Many health systems are not currently considering inpatient capital projects because it is incredibly difficult to generate an appropriate profit margin with the current market pressures around reimbursement, rising expenses, and construction cost escalation. Expenses are even more challenging after COVID-19: national total expenses are up 18% YTD 2023 versus YTD 2020.
But if a health system's need for additional bed capacity is significant enough or aged facilities create a cost or competitive imperative, we illustrate the layers of due diligence we undertake to generate a positive ROI (Return on Investment) on the investment.
Instead of starting with an inpatient bed target in mind, we start with the desired return on investment. At the end of the day, the financial pro-forma of a project will either enable it to be approved and move forward or become another "nice idea." So why leave it at the end of your planning process to become a frustrating exercise of value engineering?
Here we will break down the components of achieving a positive ROI on an inpatient project:
- Increase the right type of revenue.
- Reduce fixed costs.
- Reduce variable costs.
- Right-size the project based on margin, not volume.(We realize this is a provocative statement.)
1. Focusing on the Right Type of Incoming Revenue
- Market Demand. Is the project located in a
rapidly growing market? Most markets are experiencing stagnant to
declining population growth. An estimated 87.7% of U.S. Counties experienced
population growth of less than 1,000 people between 2021 and
2022. In our fee-for-service environment, there are still
incentives to drive volume for certain specialties and within
certain payer classes. A market analysis is a good starting point
to identify untapped market demand and its potential to support
your inpatient project.
- Reimbursement. Academic medical centers (AMCs)
are typically well-positioned for inpatient expansion given their
higher case mix index (CMI) and downstream revenue. For instance,
Stanford Hospital's average revenue per bed is almost 800%
higher than the national average, at just over $49.5M average annual revenue per bed (AHD)
compared to the national average annual revenue per bed of $6.2M.
With this kind of revenue stream, it is easier to absorb sizeable
increases in construction costs.
But even if you are not an academic medical center, leveraging your payer mix and contract negotiations based on performance and quality of care can incrementally increase your reimbursement and start to boost your margin for existing volumes.
- Referrals. Rising expenses aside, a major
reason several inpatient projects never hit their ROI target is
that original volume projections did not come to fruition. We
recommend taking a conservative approach when projecting future
volume by overlaying market utilization trends and embedding only
volume growth that has a commitment from referring providers and
current recruitment initiatives.
- Case Mix / Acuity Level. If a system has multiple hospitals across its market, there is an opportunity to shift services to maximize each campus's case mix index (CMI) and associated reimbursement. We call this lever "geographic level loading" and it can help support replacement beds or desired referral patterns for expected ROI. But be careful not to "rob Peter to pay Paul." Otherwise, everyone loses.
- Payer Negotiations. While these do not occur
frequently, there are opportunities during renewal periods to
negotiate higher rates based on volume and outcomes. Data is
crucial to building a persuasive case for higher reimbursement. We
recommend this regardless of associated capital deployment as it is
good balance sheet and liquidity management, but it is becoming
increasingly harder to do in today's payer environment,
especially for inpatients.
- Revenue per Square Foot. One metric we scrutinize when planning for strategic success is revenue per square foot targets. Profitable retail businesses use this metric to size their footprints appropriately. For instance, Starbucks generates $781 in revenue per square foot, and this is why different stores are larger or smaller in different markets. If you follow the mantra of margin before volume, you will start to manage your overall service portfolio and capital more efficiently while still proving core mission-driven services. Hence Sister Irene Kraus' motto, "no margin, no mission."
2. Fixed Costs
The premise of this category is that if a proposed inpatient project cannot be profitable by moving the needle on the revenue, then it must become profitable by reducing costs. For instance, for each new case we add, the fixed cost per case is reduced. Fixed costs can include buildings, equipment, IT, housekeeping, and medical records, among other things.
- Reduce fixed costs by increasing facility
utilization. Capacity challenges may drive the need for
new inpatient beds at one hospital, but before you build, look for
existing underutilized beds across the system. Consolidate
low-volume locations to have fewer but more highly utilized
inpatient service offerings, by emphasizing different specialties
at distinct locations rather than trying to offer everything at
every location. For instance, shift services so that different
campuses have different focus areas, such as ortho, cardiac, and
oncology. We use market data and capacity analyses to help quantify
the amount of space that can support a fiscally viable utilization
percentage.
The days of planning around 65-75% utilization are gone. If it does not consistently hit 80% or above, it most likely will not cover both indirect and direct expenses. Too many of our capital projects only focus on direct expenses plus capital and assume the indirect are handled by corporate or in another category outside the proforma. Our motto: "fill it or kill it!" Facility variability and specialization can also erode utilization so when you are planning new facilities or evaluating existing ones, look for opportunities to create a flexible standard.
