(Originally published in Hospitals & Health Networks Daily 3/25/14)

The conversation has changed.

The old conversation: “You cost too much.”

“But we have these sunk costs, patients who can’t pay…”

“Okay, how about a little less, then?”

The new conversation: “You cost too much. We will pay half, or a third, of what you are asking. Or we will take our business elsewhere. Starting now.”

“But…but…how?”

Exactly: How will you survive on a lot less money? What are the strategies that turn “impossible” to “not impossible”?

New Strategies

The old conversation arises from the classic U.S. health care model: a fully insured fee-for-service system with zero price transparency, where the true costs of any particular service are unknown even to the provider. The overwhelmingly massive congeries of disjointed pieces that we absurdly call our health care “system” rides on only the loosest general relationship between costs and reimbursements. It’s a messy system littered with black boxes labeled “Something Happens Here,” full of little hand waves and “These are not the droids you’re looking for.”

With bundling, medical tourism, mandated transparency, consumer price shopping, and reference pricing by employers and health plans, we increasingly are being forced to name a price and compete on it. Suddenly we must be orders of magnitude more precise about where our money comes from and where it goes: revenues and costs. We must find ways to discover how each part of the strategy affects others. And we need some ability to forecast how outside forces (new competition, new payment strategies by employers and health plans, new customer handling technologies) will affect our strategy.

Key Strategy Questions

For decades, whenever some path to profit in health care has arisen (in vitro fertilization, urgent care, retail, wellness and the others) most hospitals have said as if by ritual, “That is not the business we are in.” As long as we got paid for waste, few health care organizations got serious about rooting it out. And most have seemed content with business structures that put many costs and many sources of revenue beyond their control.

In the Next Health Care the key strategy questions become:

• Why are you not capturing as many revenue streams as possible?
• Why are you not capturing as many savings as possible?
• Why don’t you have a business structure that converts savings into profit?

Different Revenue Streams

The new environment brings a number of different revenue streams, each with different characteristics. These include:

Bundled offerings and medical tourism. The game here is to lower costs through efficiencies and scale, lower the price and make it up on volume.

Primary stream. Medical homes, direct pay primary care, urgent care and retail care each have their own revenue streams which may include pay-for-performance or other quality payments, per patient per month prepayments, or fee-for-service. This is genuine revenue, but your very success in the primary sphere will (and should) cut your income from the emergency department, as well as many expensive and profitable inpatient and outpatient procedures.

Onsite clinics. Medical homes run on a “cost plus” basis; these bring some income and have the same effect as other primary care streams.

Capitation. Like Kaiser Permanente, where the monthly premium plus co-pays or coinsurance cover everything in system-owned facilities with staff clinicians. Capitation spreads costs and revenues across the system, at least nominally aligning the incentives of all involved. The Kaiser structure, for instance, automatically rewards the physicians for efficiency and effectiveness: Half of the system margin (profit) every year goes directly to the Permanente Medical Groups.

Subscription (mini-cap). Payment per patient (or employee) per month buys all care for a specific condition, such as diabetes or back care. This drives efficiencies (to keep the cost down) as well as effectiveness (to keep the contract).

Classic fee-for-service. This will likely always remain as some portion of your revenue. Its incentives oppose those of most other revenue streams.

The Problem

The organization that is prepared for these different streams is most likely a different kind of organization from what you now have.

The problem you are trying to solve is not making the most money, or making your life as comfy as possible, or saving particular jobs, or even saving your institution. The reason your problem is so hard is that it is a five-dimensional Rubik’s cube. Imagine these dimensions crossing and interacting:

• How do we heal the sick and keep people well, with …
• the resources, capacities, physical plants and people that we have, and …
• the revenue streams we have, can capture or can create, given …
• the wants, needs and attitudes of various large payers in the area, and …
• the various other payers in the region, state, nation or world that might bring business your way.

Costs

There are three types of savings possible in a health system:

1. Doing the same procedures and tests, but as leanly as possible;
2. Correcting the medical problem using the least expensive and intrusive way possible (substituting medical therapy for unnecessary surgery, for instance); and
3. Preventing the need for doing anything at all.

Under fee-for-service, all three are a cost to the hospital. This is why we are not very skilled at capturing and reducing costs. Under any other payment system, we need to get fierce and intentional about capturing, characterizing and cutting internal costs.

Is this possible? Imagine going through every service, from performing a pregnancy ultrasound to excising a brain tumor, and just doing the arithmetic. Run down every step of every task, the labor cost of the person doing it, the actual cost of the supplies involved, then throw in something for overhead and for margin. Add it up to determine how much it costs you to install a hip or repair a hernia. That’s “time-driven activity-based costing” or TDABC.

