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Strategic Cost Repositioning

A Priority for ACOs Pursuing Population Health Management


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The past few years of the “Great Recession” have been a wake-up call for many health systems. After decades of steady revenue growth, since 2008 the “cost curve” of healthcare expenditures has actually “flattened” somewhat: Average annual growth of national health expenditures from 2000-2008 was 7.2%, but only 3.9% from 2008-2011 (still 1.9% more than GDP growth). While some systems have maintained healthy operating margins due to historical contracts or unique services, most are facing increased financial pressures. Not surprisingly given the gloomy revenue forecast, healthcare systems are turning to cost reduction as a core strategic priority.


One major problem health systems face is that they are saddled with clinical assets and operating models that were designed and built around privately funded fee-for-service medicine, and are misaligned with their future revenue and income streams under “accountable care.” Most health systems, for example, still have too many beds. Despite a 31% reduction in the number of hospital beds since 1980, community hospital occupancy is only 66%, down from 76%. At the same time, health systems’ emphasis on building outpatient services on hospital campuses caused them to miss out on much of the growth of distributed ambulatory services over the last 20 years.


In addition to misaligned clinical assets, the operating models utilized by most healthcare systems are still hospital-centric. Fast-growing fee-for-service (“FFS”) revenues caused health systems to over-invest in revenue-generating activities (transplant services, high-end surgical procedures, advanced imaging, etc.), and under-invest in many activities and processes that have greater impact on population health (home care, case management, mental health, etc.) which is the focus of emerging reimbursement reform. This FFS mentality infused all aspects of health system operations, determining who got paid more and who got paid less, how physicians related to hospitals, and many other “cultural” dimensions of today’s health systems.


Current Cost Reduction Methodologies: Limited Options

Compared with the magnitude of this strategic cost problem, the toolkit most health systems have to reduce costs is relatively limited. Figure 1 arrays various types of cost reduction processes health systems have used over the past 20-30 years on a grid with two dimensions: (1) typical percentage reduction in operating costs achieved; and (2) sustainability of these cost reductions. While the chart is impressionistic, it reflects the experience of many different health systems.


Relatively few methodologies have achieved reductions of more than 7-8% of total operating costs in a single cycle, and those that have, such as budget cuts, have had trouble sustaining these savings more than a year or two. Lean Six Sigma may be the most sustainable approach, since it reengineers core processes, but it is usually focused on improving quality and efficiency or reducing variation in specific processes, not directly on reducing costs. Some health systems have combined these methodologies, but even so, achieving and sustaining reductions in system-wide operating costs of more than 8%, net of revenue shrinkage, is rare.


A Comprehensive Approach: Strategic Cost Repositioning

Building on the work of others, BDC Advisors has developed an integrated top-down, bottom-up methodology for strategic cost repositioning that begins to address the cost problem most health systems face.

This approach, illustrated in Figure 2, has helped clients achieve and sustain operating cost reductions of 8-10%, with the promise of greater savings over time, while maintaining quality and minimizing revenue loss. It has also helped move health systems’ operating models and clinical assets away from dependence on FFS and positioned them better for “value-based care.”

Figure 1: Cost Reduction Methodologies

This strategic cost repositioning methodology is distinctive in a number of ways:

  • It applies disciplined top-down strategic analysis to “size” the delivery system for future needs and resources. This involves:

    • Identifying how community needs and resources will likely change under health reform

    • Assessing the system’s overall need and opportunity to improve its cost position

    • Projecting how the system must change to accommodate these needs and sustain financial performance


  • It uses creative bottom-up process improvement to:

    • Identify and evaluate potential restructuring initiatives

    • Prioritize initiatives and decide which to pursue

    • Develop implementation plans and drive execution of these plans


  • It does not shy away from strategic issues—in fact, it seeks out opportunities to restructure clinical assets to reduce costs

  • It is driven by health system administrative and medical staff, not consultants

Strategic cost repositioning is a robust methodology that works with all types of hospitals, from 150-bed community hospitals to 1,000-bed academic medical centers and multi-hospital systems. The two complementary processes that comprise this methodology are discussed below.

Top-Down Strategic Sizing

The purpose of “Strategic Sizing” is to help health systems set achievable operating and financial goals at an actionable level. This methodology begins with a number of analyses aimed at developing a strategic vision of what clinical assets the health system should own and how it should operate in the future to deliver “the right care at the right time in the right place at the right cost” and remain financially viable.


