Bending the cost curve for hospitals

In tough economic times, where rising general and medical inflation rates have taken a toll on the financial viability of hospitals, healthcare providers are struggling to bend the cost curve. Raelene Kambli identifies ways to reduce operating cost in order to make hospitals financially viable How do hospitals strike a balance between their operating cost and revenue? This is the one of the most frequently asked questions to healthcare financial experts, especially during times when hospitals find it hard to augment their revenues. Reasons to this are numerous, some due to economic pressures like rising inflation rates as well as changing government policies and others being misallocation of funds, and technical and managerial inefficiency. All of these factors often make this balancing act a complicated affair. Virtually, all hospitals work towards obtaining a good profit margin without compromising on quality healthcare delivery. The challenge here is to reduce operating cost in order to increase revenue saving but at the same time maintain high quality and efficiency. Another misconception that hospitals these days live in is that, improvement of quality calls for an increase in operational cost. In fact, these two factors do not directly comprehend with each other. While operational cost is a amalgam of medical consumables, manpower, regular repairs and maintenance expenses as well as hospital services like housekeeping expenses, F&B, laundry, medical gases etc., that hospitals have to incur for their day to day affairs; quality is a result of high intention, sincere effort, intelligent direction, and skillful execution of work. In the wake of such circumstances, striking the balance between operating cost and revenue is quiet meticulous. Explaining the challenges faced by hospitals on this aspect, Narendra Karkera, Director Operations HOSMAC reckons, Cutting back on operations cost is a challenge for hospitals as they are driven by human resources. Reducing benefits and wages might have an impact on the brand value as well as loyalty of employees to the organisation. Adding to this Dr Rashi Agarwal, Director- Praxis Healthcare Consultancy says, In an effort to reduce operational costs through optimum staffing, or reduction in overtime etc., it may lead to higher staff turnover which in turn leads to increase in operational cost in another department like HR for recruitment and also declines patient clinical outcomes thereby affecting quality of care. On similar lines, Deepak Samant, Director Finance, PD Hinduja Hospital admits that shortage of skilled manpower and rising competition is the major factor that makes cutting operating cost a tall task. Among others are ever-rising inflationary pressures on all other cost components, Government policies related to the sector and taxation etc. The hospital management can do little to influence these external factors. High operating cost and its implications Factors that are responsible for the increase in operational cost are mainly high attrition rates within the hospital, constant up-gradation of technology, forex associated materials cost raise and high costing of fixed expenses. Says, Ratan Jalan, Principal Consultant, Medium Healthcare Consulting, It is very critical to keep an eye on the operating costs and

understand their impact on the overall profitability of the hospital. For instance, the cost may be high because of high resource utilisation or it may be high because of underutilisation. These high cost components act as a barrier for healthcare providers to strike a balance between its operating costs and revenue. So what happens if a hospital's operating cost remains high for a long time? Experts analyse this situation as critical for a hospital's sustainability; high operating cost within a hospital tends to hampers the financial viability of that hospital. Explains, Karkera, If operational costs remain high, the hospital will incur losses for a long time. In order to run the hospital, the management might have to rely on banks loans, which means they have to pay interest for the money borrowed. All operating cost ingredients need to be kept under tight control. Any increase in any of these ingredients would reduce the operating profits/ increase operating losses and would put the organisation into a financial turmoil. This impairs the capacity of the organisation to sustain operations or to grow, chips in Samant. Moreover, high operating cost often compels hospitals to focus on increasing patients' stay at the hospital and increasing overall tariffs or resource addition. According to Dr Agarwal, though rising healthcare cost can be attributed to several other factors like inflation, lack of skilled manpower etc., increase in operating costs has a direct co-relation with increasing prices. In such circumstances, the hospital's focus turns towards increasing the revenue to offset the cost. Instead, the focus should be on analysing the high cost items and arriving at ways and means to address it. On the other hand, Ashish Bhatia, COO, Fortis Healthcare has a different perspective. He says, While there is a surge in demand for quality healthcare, yet it comes with a cost. The cost here means cost associated with smooth functioning of the hospital, which is primarily very patient centric. Increasing cost of consumables, cost associated with quality manpower considering the demand for skilled manpower in this industry, substantial hike in the fuel cost in last few years combined with increase in power tariff and maintenance of hospitals as per the desired standards has been diminishing the profit margins. Owing to increasing operating cost in the last few years, people have witnessed rise in healthcare cost. Given the fact operational cost reduction effort a daunting task, it is critical to prepare an effective cost reduction plan and execute it. Tackling the tall task Striking this balance isnt rocket science; it is just a matter of preparing a clever plan and executing it effectively. For this, senior finance managers within hospitals need to change their perspective. The first step towards reducing operational cost is to analyse the cost components that have remained high over a period of time. For instance, assigning a certain cost head as a percentage of the overall revenue or Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA) margins is not an analysis; instead it should be driven by a more thorough understanding. For example, the order cycle for consumables or the ideal electricity load, light intensity requirements for a particular type of OT. There are numerous such items which when added together can make a cumulative difference in the overall cost. This should be followed by implementation of some initiatives and close monitoring to arrive at the overall cost savings. Today, hospitals across different specialities and capacity will have the EBIDTA margins ranging from 12-13 per cent to almost 25 per cent. A lot depends on how the hospital has ensured maximum resource utilisation by driving volumes, keeping Average Length Of Stay (ALOS) down and monitoring manpower and material costs. For some of the well-known hospitals, consumables and personnel cost together accounts for almost 50-60 per cent of the overall revenue. Recent analysis of the

