10 Challenges Facing Community Hospitals

The nation's community hospitals, long a backbone for healthcare provision in this country, face increasing challenges as reimbursements fall, regulations become more complicated and payors demand closer collaboration with physicians and other outpatient providers. These hospitals continue to join larger organizations. Of the 5,010 community hospitals in the nation, the AHA reports 2,868 are now part of healthcare systems. Here we ask five experts to comment on specific challenges faced by this sector.  

1. Lower discounts on supplies.
Community hospitals often do not have enough spend to get great prices on drugs, devices and supplies. Even inside group purchasing organizations, hospital systems with high volume get better deals than community hospitals, says Barton C. Walker, an attorney for McGuireWoods in Charlotte, N.C. "The cost of medical supplies goes up faster than reimbursements," says Nick A. Fabrizio, a principal of MGMA Health Care Consulting Group based in Baldwinsville, N.Y.

2. Lack of economies of scale. The advantages of having a larger cost structure to spread administrative costs over become evident when employing physicians, Mr. Fabrizio says. "A lot of the community hospitals manage two or three physician groups," he says. "But if they could cover five to seven groups, you might be able to cover their costs." Mark Grube, a partner at Kaufman, Hall & Associates, a healthcare consulting firm in Skokie, Ill., says: "This is a big deal and it's going to be a bigger deal in the future. Hospitals are going to be pushed to achieve higher cost efficiencies."

Rex J. Burgdorfer at Juniper Advisory, an investment banking firm in Chicago, thinks U.S. hospitals have a long way to go in consolidating and creating economies of scale, as has occurred in just about every other industry. "Large hospital systems can save a great deal of money by standardizing operations, he says. For example, the CEO of a large Catholic system on the West Coast recently told Juniper it saved $4 million a year simply by agreeing to use the same type of trash bag at each hospital.

3. Lack of negotiating clout with managed care.
"Bigger hospitals get better deals from managed care," says Robert Betka Jr., operator of Catalyst Management Advisors in Grand Rapids, Mich. Mr. Walker says the gap in reimbursements between a large system with negotiating clout and community hospital without it can be significant.

"This is a huge issue," Mr. Bergdorfer says. He notes that payors have both the power to set prices and the ability to drive volume to certain institutions. His firm is currently advising a community hospital in a large midwestern market on its strategic financial alternatives primarily because it lacks access to a dominant managed care contract.

Mr. Grube says community hospitals in isolated geographic markets still represent "must have" providers for payors. And even in metro areas such as suburban Chicago, it's hard to believe that a big system like Advocate could elbow out a strong community hospital like Edward Hospital. "This is the biggest issue affecting community hospitals," Mr. Fabrizio says. To strengthen its clout, a community hospital needs to grow its network of affiliated physicians to give the hospital more revenue, he says.

4. Increasing compliance costs. Hospitals have become more heavily regulated what with recovery audit contractors, HIPAA and other regulations, Mr. Walker says. "Regulatory and compliance costs are driving up administrative costs," Mr. Betka says. "One example is RAC audit programs. You've got to beef up your coding and billing operations. That can be a significant administrative burden."

5. Lack of high-end service lines to drive profits. "Smaller community hospitals aren’t able to offer the high-margin services that add to revenue, such as cardiology and orthopedics," Mr. Bergdorfer says. Mr. Walker agrees. "Community hospitals would find it difficult to create a true center of excellence," he says. "They have fewer resources and lower patient volumes." However, Mr. Grube says some community hospitals, such as Hoag Memorial Hospital Presbyterian in Newport Beach, Calif., offer exceptional service lines, such as Hoag's orthopedics program.

6. Limited access to financing.
Mr. Bergdorfer says non-profit hospitals' only source of external capital is debt financing through the bond markets. "If their leverage ratios are high, they're going to struggle to secure future funding," he says. Since the financial crisis, Mr. Walker says, credit rating agencies have become more careful. Criticism of their activities in other financial sectors has affected how they handle hospitals. Mr. Walker adds that the costs of issuing tax-exempt bonds favor larger organizations. "You don’t do a small bond operation because the transaction costs wouldn’t justify it," he says.

"The single biggest issue for community hospitals is access to capital," Mr. Betka says. A lot of hospitals need to upgrade their physical plants, some of which were built in the Hill-Burton era in the 1950s. "You've got to find the money for that, but when you have a lower bond rating you have increased your cost of borrowing," he says.

Mr. Grube says rating agencies tend to view larger scale organizations as less risky, in the belief they are involved in diverse markets, have a greater portfolio of services and provide better liquidity. But he adds there are lots of strong community hospitals that have good access to capital, such as Central Du Page Hospital in Illinois, and many large systems with poor financial ratings, such as Caritas Christi Health System in Boston.

7. Inability to take on risk and drive ACO programs. A lot of hospitals are spending a great deal of time and resources planning ACOs, Mr. Walker says, noting larger systems have more resources to hire physicians and physicians may prefer to work in larger systems. Mr. Grube agrees to an extent. "A large organization can absorb the substantial overhead costs in establishing an ACO," he says. "On the other hand, the challenge for a large organization is getting lots of physicians with diverse interests to agree."

8. Loss of key physicians to bigger systems.
Mr. Burgdorfer says hospital systems have more active recruiting operations while community hospitals may not be able to take on the financial burdens of establishing new physician practices. Mr. Grube disagrees that community hospitals don’t have enough capital to buy practices but concedes physicians may migrate to larger organizations in the belief that they have more staying power.

Mr. Walker says some physicians prefer larger systems because they can offer richer resources and greater negotiating clout. Retaining general surgeons, in particular, is a challenge for community hospitals, Mr. Fabrizio says. He can count 10 hospitals that are struggling to recruit general surgeons.

9. Inability to attract leadership.
Mr. Grube believes larger organizations can assemble the broadest and deepest talent in the C-suite. "There can be greater specialization," he says.

10. Inability to shift resources.
Finally, it can be more difficult for a community hospital to shift programs to take advantage of changes in reimbursements or regulations, Mr. Fabrizio says. "The big system has bigger budgets that are often easier to move around," he says. Mr. Grube, on the other hand, thinks a prosperous community hospital can be more nimble than a larger hospital because there is less bureaucracy. In any event, "there are fewer low-hanging fruit for hospitals," Mr. Walker says. "The number of areas that are truly profitable are getting fewer and fewer because of reimbursement changes and other factors."

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