Figure 2. Strategic Cost Repositioning

Strategic Sizing Analyses

Strategic Sizing analyses include:

  • Projections of the future needs of the population the system will serve

  • Projections of the revenue base this population will generate

  • Analysis of competitors’ costs and operational trajectories

  • Analysis of operating performance, relative to external and internal benchmarks

One core Strategic Sizing analysis is predictive modeling that integrates trends in demographics, payer mix, utilization, market share, and revenue by line of business (inpatient care, primary care, ambulatory surgery, etc.) for defined geographic markets and submarkets. The purpose of this modeling is to develop a comprehensive picture of: (1) the healthcare services the population in the relevant geographies will need in the future; and (2) the revenues that will flow from private and public sources to support these services.


The methodology is illustrated in Figure 3 for a health system that owns a large health plan. Projected changes in demographics and coverage are used to project enrollment in health plans and direct government programs such as traditional (non-managed) Medicare and Medicaid, as well as cash flows to these different plans / programs. These enrollment and cash flows are then used to project future utilization and revenue streams to different types of providers – hospitals, outpatient facilities, physicians, andother covered services like home care, DME, etc. The health system’s historical market share and likely changes in competitor behavior are then factored in.

Figure 3: Strategic Sizing Predictive Model

The result is a comprehensive “map” of future patient and revenue flows to the health system that can be used to quantify its need for strategic cost reduction (among other things). This map also provides important input about where cost reduction can be achieved—how many beds can be taken out of service, what clinical programs can be consolidated, etc.—and where capital should be invested to meet needs in lower-cost ways.


Another relatively straightforward Strategic Sizing analysis is comparing a system’s cost position with competitors’ costs. Figure 4 illustrates a competitive cost analysis conducted for a health system with four hospitals (“Sunshine Health”) in a medium-sized city (“River City”).

Figure 4: Competitive Cost Analysis


As Figure 4 shows, after adjusting for outpatient business and Medicare CMI, Sunshine’s hospitals [blue line] were relatively low-cost. (They are below the overall market regression line [black] and the line for Sunshine’s major competitor [red]).

Goal-Setting

Once Strategic Sizing analyses have been completed, health system leadership must translate the implications of these findings into cost repositioning goals, addressing issues like the following:

  • What overall cost position should we have five years from now—e.g., “low-cost provider in our market,” “low enough to break even on Medicare patients,” “10% lower adjusted cost per discharge than we have today?”

  • How much cost savings should come from different operating divisions—inpatient care, outpatient care, employed physicians, etc.?

  • How much savings should come from direct patient care? How much from hospital overhead? How much from supplies and purchased services? How much from ancillary services?

  • How much savings should come from clinical integration and strategic repositioning? How much from operating process improvement? How much from reductions in unit costs (e.g., labor costs, supply costs)?

Based on strategic and financial projections, Sunshine’s management team set a goal of reducing total operating cost by 8%, illustrated as a green line in Figure 4. After plotting this reduction, management was concerned that an 8% cost reduction target might be overreaching, so we expanded our comparisons to several other low-cost systems across the country. After adjusting for cost-of-living differences, we found a health system in Southern California whose costs were about 12% below Sunshine’s cost, which reassured management that the 8% target was indeed achievable.

Goal-setting in the top-down, bottom- up strategic cost repositioning process steers a middle course between departmental budget targets and across-the-board cuts. Customized goals are set for broad areas, such as inpatient care, ancillary services, overhead, clinical effectiveness, and/ or groups of DRGs, in order to give Clinical Asset Restructuring work teams [described below] some discretion in deciding where to attack costs. The Steering Committee is responsible for ensuring cost-savings goals are: (1) essential for system success in the future environment; (2) achievable within a reasonable timeframe; and (3) “actionable” by work teams.

Bottom-Up Clinical Asset Restructuring

Clinical Asset Restructuring is a participative process of developing initiatives that can reposition clinical assets and modify operating processes to reduce costs, while maintaining or improving quality of care and patient experience. Like Deming’s “Plan-Do- Check-Act” cycle, CQI teams, Lean Six Sigma, and other improvement programs, Clinical Asset Restructuring is implemented by work teams that generate, prioritize, evaluate, and plan the implementation of high-potential cost-saving initiatives. Like most CQI teams, restructuring work teams.

