A Hospital's Three-Legged Stool of Success

A carpenter will tell you a three-legged stool is strong and sturdy, and each leg of the stool is equally important. A hospital's "three-legged stool of success" requires focusing on three equally important legs of the stool:

  1. Capital
  2. Customers
  3. Cost (of doing business)

These three "legs" are the principles that must be present for hospitals to survive and flourish in the future. Successful hospitals will need to increase productivity, get a lot closer to their customers, and have the necessary capital for the future. If one leg of the stool is missing or is weak, the whole enterprise will be in jeopardy.

"Trying to predict the future is like trying to drive down a country road at night with no lights while looking out the back window."
— Peter Drucker, legendary management consultant


We do not know what is going to happen in the future, but we can be ready for whatever comes our way. Clearly, there are strong volume and reimbursement challenges on the horizon for hospitals, for example:

  • The past five years have brought softer volumes of high-margin elective procedures for hospitals, and many experts predict that this trend will continue.
  • We are seeing more pressure on hospital price point revenue. This trend is also expected to continue, and perhaps become more acute.
  • Medicaid, Medicare and commercial insurers have all started reducing reimbursement rates.
  • Much of the hospital merger and acquisition activity is coming because of financially weak hospitals that have not prepared for market uncertainty.

What should a hospital manager do? Ensure the three legs of your stool — capital, customers and cost — are strong and well built. Disciplined approaches to each of these will help hospitals thrive in uncertain times.

1. Capital

Now is the time to develop a stronger balance sheet. Have a plan to grow cash and cash equivalents each year, and likewise, improve leverage. In "Managing in Turbulent Times," Peter Drucker states that in times of extreme market uncertainty, the balance sheet becomes more important than the profit and loss statement. Having enough financial flexibility to get through an extended period of uncertainty becomes very important.

Aggressive measures should be taken throughout the revenue cycle to insure that cash comes into to the organization faster that it is going out. History is full of organizations that ran out of cash just before they were able to execute their business model.

Debt should be managed. Maturities should be lengthened and refinanced at lower interest rates if possible. Variable rate debt should be managed closely, including underlying credit facilities. Taking on long-term debt to pad the balance sheet, even if at slightly higher interest rates now, may protect a hospital if debt markets become turbulent again, providing "opportunity" capital in future hard times. Ford Motor Company is doing well today because it took on long-term debt to increase their cash position, strengthening the balance sheet before going into the recession, allowing them to avoid a government bailout and significant opportunities to invest during the downturn.

Capital spending cannot be stopped, but informed decisions should be made. A good example of this would be balancing capital spending between information technology and other uses. Deferring clinical expenditures today will be costly in the future. Hospitals with a capital budget of less than 1.3x depreciation are likely under-investing in their enterprise, which could force a liquidity event if chronic under-investment continues.

2. Customers

Get close to your customers. Hospitals need to know who their customers are and have a plan to listen and respond to the needs of those customers, both patients and physicians. The forgotten customer is often the payor, which has a growing influence on how other customers (patients and physicians) make healthcare decisions.

Know who your customers are and where your revenue comes from. It's important to view daily information that shows where revenue is currently sourced: physician referrals, by department. Executives should identify and understand potential new referral sources that can translate into new revenue, then act on the referral opportunities and meet with the customer.

Spend at least half of each workday solving your customers' problems. Now is the time to engage your customers as never before. All hospital executives should be able to understand their customers and their needs. Who are your customers? What are the biggest problems of your customers? Help your customers solve their problems; then ask them for their business. Getting close to your customers and community physician groups will pay big dividends up front — and secure the hospital a physician base, if and when payors or cost pressures force closer hospital-physician partnerships in your market.

Build close relationships with the major insurance payors in your market. Know which services are growing, which services are declining within your hospital, and where you are investing your future capital. Use this information to come to the negotiating table with prioritized concessions on declining services so that you can negotiate strong contracts in growing services where you are allocating future capital.

3. Cost

Focus on your strengths, cut costs by eliminating weak services and improve productivity. Now is the time to cut overhead, shrink services with a limited future and focus on your strengths. GE only operates in industries and businesses in which it can be number one or two in market share. Similarly, find services to deliver where you can be number one or two in your market. If you have a service line where you rank third or fourth in your market in terms of market share or quality with no hope of moving up, now is the time to cut your losses. Focus on innovative services and physicians that are high volume and high quality.

Reduce fixed costs and expenses by identifying poorly performing departments and services. Find the departments and services in the hospital with growing expenses and declining or flat revenues. Understand the causes, and determine if the hospital should eliminate or outsource the service. Lab services are a prime example. National lab companies have taken market share from hospitals, while lowering the industry cost curve, leaving little opportunity for the high-overhead hospital industry to make money. Hospitals have been selling their lab businesses to cut expenses and allocate capital in areas of opportunity.

Improving productivity is achieved by growing revenue and effective cost control. Many hospitals are now focused on cutting costs, and have forgotten about growing their volumes. Focus on both. If a hospital can grow their revenues by four percentage points with the same work force, then productivity will improve.

Hospitals have tremendous investments in expensive plants and equipment that often have significant spare capacity. Work to improve the effectiveness of your invested capital. Find where the additional capacity is in the OR, then work with surgeons to enforce block time rules. Expand hours of operation on expensive, high-margin imaging equipment to increase volume, such as MRI. Additionally, increasing the shift of hourly employees by a couple of hours can allow for thousands of dollars of daily incremental revenue.

Summary

A crucial point to remember about a hospital's three-legged stool of success is that none of the principles or "legs" — capital, customers or cost — are more important than the others. If too much emphasis is given to one or two of the legs, the "stool" (and the hospital) will become unstable, jeopardizing the future of the organization.

The times and problems we are in are nothing new; even Ronald Reagan made rising healthcare cost pressures an issue in the early 1980s, saying, "It's high time that we put healthcare costs under the knife and cut away the waste and inefficiency. The growth in medical costs is malignant and must be removed for the continued health of the American people."

Hospitals that follow the principles of the three-legged stool of success will lead the industry, create efficiencies, add value to their organizations, and ultimately serve their patients better.

J. Stephen Lindsey, FACHE, was CEO at HCA Henrico Doctors’ Hospital for 16 years. He has served as an affiliate professor in the MHA program at Virginia Commonwealth University. Mr. Lindsey is a principal of Ivy Ventures, LLC, a consulting firm that helps hospitals grow outpatient service lines. He is a fellow of the American College of Healthcare Executives. He can be reached at slindsey@ivyventures.com.

Peter F. Gallagher, CPA, FHFMA is president of Manakin Associates, LLC, a healthcare consulting firm specializing in finance, litigation support and new product and service development. He was a health system CFO for over 20 years, most recently for Bon Secours Virginia. He can be reached at pfgallagher@manakinassociates.com.

Barrett Clark is the director of strategy and analytics at Ivy Ventures, LLC. His focus is on identifying and implementing strategic initiatives to help health systems grow profits. Prior to joining Ivy Ventures, Barrett was a financial analyst for the Financial Planning & Analysis Team at Wachovia Securities (now Wells Fargo Securities). He can be reached at bclark@ivyventures.com.

More Articles by These Authors:

5 Ways for Young Healthcare Leaders to Achieve Their Most Important Goals
4 Keys to Effective Administrative Rounding
5 Ways to Grow Outpatient Volume



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