3. Variable Costs
While it can be challenging to manage variable costs like supplies, medicine, and overtime, there are opportunities for cost savings centered around efficient operations and contracting. From an inpatient operations perspective, dated infrastructure and design can lead to inferior operations because of extended travel distances, insufficient staffing ratios, and physical workarounds.
- Length of Stay. Is the justification for a new
inpatient project that an existing inpatient platform does not have
the capacity? Perhaps the underlying problem is that ALOS (Average
Length of Stay) is going up. Here, a quick review of ALOS trends
often reveals that the unit has treated more patients with a
shorter length of stay in the past, cycling them through more
quickly so that a larger volume can be treated. In these instances,
we recommend operational improvements to reduce capacity needs,
such as addressing the root causes of slow discharges. Perhaps the
true need is for a skilled nursing facility so that inpatients have
somewhere to be discharged, and that is a much more affordable
solution than building additional inpatient beds.
- Staff Utilization. We recommend designing inpatient units in even multiples of the system's preferred nursing ratio. So, if the system has a ratio of 1:6, then a unit with 30, 36, or 42 beds utilizes staff more efficiently than a unit with 32, 37, or 40 beds. Additionally, larger nursing units have been found to be more efficient to operate from a staffing perspective.
4. Make the Project Smaller
If a project has the potential to be profitable, we challenge the team to create the most rightsized construction solution possible in the following ways:
- "Shrink to grow." Leveraging the
same market analysis used to identify growth opportunities, systems
can also evaluate if there are over-bedded services across the
market and opportunities to shed low-volume, non-profitable service
lines. This strategy allows hospitals to avoid the "jack of
all trades, master of none" conundrum and focus on its core
inpatient services. Once a system goes through this exercise, it
may find existing capacity within the system to leverage to reduce
the size of its new inpatient build.
- I2 Versus Business Occupancy. Greenfield I-2
construction costs in most parts of the U.S. are currently in the
range of $700-800 per square foot, whereas business occupancy
construction costs are $500-600per square foot. Because of this,
when building new healthcare projects, we tend to take functions
such as administrative space, facilities management, case
management, physical therapy, lab, and pharmacy out of the hospital
and into an adjacent medical office building or other business
occupancy space.
This way they have functional proximity and adjacency without paying extra to build them. Similarly, when splitting the hospital functions into business occupancy, "adjacent" could actually be within the same building as long as the functions have appropriate fire separation.
Just as we are looking to lower costs by having all licensed personnel work at the top of their license and be well supported, we want I2 space to function "top of license" and house only what is absolutely necessary for that complexity of infrastructure and construction.
- Make Sure Outpatient, Non-Clinical, and Administrative
Functions Are Off Campus. We recently helped a
capacity-constrained academic medical center position the
"highest and best use" functions on its inpatient campus,
reallocating twenty-seven departments to liberate 80,000 square
feet for new revenue-generating clinical services. For example, by
relocating Team Member Health, we were able to backfill the space
with much-needed additional PICU (Pediatric Intensive Care Unit)
beds. Be mindful that this is often a substantial change management
initiative for the organization and may require some level of
service and staffing duplication and inefficiencies if current
resources are shared and cover multiple departments or services.
Weighing the cost benefit of separation for long-term operations
versus initial capital cost is vital.
- Benchmarked SF per Planning Target. We
recently trimmed more than 20,000 square feet of I2 construction
out of a floor plan, saving the client more than $10m in renovation
costs. We measured that the proposed design had larger than
necessary square footage in several areas, exceeding FGI (Facility
Guidelines Institute) and other commonly used benchmarks.
Circulation consumes a huge amount of space and often erodes margin
faster than any other design element.
Many of these cuts came from asking questions about non-clinical spaces in I2 construction. The following examples show the different types of data we use to pressure-test the true capacity needs of a space:
- Badge swipe data in administrative offices to show how frequently the space is utilized. This helps clarify utilization in the new hybrid work environment to ensure we are not overbuilding space.
- FGI guidelines and internal SF (Square Feet) benchmarks to ensure we are not overbuilding or overdesigning.
- Operational time-stamp data to identify bottlenecks and inefficiencies. For instance, data may highlight delays in OR First Case On-Time Starts - suggesting we are not maximizing our OR (Operating Room) capacity or staff.
- Clinical and operational interviews where we ask about staff locker and lounge space needs, how many guests visit the chapel, whether recovery patients need a private toilet given their procedure type, and so forth.
Conclusion
Ultimately, we foresee that remote monitoring and hospital at home will reduce the size and number of beds in brick-and-mortar inpatient solutions. As we start to anticipate that future, it is important not to overbuild, and build only what we can afford with inpatient projects that produce margins for long-term viability and to fund community mission-driven services.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.