Nearly 40% of American hospitals operate with negative margins, and while efforts to optimize revenue have accelerated in recent years, cost containment continues to lag. Healthcare organizations have made commendable strides in improving documentation and coding, reversing denials, aligning reimbursement with patient mix and geography, and enhancing value-based payment strategies. But these revenue-focused efforts alone are no longer sufficient.
To remain sustainable — especially under Medicare-level reimbursement — health systems must become equally rigorous in managing costs. Yet many organizations continue to rely on Direct Contribution Margin (DCM) to evaluate service line performance, a practice that creates blind spots in understanding true cost drivers.
DCM, by design, excludes indirect costs. While it’s logical that service lines are evaluated based on what they can control, this siloed approach distorts financial visibility. Typically, 15%-30% of a health system’s cost base — depreciation, administrative overhead, facility support and executive functions — is excluded from DCM calculations. The result: an overly optimistic picture of profitability and a false sense of efficiency. The consequences are tangible: less urgency to address underlying cost structures, greater demand for incremental resources and underappreciation of capacity management as a lever for financial improvement.
Take the example of imaging. A DCM analysis may support the addition of a new MRI machine based on marginal profitability. However, if the system’s existing MRI fleet is underutilized, this decision — divorced from total cost considerations — only compounds inefficiency. Overreliance on DCM leads to excess capacity, higher fixed costs and greater operating leverage, all of which pose challenges under volume risk and value-based payment models.
To course correct, systems must adopt a total margin view — one that incorporates indirect costs and reflects the actual financial contribution of service lines. At our institution, we’ve taken this a step further by including professional fee support in total margin analyses, allowing us to account for the full economic impact of physician enterprise losses on the organization.
This expanded approach has been transformational. It has fostered greater urgency to reduce length of stay, surgical supply expenses and resource utilization. It has also accelerated improvements in coding and charge capture — critical steps toward achieving Medicare breakeven. Most importantly, it has sharpened our focus on maximizing asset utilization across the enterprise, from high-cost technical equipment to underused clinical space.
DCM has long been a convenient proxy for evaluating local performance. But in today’s environment, where every dollar counts and payment models are shifting, we can no longer afford an incomplete picture. Finance leaders must champion the shift to total margin accountability — creating transparency, driving better decisions and advancing the shared goal of delivering high-value, sustainable care.
Peter J. Pronovost, MD, PhD, is Chief Quality & Clinical Transformation Officer and President of Veale Healthcare Transformation Institute at University Hospitals, Cleveland, Ohio.
Bradley C. Bond is Chief Financial Officer at University Hospitals, Cleveland, Ohio.
