As markets make the transition to managed-care dominance, hospitals can be thrown into financial gyrations the likes of which they've never felt. Bottom-line results can go south from one year to the next, catching experienced financial operators by surprise.
Indeed, as they move through the four stages of managed-care penetration, many hospitals get trapped in a severe financial squeeze in market Stage 3. By the time they reach Stage 4, they are very different organizations, financially, operationally and physically.
That's the experience of Robert McDonald, chairman of Coopers & Lybrand's healthcare industry practice group. At a recent conference in Boston, McDonald laid out his theory of what happens to healthcare providers as their market matures around them, and how they can survive-prosper, even-by preparing for those stages.
The moral, McDonald warns, is: "Don't wait until market Stage 3 to get your costs under control. Anticipate what your costs are going to be in Stage 3 and get your costs down to that level now."
Coopers & Lybrand analyzed 57 healthcare organizations around the country, trying to fit them into a local market-stage matrix. In essence, the stages look like this:
Stage 1: The professional practice model dominates. Costs are uncontrolled. Patients get episodic care. Access and choice are key; charges are irrelevant. Examples are Little Rock, Ark.; South Bend, Ind.; and Des Moines, Iowa.
Stage 2: Managed payment dominates. Choice and convenience are limited. Purchasers gain market power. Total cost of care matters; premiums are flat. Healthcare becomes a commodity. Examples are Boston, Philadelphia and Washington.
Stage 3: Organized care dominates. The market defines price. Capital is scarce. Payers demand reduced utilization. Premiums decline. Providers and payers consolidate. Examples are Cleveland, Phoenix and San Francisco.
Stage 4: True medical management dominates. Organizations are accountable for medical management, quality, service and access. Purchasers possess full market power. Examples are Minneapolis and San Diego.
Most institutions, Coopers & Lybrand reports, fall into late market Stage 1 or Stage 2, where utilization and revenues haven't yet declined the way they will in Stage 3.
What triggers the profitability dip as hospitals move from Stage 2 to 3 is a reduction in utilization and net reimbursement combined with an inflexible cost structure.
Typically, hospitals are used poorly from a revenue-stream point of view and must learn to earn better financial returns from their real property. They also need to shed 10% to 30% of their debt structure to deal with declines in revenues as they move through this transition.
Increasingly, capital expenditures are financed through equity rather than debt. That occurs for several reasons: The pool of debt available shrinks; the hospital becomes more reluctant to finance new capital projects when the return is uncertain; the hospital wants to become more attractive for acquisition or wants to acquire others; or it shifts from not-for-profit to for-profit status.
Knowing what's around the bend, many executives are working diligently to pluck excess costs from their systems.
By careful planning, could a healthcare delivery system bypass Stage 3? No dice. So far, providers haven't been able to skip a stage and be economically rewarded for doing so.
Said another way, anticipate as much as you dare, just don't get too far ahead of the curve. One organization that did was punished severely by the market. Good Samaritan Hospital in San Jose, Calif., ended up in a financial crisis after transforming itself into what it thought the market wanted. "They were so focused on creating this future integrated delivery system but had left out vehicles that would get the physicians to join with them," McDonald says. The hospital spent a lot of money creating an advanced delivery system that had no customers when it was done. "The physicians said, `I don't understand what you're doing,'*" and voted with their feet. The system sank so deep in financial quicksand that it had to be sold to Columbia/HCA Healthcare Corp.
That said, not all markets will reach Stage 4. There has to be excess capacity to allow payers to push the market to that level of integration and performance. Payers must be able to turn healthcare delivery into a commodity to pull this off. They must be able to say: "I'm not happy with your costs or with your clinical outcomes. If you don't give me what I need, I'm going to move my business to another organization across town."
This is least likely to happen in rural areas or smaller cities. It's most likely in large metropolitan areas with too much healthcare capacity.
Take Phoenix, a classic Stage 3 market, and consider the experience of Samaritan Health System. "For all the good management that's there, one of the challenges they're facing is they did not cut costs in market Stage 2," McDonald says. "When revenue and utilization further decline in Stage 3, you get the effect that's depicted here (See reduced revenues in chart).
"If you fail to (cut costs) when you have a little bit of time in market Stage 2, when market Stage 3 hits, the revenue and utilization decline is so significant that organizations can't cut expenses fast enough to produce the same bottom line they used to produce in Stage 2. In some cases they actually end up with red ink."
Samaritan has endured wave after wave of layoffs and service consolidations over the past three years as it tries to steady its wobbly finances.
The $64 million question is whether any organization can truly prepare to deal with a Phoenix-like environment. "In many organizations it takes a bit of a crisis to get through the real cost reduction that's required in Stage 3," McDonald says. "In some cases, I'm not sure executives have support of the board. `Why lay off when we're doing well?"'
It's up to senior hospital executives to make sure their business strategy addresses the demands of the market stage they're in, while getting ready to meet the next one, McDonald says.