Need Quality Healthcare?

Value For All?

dem

By Dr. David Edward Marcinko MBA

http://www.CertifiedMedicalPlanner.org

Defined by Professor Michael Porter at Harvard Business School, value is defined as a function of outcomes and costs. Therefore to achieve high value we must deliver the best possible outcomes in the most efficient way, outcomes which matter from the perspective of the individual receiving healthcare and not provider process measures or targets.

Sir Muir Gray expanded on the idea of technical value (outcomes/costs) to specifically describe ‘personal value’ and ‘allocative value’, encouraging us to focus also on shared decision making, individual preferences for care and ensuring that resources are allocated for maximum value.

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Conclusion

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Contact: MarcinkoAdvisors@msn.com

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A Better Approach to [Hospital] Cost Estimation

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Re-thinking the Ratios-of-Costs-to-Charges [RCCs] Financial Meter

By Russ Richmond MD

Russ Richmond MDUsing the ratios-of-costs-to-charges [RCCs] can lead hospitals down a garden-variety strategic path that’s wrong for them.

A strategically safer method of cost estimation can more accurately reveal costs.


At a Glance

  • Using ratios of costs to charges (RCCs) to estimate costs can cause hospitals to significantly over- or under-invest in service lines.
  • A focus on improving cost estimation in cost centers where physicians have significant control over operating expenses, such as drugs or implants, can strengthen decision making and strategic planning.
  • Connecting patient file information to purchasing data can lead to more accurate reflections of actual costs and help hospitals gain better visibility across service lines.

To put it bluntly, there is an almost complete lack of understanding of how much it costs to deliver patient care, much less how those costs compare with the outcomes achieved. Instead of focusing on the costs of treating individual patients with specific medical conditions over their full cycle of care, providers aggregate and analyze costs at the specialty or service department level.

—Professors Robert Kaplan and Michael Porter, “The Big Idea: How to Solve the Cost Crisis in Health Care,” Harvard Business Review, September 2011.

Of all the challenges hospitals face in today’s uncertain healthcare environment, estimating their costs might not be their top concern. However, the method most hospitals use to estimate their costs can have serious strategic and financial ramifications on their bottom line.

More than 60 percent of hospitals today use ratios of costs to charges (RCCs) as their primary cost estimation method, because true cost accounting is viewed as prohibitively expensive. But using RCCs to estimate costs can lead to significant problems for hospitals. For example, results of a recent study disclose that among 184 mid-sized community hospitals (i.e., with roughly 300 beds), the use of RCCs led 85 percent of the hospitals to overestimate the profitability of orthopedic surgery service lines. On average, the overestimates amounted to $1.2 million per year per hospital.

Such incorrect cost estimates can cascade into potentially serious strategic, financial, and operational issues. Because of faulty cost estimates, hospitals can over-invest—or under-invest—in service lines based only on high-level insight into the actual profitability of these areas. Either scenario has the potential to produce negative consequences.

Suboptimal strategic decision making based on faulty data and conclusions leads to suboptimal results. No hospital can afford such results and stay competitive in an industry of increased cost and pricing transparency.

So what’s the solution for hospitals? Even without switching to a full procedural cost-accounting system, hospitals can make adjustments that improve their cost estimating and thus strengthen their decision making and strategic planning. The operative principle is that hospitals should focus on improving cost estimating in cost centers where physicians have the most control of operating expenses—namely, drugs and implants.

Making the Right Cost Connections

Connecting patient file information, where costs are estimated, with purchasing data, which reflect actual costs, can produce a significant impact on a hospital’s pricing methodology. Drugs and implants, which represent 17 percent of a typical hospital’s total costs, are a good starting point for adoption of this approach.