For the last few years Harvard’s Michael Porter and Robert Kaplan have been running exactly such programs at MD Anderson, the Cleveland Clinic, the Mayo Clinic, Boston Children’s, Brigham and Women’s Hospital and other top hospitals.

Rigorous, tough, time-consuming, expensive to do, yes, but combined with lean manufacturing techniques, such analysis can drive real costs down. Organizations find that they do many things that don’t help, or that could be done by someone less highly trained and expensive. MD Anderson, for instance, was able to cut the staff in its pre-operative anesthesia center by 17 percent while seeing 19 percent more patients and while dropping the internal cost by 46 percent with no loss of quality.

If this seems impractically difficult, it’s still where we have to go. We simply must know our real costs, how we can cut them and which costs we can safely cut.

Targeting (market segmentation). An old subject in these columns, more relevant here than ever: Five percent of the patients generate 50 percent of the costs, 1 percent generate 20 percent — and many are in those categories for months and years with poorly addressed chronic problems. Under fee-for-service they are a revenue source, if they have a payer. Under other business models, they are a cost, while driving costs down by taking better care of them is a big revenue source. The algorithm: Find the chronic high-cost patients whose health you can actually affect. Be at risk for their costs. Put a crew on it. Drive the costs down dramatically. Programs at Boeing, at the AtlantiCare Special Care Center in Atlantic City, N.J., and elsewhere prove that you can drive their costs down by 25 percent or more — thereby driving down the costs of the whole population by 12 percent or more.

Outreach. A well-designed, vigorous medical-home outreach program, staffed with real humans in the community, run out of clinics and primary care offices in the community, will do the same thing without the market segmentation. If you call everybody, you are going to spend the most time with those who need the most help. It’s highly efficient: The Vermont Blueprint drove down overall costs for the whole population it served by 12 percent, with a total staff cost of $17 per patient per year. Peanuts. Bupkis. Lost in the noise.

Trust. It’s the least understood business efficiency engine. Outreach that changes people’s lives, gets them compliant with medication, gets them to eat differently or find a way to kick the addiction does not come from cold-calling by unqualified strangers reading scripts. It must be built on trusted relationships, a nurse or doctor who lives in your community and knows you, calling up or coming to see you. Expensive? Highly efficient, because it works.

Docs on board. You need to work strongly with the physicians. This means more than hiring them or buying their practices. It means getting them on board with the new business models, which means finding not only where the costs are, but how those costs become profit across the organization. So primary care physicians who help the bottom line by keeping people out of the ED and the surgical suite should benefit from that and see it as part of their business model.

Population health management. Investigate the special health needs of your population, asking particularly: What turns into medical costs? What would it take to reduce those costs? Develop preventive programs with others in the community. Don’t assume that you can’t make a difference. The Healthy Communities movement and the AHA’s own Association for Community Health Improvement share many success stories of reducing teen pregnancy, drunk driving, addictions and other risky behaviors in communities.

Be your own payer. All this makes more sense with your own insurance arm. This can be expensive and difficult to build. Health insurance is a significantly different business. The risks of getting it wrong are large. But it allows you to operate as a much more integrated business, and reap profit from your savings. Many of the most progressive health care organizations have done this, including Sharp, Sutter, Intermountain, Geisinger and Scripps. Some organizations, such as Nebraska Medical Center and Methodist Health System in Omaha, have joined together to build regional insurance companies.

You

You must take leadership. Others will carve out pieces that work for them (such as urgent care, specialty clinics and other limited money-making operations). They listen to station WII-FM (“What’s In It For Me”). In fact, a good rule of thumb is that any cost-cutting or regulatory constraints will be received as a matrix for schemes to make more money and build bigger empires. Expect this.

Hospitals and health systems, as the biggest game in town, must think, act and lead at the regional system level. If you don’t, you will be left with only what no one can make profitable. This is the reactive path of doing as little as possible.

Engage seriously with other regional players — other hospitals and health networks, payers, employers, local and state governments. When you can, form larger entities or affiliations to relocate some of the risk more broadly.

Engage the unions. Help them understand where you need to go and why. Engage everyone you might think of as an adversary, because you need them. Well-led people will pitch in (many of them) if there is a goal, if the path makes sense, if they understand that the need is dire.

The efficiency of trust is even more important in leadership. Be transparent. The new competitive environment has no room for corrupt relationships siphoning off resources for private use.

Management is a lived, human process. Speak plainly and seriously. Drop the biz-speak consultant-y jargon that Very Serious People use. Just say what’s real.

Some of you will succeed and transform your businesses. Many of you will not — and your businesses will be closed, or sold to some larger entity that can do it better, or to a hedge fund that will strip mine it. Or it will limp along on handouts, failing to provide excellent care to the thousands who depend on it. You have to choose. You have to believe that it is not impossible, and help others to see that it is not impossible.

Now is the time; where you are is the place. Engage.