How health systems can avoid a negative 4.2% operating margin by 2025

Today's business and financial pressures make it difficult for hospitals and health systems to achieve and maintain strong operating margins.

A report published by Moody's Investors Service in August 2018 showed that while the median annual expense growth rate for nonprofit and public hospitals declined from 7.1 percent in 2016 to 5.1 percent in 2017, it still outpaced the median annual revenue growth rate for both years, which declined from 6.1 percent in 2016 to 4.6 percent in 2017. Due to this significant expense growth and slower revenue growth, median operating margins fell to an all-time low of 1.6 percent in 2017.

A recent Kaufman Hall analysis found that hospitals became more profitable in 2018, with a roughly 5 percent national improvement in operating margins compared to the year prior. However, recent research from Advisory Board indicates margin management will be a challenge for hospital and health system leaders for the foreseeable future, said Rob Lazerow, managing director of Advisory Board's flagship research program.

Using a model health system to assess the challenge

The research used statistical modeling to examine financial performance and demographic statistics for a hypothetical five-hospital average system with $1 billion in top-line revenue and a positive 3 percent margin in 2017. The model system was called Antares, which is on average the fifteenth-brightest star in the night sky.

"It is burning so brightly because it's running out of hydrogen and will collapse, and the goal is to prevent the model health system from collapsing," Mr. Lazerow explained.

The statistical modeling process used data from Moody's but also factored in adjustments starting in 2018 to cost and revenue growth rates to account for future market forces.

The overall goal was to determine the cost savings and revenue growth that Antares, or an existing average health system, will need for long-term stability.

Researchers found that Antares will see a negative 4.2 percent operating margin by 2025 without intervention and needs to avoid costs strategically while also growing top-line revenue, which grew more slowly than costs in recent years.

They determined the system will need to avoid $40 million to $44 million in costs annually between 2017 and 2025 and grow top-line revenue by $35 million to $45 million annually during that period, to achieve its positive 3 percent margin in 2025.

This means 55 percent of the system's margin adjustments should come from costs and 45 percent from revenue growth, said Mr. Lazerow.

Without such adjustments, Advisory Board predicted Antares will see margins go negative in 2021 and continue to decline.

"As long as [the health system] can continue to grow their top-line revenue, they don't need cost cuts in the absolute sense," said Mr. Lazerow. "This isn't about slash and burn by any means but about slowing the rate of expense growth while gently increasing the rate of revenue growth to reverse the trend that had been at the heart of margin challenge [for many hospitals and health systems], which is [that] for years expense growth has been outpacing revenue growth."

The takeaways  

For healthcare organizations, the main takeaway from the research is two-fold.

First, Mr. Lazerow said, Advisory Board expects hospital and health system leaders will continue to face margin management challenges.

"I have yet to meet a hospital leader who does not have margin management at top of their strategic agenda or who've looked at the [trends with] model [health system Antares] and said, 'That's not us.' This is really resonating with leaders across the country because this is what they're seeing on the ground day in and day out," he added.

Mr. Lazerow said hospital and health system leaders also won't be able to cost-cut or grow their way out of this problem. Instead, he recommended that organizations focus on having a balanced margin management formula that incorporates strategies to both slow their expense growth and reignite their revenue growth simultaneously.

In terms of how to get that revenue growth, the company advised hospitals and health systems to start by focusing on revenue cycle management and collecting money they are due for services rendered, especially with an increased national focus on prices, charges and surprise billing. This involves focusing on the effective price (how much money the organization is collecting), rather than the sticker price.

"We advise leaders to start with this because it can enable a considerable amount of revenue growth without any more volume growth," said Mr. Lazerow. "Before you begin thinking about market share or increasing volumes, collect what you're owed for what you've already provided. And it has the potential to create a benefit as you get into volume growth. So, we believe that improving revenue cycle performance is the first big step to improving the revenue side of the equation."

As far as cost control, building a cost-disciplined organization should begin with supporting and enforcing enterprisewide efficiency, Mr. Lazerow said.

"This begins with reining in diffuse, low-quality spending decisions by elevating where those decisions are made," he said. "Executives must intervene in the operational areas where low-value choices most persistently occur. This should include having top executives carve out time to build and support new-hire protocols."


More articles on healthcare finance: 

Real-time billing estimates, time-saving bots: Revenue cycle tools that make healthcare leaders smile
New law requires Colorado hospitals to report annual spending
Academic medical centers will face tougher competition, Moody's says


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