Drugs. To better estimate drug prices, hospitals should make the patient file/purchasing data connection based on generic class, route of administration, and dosage. The patient charge file and the purchasing file can be connected using a common taxonomy. For instance, a hospital’s purchasing file may record a box of 10 Tylenol tablets as “10 Tylenol tablets of 325 mg,” while the charge may be recorded in the patient charge file as “Acetaminophen cap 325.” This results in a direct text mismatch for calculating cost, which can ultimately lead to faulty cost-estimating data. A common taxonomy would group these two entries into a common bucket to produce an accurate mapping of costs.

Implants. Implants are also a major price item for hospitals. To better estimate implant costs, the patient charge file and the purchasing file should be mapped using the implant log, using the same process described for mapping drug costs. The implant log is used by surgeons after an operation to log the type of procedure, detailed description of supplies used, and general comments.

When a physician orders a knee implant, the implant stock-keeping unit (SKU) number is often recorded in the implant log. If the SKU number in the implant log were mapped to the SKU number in the hospital’s purchasing file, the hospital would be better able to determine the actual cost for the implant. The cost could then be assigned to the patient file, resulting in a more accurate cost picture for orthopedic cases.

For example, to assign true implant costs to a patient who has undergone a knee replacement, a hospital would look up the implant SKU recorded in the implant log by the physician—in this example, SKU123. Then, the hospital would open the purchasing file and locate, for that particular month, the description and price for SKU123 (in this instance, XYZ knee replacement part; cost: $4,950). Next, the hospital would map the more detailed description and price for the implant to the patient charge file. This process can help to ensure that the true cost of the implant used by the physician is assigned to the patient’s charge file.

In some hospitals, the implant log, purchasing file, and patient charge file are part of the same system. For the majority of hospitals, however, the implant log is a separate electronic file, not connected with the other file system or systems. And in some hospitals, the implant log is manually managed.

A hospital can complement this process by comparing its drug and implant costs with price benchmarks from subscription-based national databases or with databases maintained by consulting firms. In our experience, a 65 percent match can be achieved by connecting the drug and implant purchasing files with the detailed charge files, as outlined above. By comparing these costs with price benchmarks from subscription-based or consulting-firm databases, a hospital can better determine how the prices it is paying for drugs and implants compare with national averages.

By connecting these data sets, hospitals can gain better visibility of what they are really spending across various service lines and operational functions.

Understanding a Rural Hospital’s True Costs

The experience of a 250-bed rural hospital in the north central United States provides a good example of the pitfalls of using RCCs to estimate costs. This hospital found itself making key strategic planning decisions based on misleading cost data.

In analyzing the drug usage data from two physicians (A and B) at the hospital, physician B appeared more cost-efficient than physician A at treating the same disease. However, on examining physician B’s actual drug expenditures, hospital leaders realized this physician’s costs were in fact higher than those of physician A (see the exhibitbelow).

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f-richmond

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If RCC costs are considered, physician A seems to be treating patients at a higher average cost per case than physician B. But if actual costs are considered, physician A is actually treating at a lower cost per case than physician B. Strategically, based on the RCC analysis, if the hospital encouraged all of its physicians to emulate physician B’s treatment approach, it would lose the opportunity to save money on every case.

The data generated by RCCs can be especially problematic in measuring the profitability of various hospital services lines. Because of these misleading cost data, the team at this rural hospital was under the impression it was making a healthy $477,000 profit annually from its orthopedic surgery group.

The reality was the hospital’s profit from this key service line was about $170,000 less—a material difference for a rural community hospital.

For years, the provider thought it was making money on hip replacement surgery, but those profits were much lower because costs of implants used in these orthopedic procedures were continually underestimated. An incorrect profitability picture such as this can wreak havoc on vital strategic-planning efforts.

The rural hospital is by no means an outlier in regard to its problems with cost estimation. The research finding cited at the beginning of this article suggests institutions regularly underestimate costs per orthopedic procedure (and the costs of implants) because of their use of RCCs.

