Hospital and health system operating margins have plummeted in recent years. Leaders are anxious to see if this trend has bottomed out or if margins will remain in freefall.
In 2016, the typical not-for-profit system's expenses grew by 7.1%—outpacing revenue growth by a full percentage point.1 The next year things got even worse, as operating margins fell to an all-time low of just 1.6%.2
Unlike in previous eras, hospitals can't blame today’s grim financial picture on a single economic factor. Rather, they're facing a variety of volume and pricing pressures—including direct pricing threats, site-of-care shifts, and new payment models—which are hitting the industry all at once.
These trends aren't going away anytime soon, and leaders must prepare their organizations to weather a long-lasting financial storm. In particular, they must rein in cost growth.
Not all hospitals and health systems can become "low-cost" in an absolute sense. But all leaders should strive to create cost-disciplined organizations, which are able to keep cost growth low relative to revenue growth and manage closely to their budgets.
To identify how some hospitals and health systems are meeting this challenge as the rest of the industry struggles, our team at the Health Care Advisory Board interviewed 150 hospital executives and industry leaders. While each executive described a slightly different approach to reining in costs, three hallmarks of cost-disciplined organizations consistently surfaced.
Many hospitals and health systems approach spending in an uncoordinated manner. As a result, local departments often spend "their" money in low-value ways.
A better approach is to centralize decision-making authority, particularly in areas experiencing rapid cost growth. When University of Utah Health found that its pharmacy spending was growing out of control, it developed a formulary-management process that employs researchers to track real-time price fluctuations and monitor the availability of lower-cost drug equivalents.
Each month, these researchers make recommendations to a physician-led pharmacy and therapeutics committee. Where clinically appropriate, the committee communicates therapeutic interchanges to physicians and updates their EHR system to include "hard stops" on inappropriate prescriptions. Previously, when a physician encountered a hard stop, he or she had to appeal to the system CMO or service line director to request an exception. Now that the process has become hardwired in clinical workflows, pharmacy leaders often adjudicate the exception requests.
Using this strategy, Utah saves $2 million each year.
This approach isn't limited to pharmaceutical spending. To learn more about University of Utah Health’s approach and to see how Methodist Health System applied this strategy to rein in labor spending, see our report about creating sustainable expense growth.
Here's a concerning reality about hospital expenses: many organizations simply don't know their true operating costs. Data often resides in multiple IT systems, and the methodologies used to estimate the cost of providing care are often outdated. Without accurate expense data, it's nearly impossible to identify high-value care pathways or reduce unwarranted care variation.
UPMC recently sought to overcome this challenge by investing in an activity-based cost-accounting system. They deployed the technology to examine the quality and financial performance of their women's health service line, diving deep into cost and quality data to compare four different methods of performing hysterectomies.
After sharing the data with physicians, UPMC saw a 200% increase in pathway adherence and a 28% reduction in 30-day hysterectomy returns. During this time, the clinical service saw a 25% improvement in contribution margin.
At many hospitals and health systems, patients with low-acuity needs are frequently treated at specialized, expensive locations, thus incurring unnecessary expenses without improving care quality.
Northwell Health holistically manages capacity across its system. To reserve capacity for high-acuity cases at the system's flagship children's hospital, Cohen Children’s Medical Center, providers immediately identify and triage low-acuity patients to regional locations.
As a result, in 2017, Cohen Children’s improved its case mix index and realized a $2.5 million gain in the orthopedic service line contribution margin, which leaders attribute to the transfer-and-backfill model.
Many hospitals and health systems may appear financially healthy, but growing operating expenditures are poised to outpace revenue in the long term. Download this briefing on margin management to learn more about financial challenges on the horizon—and what you can do to prevent them.
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