  • Are small (8-12 people, typically)

  • Are co-directed by physicians and administrative managers

  • Include professionals directly involved in the processes being examined, along with one or two outsiders from other areas to stimulate idea innovation

  • Are staffed with data analysts, including financial analysts

  • Assign initiatives out to members for evaluation & implementation planning

Restructuring work teams differ from CQI teams in several ways:

They are aimed directly at cost reduction for the health system as a whole

While maintaining or enhancing quality is an appropriate requirement for cost-saving initiatives, the main goal of restructuring teams is to reduce health system operating and/or capital costs. The system-wide perspective is important, because initiatives that reduce costs in one department will often add costs in another. Work teams are required to “net” the effects of reductions and additions across the entire health system.

They are target-driven

For a variety of reasons, some CQI advocates believe that targets get in the way of real change. Our experience over 25 years is the opposite: Time and again we have seen target-driven teams exceed their goals, while teams without targets make incremental improvements that never get close to their real opportunity.

Each Restructuring team is assigned targets, which their leaders agree are achievable.

They are time-limited

Restructuring work teams operate in parallel to achieve an overall organizational goal. Because of this, they must achieve their targets in a defined timeframe. This timeline has the virtue of forcing teams to prioritize and evaluate opportunities quickly.

Strategic repositioning initiatives are “carved out” and dealt with separately

One drawback of a strict timeline is that it discourages teams from pursuing complex initiatives that have significant potential to reduce costs, but are difficult to evaluate and may be politically sensitive (e.g., converting an acute care hospital to an outpatient center). To deal with this, we triage these initiatives to a separate “Strategic Repositioning” work team As one might expect, quantifying current costs and estimating the true savings potential of complex initiatives requires considerable process and infrastructure support. A common set of planning tools and data analysis tem- plates are important to bring discipline to the process and help work teams and the Steering Committee monitor progress. Work teams also require staff support, including financial analysis (typically provided by internal Finance Department staff), operational analysis, market analysis, and implementation planning (which often requires consultation across different departments like human resources).

Benefits of Strategic Sizing and Clinical Asset Restructuring

The methodology described above has several important advantages over other cost reduction methodologies health systems can use:

  • It forces explicit choices to be made about the size and composition of the market the health system serves today or wishes to serve tomorrow.

  • It identifies important changes in consumer needs that are often ignored when decisions are made to rationalize clinical services. For example, a decision to close or convert a hospital to alternative use may not take into account the need to provide ambulatory services to replace inpatient services and avoid losing market share.

  • It helps systems match capacity with demand across the continuum of care.

  • It sets cost repositioning targets based on projected need and expected changes in revenue. This is important because in the future, need and revenue may not always coincide, and costs may need to be brought in line with lower revenue than in the past.

  • It provides a solid foundation of facts and reasoned assumptions about future needs of the population that can justify decisions to internal and external constituencies (e.g., independent physicians, regulators).

Above all, the combination of Strategic Sizing and Clinical Asset Restructuring forces health systems to integrate their operating models with their clinical, business, and organizational models, so their pursuit of accountable care is not weighed down by 20th century assets or derailed by 20th century thinking.

A Case Study

One health system in a medium-sized city of 1.8 million in the Western U.S. undertook this top-down, bottom-up repositioning process with positive results. Strategic Sizing projected that expanded Medicaid eligibility and the implementation of a health insurance exchange would cause the system’s average daily census to grow by about 5% through 2016. However, because of shifts in the composition of patients and reduced revenue from government payers, average net revenue per patient-day (“price”) would remain essentially flat (0.3% growth over 5 years). This finding spurred system management to adopt an ambitious cost-saving target that would sustain its operating margin for five years in a flat pricing environment, despite unit cost increases and to undertake a Clinical Asset Restructuring process to achieve this goal.

This process, which rolled out over eight months, led to a number of significant changes in the system’s assets and operations, including:

  • Deferring a $300M plan to expand inpatient capacity in a tertiary care center

  • Closing OB in a community hospital and shifting the program to a tertiary care center with a large NICU

  • Consolidating two high-quality, financially healthy open heart surgery programs into a single service to reduce operating cost

  • Converting a community hospital into an ambulatory center

This system is in the process of implementing these changes, as well as evaluating several other complementary initiatives, including:

  • Innovative approaches to sub- acute clinical care delivery, including the Johns Hopkins “hospital-at-home” model and Anthem’s CareMore model for Medicare Advantage patients

  • Opportunities to grow off-campus ambulatory services

  • Leadership sees these changes as the first wave of strategic cost repositioning, with more to come.

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