Rising costs are at the heart of the cost challenges that are prevalent in health care. Healthcare reform was designed, in part, to help alleviate this persistent cost problem, but much work still needs to be done to fully understand the true costs of health care. Once these costs are better understood, the goal then must be to manage costs more effectively, efficiently, and sustainably. A critical starting point is for healthcare providers to have a more accurate and realistic picture of what their current costs are, not what they think costs may be.

By connecting key data sets and analyzing costs in a more systematic way, hospitals can develop a stronger and more accurate understanding of their actual costs. This system will provide more data visibility to enable hospital leaders to enhance strategic decision making related to key service lines, improving value.


About the Author

Russ Richmond, MD, is CEO, Objective Health, Waltham, Mass., and a member of HFMA’s Massachusetts-Rhode Island Chapter (russell_richmond@mckinsey.com).


Footnotes:
a. This amount is based on an average overestimation in contribution per orthopedic surgery case of $1,200 multiplied by an average of 1,000 cases annually per hospital.


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Sidebar 1:  A Step-by-Step Guide to Improving Hospital Cost-Estimating Processes

Hospital leaders should follow four relatively easy-to-implement steps to improve their cost-estimating processes related to drugs and implants—two cost centers where physicians have significant control over operating expenses.

Step 1: Establish the Data Foundation
Ensure that the hospital has core data sets on which to develop. Keep the following practices in mind:

  • All encounters and detailed charges should be available in corresponding files.
  • All purchased drugs, implants, and other medical/surgical products should be available in a purchasing file (often provided by the group purchasing organization or distributor).
  • All implants should be tracked in electronic implant logs (e.g., in the operating room, intensive care unit, and cath lab).

Step 2: Assemble a Cost-Estimate Improvement Team

This team, which will lead the project, should include the following representatives:

  • Director of pharmacy, to provide guidance and sign-off on drug cost estimates
  • Materials manager, to provide guidance and sign-off on implant cost estimates
  • Chargemaster manager, to incorporate input from pharmacy and materials departments into the granular charge codes that are charged to patients
  • Analytics expert, to connect purchasing files, implant logs, and patient charge files
  • Strategy and finance leaders, to leverage the improved cost accounting to derive savings and align on growth strategy. 

Step 3: Connect the Data Sets

The analytics expert connects the data sets as described in the “Making the Right Cost Connections” section of this article. 

Step 4: Leverage Insights from True Cost Data

Three areas of understanding or capability can ensure that a hospital can put the cost data to effective strategic use.

Understanding of actual profitability of service lines/departments and definition of growth strategies.

A hospital with true cost data can understand which service lines drive most of its profit and which departments lead to maximum losses. This understanding enables hospitals to strategically define departments they should invest in and areas where they should become leaner. On the other hand, a hospital that uses ratios of costs to charges (RCCs) can, at best, give average estimates of service-line profitability, with the potential for categorizing unprofitable service lines as profitable and vice versa. 

Ability to accurately measure clinical variation in the hospital and use the measurements to guide meaningful conversations with your physicians.

A hospital with true cost data can run physician-level data profiles, such as average cost per case for each physician treating a particular disease. Such insight can support meaningful discussions with physician outliers that can influence changes in behavior and thus potentially reduce costs. Hospitals using RCCs cannot approach physicians with the same level of credibility, as seen in the rural hospital example on page 89. If hospitals instead focus on using actual costs in specific strategic costs centers, physicians once considered the hospital’s most cost-efficient may be exposed as the  organization’s most costly. 

Understanding of the impact of macro-purchasing factors such as drug shortages on the profitability of key service lines.  

A hospital that tracks actual costs can take macro-purchasing actors, such as drug shortages, and assign true costs on a daily or monthly basis, thereby allowing the effects of drug shortages on service-line profitability to be quantified. Alternatively, hospitals using RCC-based costing would average out the effects over a year, leading to inaccurate service-line profitability insight during times of drug shortages.


