Better managing costs in health care
Hospitals and health systems continue to see strained operating margins and rising costs that outpace revenue. Managing and reducing costs is critical.
Eric Young, Vice President, Performance Improvement, Optum® Advisory Services, says there are several driving factors. We sat down with Eric to discuss trends, challenges and cost-saving opportunities.
What’s driving health care’s rising costs and strained operating margins? And what are some trends that you’ve seen?
Several factors are driving high costs and overall low operating margin performance — and they didn’t just begin.
When you think about 2019 — the pre-pandemic year — hospital operating margins actually underperformed historical averages. We witnessed even further reductions in operating margins during 2020 as hospitals delayed elective procedures and incurred increased costs to address the pandemic.
What we’re beginning to see as health systems issue their 2021 reports is that, despite a slight increase in operating margins, most are underperforming even their 2019 performance. Overall, it’s estimated that about 50% of all health systems had negative margins in 2020 and 2021.
Hospitals are dealing with liquidity issues as well. As the pandemic arose, health systems began reaching out to their banks and lending institutions to increase credit lines and cash borrowings to help fund operations.
Health systems need to earn an operating margin of about 3%, enabling them to replace capital, reinvest in facilities, fund strategic initiatives and build liquidity for the disruptive crisis.
From your perspective, what are the top challenges health care leaders face today around managing costs?
Most of the challenges related to managing operating costs have to do with three things.
The first is that health leaders and staff members are exhausted from the pandemic. They may need to take a step back, catch their breath and refocus their efforts on the initiatives they were focused on pre-pandemic.
Complicating matters are staff and physician shortages. With the extra work and focus provided during the pandemic, we’ve also seen a lot of burnout.
The second challenge is supply chain shortages. Some of this we experienced pre-pandemic, but these shortages increased during and following the crisis.
When you think about the health system income statement, workforce and supply chain represent about 70% to 80% of all health care costs. Every health system needs to focus on ensuring they address these two high-cost items to increase margins, build liquidity and continue to provide uninterrupted services to their community.
The third cost management challenge health systems face is the continual need to address the concept of “systemness,” meaning the capability to make decisions that are best for the whole organization, rather than individual service lines or facilities.
We’ve seen a lot of changes in the market through merger and acquisition activities and other types of partnerships. But one area of focus hospitals still need to address is corporate costs and administrative structures.
Over the last couple of years, corporate costs and administrative structures have continued to increase instead of decrease. Health systems need to continue to decentralize those functions within their organizations and bring them to the corporate level to create scale.
In general, today’s cost structure is still too high for health systems. It’s always been high, but even more so now than before. The pandemic complicated things and put more stress on financial margins overall. Health systems will have to address this proactively to ensure that they continue to provide services to their communities and their patients.
One of the growing areas for health care executives is building strategic partnerships to create bandwidth and focus for operational results, while at the same time continuing to prioritize clinical activities and patient care.
Take the next step on your digital journey
With so many cost-saving opportunities, what should health systems prioritize?
We need to take a step back and begin with the basics. I would say the initial focus needs to be the income statement. It’s a source of truth.
Managing and reducing operational costs is a difficult process for health systems. It competes with strategic initiatives, physician recruitment and other activities.
Focusing on the income statement can enable organizations to make sure they’re assigning resources and aligning strategic partnerships to the correct expense areas.
When we think about workforce optimization, we’re not talking about reductions in force or making staff do more with less. We’re really focused on understanding the barriers that create inefficiencies in workflows.
There are many inefficiencies in health care. If we can help eliminate those inefficiencies or eliminate those non-value-added processes that staff do, we will create cost savings and increase overall staff satisfaction.
Another area to focus on for cost savings is the supply chain. This is a health system’s second-largest cost area, representing 20% to 25% of total cost.
We have seen supply and purchased service costs increase over the last year. Throughout the pandemic, supply and demand issues have increased prices for health care supplies, and now we’re seeing inflation that’s beginning to increase the cost of supply items. Now is a great time to address the supply cost issue.
I would also mention that inventory costs have increased. Organizations used to buy inventory “just in time” or when they needed it. The pandemic changed that. Health systems began to buy supplies to have on hand.
Moving forward, there’s an opportunity to balance what you really need now with what you may need in case of another emergency. Balancing this will help you ensure your inventory costs are appropriate.
If you dig further into the supply chain, you’ll find significant opportunities to standardize and rationalize products that physicians use and those that health systems need for patient care.
There is still a significant opportunity to renegotiate pricing with vendors to lower your overall costs. There are plenty of opportunities to consolidate vendors and realize cost savings by renegotiating better pricing.
Another area to realize cost savings is the capital cost of ownership. Health systems have a lot of expensive buildings and use a lot of expensive equipment for patient care.
I think there is an opportunity to understand that capital cost footprint. How many sites do you have? How much technology have you invested in, and what is the cost of that to the health system? Are you utilizing that technology and those buildings appropriately?
When you think about the capital cost of ownership, you want to ensure that you have the right assets for the patient populations you serve.
Improving the digital front door is seen as a solution to many problems. Can you talk more about how the digital front door can help reduce costs?
Yes, this is interesting. We saw a lot of digital visits and digital technologies emerge during the pandemic. And it feels like it’s all been really good for health care. It can help significantly reduce health care costs overall and give patients more convenience at the same time. So, when I think about the digital front door, I think about modernizing the patient experience.
Many patients use mobile apps or their desktops to buy things they need or schedule services in other areas of life. This opens many opportunities for health care, too.
When you think about mobile technology in health care, much of it is centered around enabling patients to schedule their services and review their medical records. It’s exciting to think about being able to pre-register for a service without answering the same question from three or four people or being able to make payments or set up payment arrangements digitally.
There are opportunities in the digital arena to search for lower cost-of-care settings, particularly with virtual visits, that reduce some of the capital costs of facilities and more. If you can implement that in a very effective way in your market, you can eliminate significant investments. Digital office visits can expand your footprint without having to invest in brick-and-mortar buildings.
Earlier, you referenced strategic partnerships and what a partnership model could look like. How should health systems approach strategic partnerships to get the most value?
There are many partnership structures out there today, and there is a need to give health care leaders additional bandwidth to continue to push their organizations forward overall. Not just from a cost optimization perspective, but also digitally to expand their market footprint.
I recommend health systems consider strategic partnerships focused on more corporate overhead functions or areas further removed from patient care.
In my 30-plus years of health care experience, I’ve seen a number of successful partnerships in specific areas that have helped organizations reduce their administrative and corporate burden.
Revenue cycle is one such area. It can be a challenge to recruit individuals who want to make a career in revenue cycle, especially in smaller markets. These are typically lower-wage positions, and you’re often competing with local restaurants and shops for that same workforce.
There are real opportunities in this area to use strategic partnerships to increase patient satisfaction and increase your focus on core competencies.
The same goes for IT. There’s high demand for IT professionals, more so now than ever before. An organization may want to focus on IT from a strategic partnership perspective.
Care management is another area where partnerships can help accelerate initiatives while balancing the bandwidth of responsible executives. Optum provides care management services to a number of our strategic partners.
About Eric Young, Vice President, Optum Advisory Services
Eric Young has extensive hands-on experience in supporting performance improvement across hospital and health system finance, strategy and operations. He supports a wide array of health system margin improvement efforts with expertise in health system finance, cost management, revenue cycle and reimbursement, debt and capital management and strategic growth.
Young has 29 years of experience in health care finance and operations, including more than 17 years as a health system chief financial officer. He holds a Bachelor of Science in business administration from Urbana University and an MBA from Capital University.
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