed care began taking root, most payers accepted hospital rates without much fuss. Typically, rates were conjured up based on Medicare's fee schedule and market prices, not hospitals' actual costs.
Today, though, you would be hard-pressed to find a metropolitan area where private payers aren't haggling over price discounts. The trouble is, payers usually have the upper hand at the negotiating table. Hospitals have become a commodity, and they are being treated like it, says David L. Knowlton, president of the Medical Inter-Insurance Exchange Healthcare Group, based in Lawrenceville, N.J.
In the healthcare battleground known as Boston, New England Medical Center is fighting back after being locked out of the market's biggest HMO, Brookline, Mass.-based Harvard Pilgrim Health Care. The teaching hospital is lobbying for legislation just passed by the state Legislature's insurance committee, which would put New England Medical back in the running. Now it's the only teaching hospital in the market excluded from Harvard Pilgrim's network. Thomas F.
O'Donnell Jr., New England Medical's president and chief executive officer, says the contract is worth some $20 million in revenues.
The hospital also saved $20 million in fiscal 1996 by eliminating 800 staff positions. And in recent weeks, it entered a risk contract for tertiary services with a group of 150 primary-care doctors. "First of all, you certainly have to be able to reduce the cost so you can deliver the price," O'Donnell says.
Balancing the equation. Finance experts say most hospitals focus on wringing out costs to neutralize payer discounts. But that's only half the profitmaking equation. To survive, hospitals must think about making up income lost on discounts. The trick is to set prices that cover variable costs and throw off enough profit to invest in network development and information systems.
Easier said than done.
For one thing, few hospitals have a good grasp of what it costs to provide various services by line of business, like trauma care or an outpatient clinic. They haven't had to track costs that way. And some chief financial officers say cost-accounting systems have not kept pace with hospitals' emerging information needs.
As a result, "matching revenues to costs has become a huge problem," says Mark Wietecha, managing director of Hamilton-HMC, the healthcare consulting division of Atlanta-based Kurt Salmon Associates.
Rex Hospital paid a price for its misstep. Its reaudited financial statement, obtained by MODERN HEALTHCARE, shows that Rex lowered its 1995 profit to $10.5 million from $14.2 million, increased estimated third-party settlements to $4.2 million from $455,372 and reduced its fund balance to $123.8 million from $127.5 million.
But Kevin Cain, Rex's vice president for planning and marketing, says the contract still satisfies the hospital's desire for a long-term relationship in which both parties would be motivated to work together.
"We knew we'd have to be cost competitive and compete on service," he says. That the hospital stumbled in the beginning is a "hindsight sort of observation," he says. In fact, the hospital remains on solid financial footing, meriting A+ and A1 credit ratings.
The problem of matching revenues to cost is all too familiar to Eleanor Anderson-Miles, director of corporate communications at Mecon, a San Ramon, Calif.-based provider of cost management services. "That's why we're in business."
Anderson-Miles recalls one hospital's reaction to a payer's request for cost information. The payer wanted to know how much it was costing to care for a baby in the hospital's neonatal intensive-care unit. "What the hospital realized was that it didn't even know what it was costing them," she says.
That is rarely the case among for-profit hospital and healthcare companies, finance experts say. Just look at Salick Health Care, a Los Angeles-based provider of cancer-care services. Under its founder, Bernard Salick, M.D., the company carved out a lucrative niche diagnosing and treating cancer patients in cost-effective settings at predetermined prices.
"Why has Salick made a fortune?" Knowlton asks. "Because he understands his costs and his price points."
Market share at what cost? Under today's competitive pressures to grow or be gobbled up, many hospitals may be tempted to lower prices to buy market share. Michael Bednarz, a vice president at Hales Corners, Wis.-based Zimmerman & Associates, has seen hospitals virtually give money away. Although no healthcare executive has admitted as much, Bednarz thinks such price breaks are part of a strategy to grab market share from competing institutions. He thinks it's a dubious strategy. "Frankly, you need a war chest to make it work," he says.
In some highly competitive markets, providers are being forced to bid low to buy back business, observers say. But that tactic doesn't necessarily pay off in the long run.
"What we're not seeing is big shifts of market with pricing," says Michael Blaszyk, a senior principal with William M. Mercer's healthcare provider consulting arm in Boston. "Hospitals are really price-takers."
According to the Center for Healthcare Industry Performance Studies, wage- and case-mix-adjusted hospital prices increased only 0.6% in 1995, the last year for which data are available, from 2.4% the previous years.
During the same period, cost per discharge (also adjusted for wages and case mix) slipped $20 on average, to $5,174. It was the first cost reduction since CHIPS began tracking such data.
CHIPS' 1996-1997 Almanac of Hospital Financial & Operating Indicators highlights the importance of price. According to the analysis, "high-performing" hospitals-those with the highest price-level-adjusted return on investment-are more profitable because of higher prices, not lower costs. High-performers' net prices average $716 per case higher than low-performing hospitals.
Often, providers are shortsighted in their pricing analysis, says Scott Roman, a San Clemente, Calif.-based attorney who represents provider-sponsored HMOs. They agree to a dollar figure-say, $120 per member per month-"and say, `Hey, this seems like plenty of money,' and, you know, initially it might be." But what about over time? Providers must determine whether the rate is going to cover costs, Roman cautions.