Sidebar 2: Improving Cost Estimates for Drugs: Action Steps by Department

IT Department

  • Create a taxonomy-based categorization tool. Assign each drug description into broad therapeutic class, dosage, and route of administration categories. This can be a string search and categorization tool, using regular expressions, to match a specific set of characters in a string (word).
  • Maintain a central database of drugs and categorizations to be used each month.

Pharmacy Department

  • When documenting purchased drugs, be sure to include compound, dosage, and route of administration information in the entry.
  • Ensure the detailed charge file has charge codes that reflect the individual drugs purchased each month.

Sidebar 3: Improving Cost Estimates for Implants: Action Steps by Department

IT Department

  • Bridge the implant log and the purchasing file. Identify the SKU number for the implant in the purchasing file as well as the implant log. Maintain or create a central database of implants and their SKUs (both the implant-log SKU and the purchasing-file SKU).
  • Connect the detailed charge file with the implant log, using the patient account number.

Purchasing Department

  • Ensure that purchased implants are assigned an internal SKU that can be mapped to the implant log SKU.
  • Ensure that the detailed charge file has charge codes that reflect the individual implants purchased each month. 

Conclusion

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Understanding Modern Healthcare Market Competition

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Updating Competitive Strategy Theory in Healthcare

By Robert James Cimasi; MHA ASA FRICs MCBA AVA CM&AA
By Todd A. Zigrang; MBA MHA ASA FACHE
By Anne P. Sharamitaro; Esq.

www.HealthCapital.com

Michael Porter[i] is considered by many to be one of the world’s leading authorities on competitive strategy and international competitiveness.  In 1980, he published Competitive Strategy: Techniques for Analyzing Industries and Competitors,[ii] in which he argues that all businesses must respond to five competitive forces.

(1) The Threat of New Market Entrants

This force may be defined as the risk of a similar company entering the marketplace and winning business.  There are many barriers to entry of new market entrants in healthcare including: the high cost of equipment, licensure, requirement for physicians and other highly trained technicians, development of physician referral networks and provider contracts, and other significant regulatory requirements.

Certificate of Need (CON) laws, which require governmental approval for new healthcare facilities, equipment, and services have been in place since they were federally mandated in 1974.  State CON laws create a regulatory barrier to entry.  New medical provider entrants commonly face substantial political opposition by established interests, which is manifested in the CON review process.

(2) The Bargaining Power of Suppliers

A supplier can be defined as any business relationship upon which a business relies to deliver a product, service, or outcome.  Healthcare equipment is a highly technical product produced by a limited number of manufacturers. This reduces the range of choices for providers and can increase costs.

(3) Threats from Substitute Products or Services

Substitute products or services are those that are sufficiently equivalent in function or utility to offer consumers an alternate choice of product or service.  An illustration of this in healthcare would be diagnostic imaging as a substitute for surgery, which is often a more costly and risky option for patients. The threat of less invasive or less expensive diagnostic tests other than diagnostic imaging is relatively small for the near term future.

(4) The Bargaining Power of Buyers

This force is the degree of negotiating leverage of an industry’s buyers or customers.  The buyers of healthcare services are ultimately the patients. However, the competitive force of buyers is manifested through healthcare insurers including the U.S. and state governments through the Medicare, Medicaid, TRICARE, and other programs; managed care payors (e.g., Blue Cross/Blue Shield affiliates); workers’ compensation insurers; and, others.  In addition to the government, many of these healthcare insurers are large, national companies, often publicly traded, commanding significant bargaining power over healthcare provider reimbursement.

(5) Rivalry Amongst Existing Firms

This is ongoing competition between existing firms without consideration of the other competitive forces which define industries. Healthcare providers face pressure from other existing providers to obtain favorable provider contracts; maintain the latest technology; increase efficiencies; and, lower prices.