finances at a few major brands in India showed personnel costs anywhere between 18-46 per cent with the rates of spending on consumables in the range of 23-33 per cent. Hence, a critical evaluation of these costs coupled with higher resource utilisation could lead to much better EBIDTA margins. In fact, some of the more focused facilities, which tend to limit to one or two specialities and are relatively smaller in size, have managed to achieve much better financial performance and that too, in a quicker time frame due to better planning and hence high resource utilisation. The EBIDTA margins over time could be as high as 40-45 per cent, informs Jalan. Operating cost components
Expense Head Salaries and wages Materials Electricity Maintenance Laundry, food services and housekeeping Printing, stationary, travel and communication Insurance, legal expense and audit fee Business promotion Total 40 per cent 35 per cent 10 per cent 2 per cent 10 per cent 1 per cent 1 per cent 1 per cent Fixed 20 per cent 15 per cent 10 per cent 2 per cent 10 per cent 1 per cent 1 per cent 1 per cent Variable 20 per cent 20 per cent

Courtesy: Narendra Karkera, Director Operations HOSMAC

The second and the most critical step to prepare a proper cost reduction plan that includes proper budgeting. A hospital which has well planned OPEX budget with clear focus on cost efficiency and productivity can run the hospital efficiently, states, Dr GSK Velu, Chairman, Medfort Hospitals. C P Tyagi, General Manager-Finance, Indraprastha Apollo Hospitals, adding to this says, Executing a proper budget will enable hospitals to better cost control and containment. Standard deviation and deviations from budget helps in identifying the areas for improvement. Thereby concentrated efforts can be intensified in those areas. Elaborating on how hospitals can regulate their labour cost, Samant goes on to say, Hospital being a 24/7-service industry is necessarily labour intensive hence it is imperative to keep manpower numbers at optimum level corresponding with the capacity utilisation. Most of the costs are related to capacity hence hospitals must invest in capacity build-up only when they are reasonably sure about the utilisation. Unduly large capacity build-ups would put strain of scarce financial resources. Citing an example of cleverly managing cost incurred for pharmacy, Jalan, opines, If spending on consumables or the pharmacy is high, aggressive renegotiations with vendors can bring down some costs. In certain cases, outsourcing these services to external companies that enjoy greater efficiency can increase margins and take advantage economies of scale. Some hospitals in recent past have started taking this approach as well. Sharing some tips for operating cost reducing, Dr Bhatia updates, Hospitals should aim at centralise procurement, which could be aggregated at a company or regional level. An overall transition towards a more variable operating structure by having similar back-ended

contracts with suppliers, where payments are linked to the volume of goods consumed or the quantum of services dispensed at a hospital is a good way of reducing cost. Operational costs can be reduced by several measures. Few of them may include appropriate staffing through an accurate method of predicting volume utilisation and staff productivity to arrive at the required staff number and staff mix. Providing accurate job descriptions to staff etc also adds to staff productivity. Use of part time staff, contract staff, overtime are some efficient ways. Energy consumption evaluation and reduction in energy consumption also contributes significantly to cost reduction. Investing in technology also reduces operational costs, Dr Agarwal adds in. Inventory control is yet another way of reducing operational costs, suggests Karkera. Successful models Even as most hospitals struggle to overcome the challenges of reducing operating cost, there are few successful examples that have efficiently bent the cost curve. Referring to some hospitals in India Jalan, points outs, Larger hospitals chains derive significant cost advantage on account of economies of scale and have considerably lower material expenses. In terms of the personnel cost, hospitals, which work primarily on the fee for service model for their physicians, do not gain when the volumes go up. This is one reason, why some hospitals (like Fortis or Dhirubhai Ambani Hospital in Mumbai) are moving more towards a salary model for their physicians. Such hospitals are keen to build the institutional brand and improve margins when the volumes go up. It does not, however, mean that they do not have variable or performance-linked components at all. Some of the hospitals have also managed to reduce expenses on energy (through smart design) and repairs and maintenance (again, through smart negotiation on warranty period and terms of maintenance with the vendors at the time of equipment procurement). However, institutions such as Narayana Hrudalaya or Aaravind Eye Hospital have managed to keep such costs quite low by managing productivity of their physicians. They have also ensured that nursing and paramedical teams get to play a more active role in care delivery, thus reducing the need for physicians, especially in routine interventions. At Aaravind Eye, a single surgeon can perform 15 surgeries per hour, thanks to the highly automated assembly line approach taken. On similar lines, hospitals abroad are exploring ways to make attendants a part of the overall patient treatment cycle. This would lead to a pleasant experience for the patients and their families as well, indirectly increasing operational efficiency, he further adds. Striking the balance Every hospital requires to maintain a balance between liquidity and profitability while conducting its day to day operations. And operating cost being the key component in the daily activities, effective management of this cost will allow hospitals to run a lucrative business. However, hospitals often in the wake of being precautious about wastage of funds tend to block their funds. Organisations block funds in inventory as well as giving credits to corporate clients. Lack of funds can wreak havoc for the organisation. So, hospitals need to ensure that the money flow is not blocked, advises Karkera.