References:

[i]  A professor of Business Administration at the Harvard Business School, Michael Porter serves as an advisor to heads of state, governors, mayors, and CEOs throughout the world.  The recipient of the Wells Prize in Economics, the Adam Smith Award, three McKinsey Awards, and honorary doctorates from the Stockholm School of Economics and six other universities, Porter is the author of fourteen books, among them Competitive Advantage, The Competitive Advantage of Nations, and Cases in Competitive Strategy.

[ii]  Porter, M.E. Competitive Strategy: Techniques for Analyzing Industries and Competitors. The Free Press, 1980.

Conclusion

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Integration as a Competitive Strategy in Healthcare Reform

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Understanding Horizontal and Vertical Integration

[By Robert James Cimasi MHA, AVA, CMP™]

Health Capital Consultants, LLC

St. Louis MO

Several potential benefits are associated with the integration of companies in the same or related industries. These synergistic benefits depend upon the type of companies and their integration strategies, as well as whether the anticipated transaction is a manifestation of horizontal consolidation or vertical integration.

Horizontal consolidation is “the acquisition and consolidation of like organizations or business ventures under a single corporate management, in order to produce synergy, reduce redundancies and duplication of efforts or products, and achieve economies of scale while increasing market share.”

Vertical integration involves the joining of organizations that are fundamentally different in their product and/or services offerings, i.e., “the aggregation of dissimilar but related business units, companies, or organizations under a single ownership or management in order to provide a full range of related products and services.”

Healthcare Locality

As healthcare is essentially a local business, horizontal integration within the local market has been limited by antitrust laws. Therefore, in order to control greater market share, a hospital’s strategy has required vertical integration. Healthcare providers and organizations have placed much emphasis on the benefits of vertical system integration in the last 10 or more years, whereby a single healthcare organization owns all of the elements needed to provide a continuum of care for all the needs of a given patient population. Much of this effect has stemmed from the desire to be able provide a “continuum of care,” i.e., to be able to single source contract for the healthcare needs of a patient population and to profit from implementing preventative healthcare and utilization management measures. The relative economic benefits of this type of vertical integration versus horizontal integration strategies remain the subject of great debate in academia and among the strategic managers of other industries. One lesson that may be drawn from other industries is that neither of these forms of integration is universally applicable or beneficial to every organization and market. There are also great costs to integration, which must be outweighed by the benefits. Each specific benefit should be identified and researched when examining the probable effects of integration, consolidation, mergers or divestitures as a competitive strategy.

Rapid Consolidation Periods

During the rapid consolidation and integration of healthcare providers, insurers, and purchasers, in recent years, there was much discussion of a concept termed “managed competition.” This term appears to have been an outgrowth of the term “managed care” and was viewed by many as the logical result of the integration of healthcare markets nationally. The concept of “managed competition” apparently related to an idealized vision of competition between very large, integrated providers (organized into integrated delivery systems), large, national managed care payors, and purchasing group coalitions that could achieve a balance of power between these interacting groups. However, many believe that the result of such an arrangement would more likely be a reduction in competition between members of each of these three groups and the creation of powerful bureaucratic and intractable organizations. Further, this scenario does not appear to effectively remove any of the existing barriers to competition and therefore doesn’t introduce any additional incentives for innovation to produce value for consumers which, of course, is the “sine qua non” of competition.

Disadvantages

The disadvantages of integration are becoming apparent, including:

  • the loss of autonomy;
  • increased bureaucracy;
  • difficulty in aligning incentives; and
  • other failed expectations.

Many organizations that sought strategic advantage through integration are ending those arrangements and now divesting acquired organizations.

Other Industries

In other industries, specialized providers of goods and services are increasingly able to offer customers a full range of services through affiliation and affinity with other independent specialists, made more seamless through the use of increasingly sophisticated communications and computing technologies. However, this move to “dis-integration” must also be carefully considered if organizations are not to make further costly organizational changes inspired by a rushed judgment of general market trends.

Porter Speaks

Michael Porter (et al.) wrote in the Harvard Business Review that,

In industry after industry, the underlying dynamic is the same: competition compels companies to deliver increasing value to customers. The fundamental driver of this continuous quality improvement and cost reduction is innovation. Without incentives to sustain innovation in health care, short-term cost savings will soon be overwhelmed by the desire to widen access, the growing health needs of an aging population, and the unwillingness of Americans to settle for anything less than the best treatments available. Inevitably, the failure to promote innovation will lead to lower quality or more rationing of care — two equally undesirable results.

Assessment

Therefore, if the emerging healthcare industry is to respond successfully to the Affordable Care Act [ACA] and related market pressures to reduce costs, then the healthcare market must first create incentives for innovation. The barriers to competition cannot include barriers to innovation as many do now. Physicians, nurses, healthcare purchasers, managers, and legislators must ensure innovation takes the forefront of any reform, if it is to be effective.

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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Understanding Healthcare Competition

Funneling Porter’s Five Forces of Business

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ho-journal12Michael Porter PhD, of Harvard Business School, is considered by many to be one of the world’s leading authorities on competitive strategy and international competitiveness.

In 1980, he published Competitive Strategy: Techniques for Analyzing Industries and Competitors, in which he argued that all businesses must respond to five competitive forces. And now, these thoughts have been condensed for the healthcare industrial complex by Robert James Cimasi; MHA, CMP™ of Health Capital Consultants, LLC, in St. Louis, MO. They are cited below from the print journal-guide www.HealthcareFinancials.com

1. The Threat of New Market Entrants

This force may be defined as the risk of a similar company entering your local marketplace and winning business. There are many barriers to entry of new market entrants in healthcare including: the high cost of equipment, licensure, requirement for physicians and other highly trained technicians, development of physician referral networks and provider contracts, and other significant regulatory requirements.

Certificate of Need (CON) laws, which require governmental approval for new healthcare facilities, equipment, and services that have been in place since they were federally mandated in 1974. State CON laws create a regulatory barrier to entry. New medical provider entrants commonly faced substantial political opposition by established interests, which is manifested in the CON review process.

2. The Bargaining Power of Suppliers

A supplier can be defined as any business relationship or vendor you rely on to deliver your product, service or outcome. Healthcare equipment is a highly technical product produced by a limited number of manufacturers. This reduces the range of choices for providers and can increase costs.

3. Threats from Substitute Products or Services

Substitute products or services are those that are sufficiently equivalent in function or utility to offer consumers an alternate choice of product or service.  An illustration of this in healthcare would be diagnostic imaging, or PET scans, as a substitute for surgery, which is often a more costly and risky option for patients. The threat of less invasive or less expensive diagnostic tests other than diagnostic imaging is relatively small for the near term future.

4. The Bargaining Power of Buyers

This force is the degree of negotiating leverage of an industry’s buyers or customers. The buyers of healthcare services are ultimately the patients. However, the competitive force of buyers is manifested through healthcare insurers including the US and state governments through the Medicare, Medicaid, TRICARE, and other programs; managed care payers (e.g., Blue Cross/Blue Shield affiliates); workers’ compensation insurers; and others. 

In addition to the government, many of these healthcare insurers are large, national companies, often publicly traded, commanding significant bargaining power over healthcare provider reimbursement.

5. Rivalry among Existing Firms

This is ongoing competition between existing firms without consideration of the other competitive forces which define industries. Healthcare providers face pressure from other existing providers to obtain favorable provider contracts; maintain the latest technology; increase efficiencies; and lower prices.

Link:

http://www.thehealthcareblog.com/the_health_care_blog/2009/02/making-price-competition-work-.html#comments

Assessment

And so, these forces should be considers by all new, mid-career, and mature independent medical practitioners. They should also be combined with an internal organizational SWOT analysis as well.

Conclusion

And so, your thoughts and comments on this Medical Executive-Post are appreciated.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com  or Bio: www.stpub.com/pubs/authors/MARCINKO.htm

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