Ways Hospitals Can Save Money—without Disrupting Communities

Ways Hospitals Can Save Money—without Disrupting Communities

Hope for Hospitals

Ways Hospitals Can Save Money

Peter Chadwick and Haywood Miller

It’s hard to think of a business more difficult than running a hospital system. The pressure to comply with regulations while finding ways to save money is relentless, and for many independent hospital executives, each day is a fight for survival. 

But while healthcare is highly complex, the business problem hospitals face is as simple as it gets: Costs run higher than revenue. Expenses have outpaced revenue for acute-care hospitals in every year but one since 2003, and rural America (where the situation is direst) has seen about 10 hospital closures per year this decade, according to the North Carolina Rural Health Research Program.

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Against these headwinds, dedicated administrators are battling to not only keep critical health safety nets alive but also preserve what are often the largest employers in their communities. Their struggle was the focus of panel discussions we moderated in April at the BRG Healthcare Restructuring Conference (HRC) in New York City. Those discussions yielded insights on the path forward for some hospitals. And they underscored something we’ve learned through advising troubled hospital systems: Those who endeavor to rescue these vital institutions must embrace a pair of blunt realities.

Finding ways hospitals can save money—and finding a partner

First, hospitals have to find ways to cut costs and, where possible, optimize revenue cycles. That will put them in a better position to take the second step: find a partner, in the form of a sale, merger or any form of coupling that can help stabilize balance sheets, reduce overhead and ensure liquidity for the foreseeable future.

Our panel discussions explored cost-cutting, restructuring and deal strategies for struggling hospitals and health systems. The panels helped shine a light on the path forward for embattled hospital executives. While each panelist was frank about the difficulties that lie ahead, they were unified in the view that community hospitals can survive, even thrive, if they make the right decisions and take the right advice.

And they shouldn’t have to pass through bankruptcy court to do it.

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“There is not a lot of room to maneuver,” said Mike Caruso, managing director at Health Trust Research Group and the former chief executive of Ohio Valley Health Services and Education Corporation, which operates a 128-year-old community hospital in Wheeling, W. Va. “But if you bring in the right experts and make the right strategic decisions, you can avoid the worst-case scenario.” 

Reducing costs in hospitals forces difficult choices

For most community hospitals, some of the most important, and most difficult, decisions will involve stabilizing the balance sheet. That will inevitably mean cutting costs. And given that payroll is by far the biggest expense for any hospital—typically around 50 percent of overall costs—labor savings will be the most obvious and effective way to shrink the cost structure. 

BRG Healthcare Restructuring Conference (2018).

BRG Healthcare Restructuring Conference (2018).

But before diving into staffing cuts—a highly sensitive area for community hospitals—it’s wise to conduct a holistic business assessment. Every aspect of the operation should be scrutinized to seek potential savings or additional liquidity sources. For many hospitals, optimized billing processes, improved collections and other forms of revenue-cycle management can help provide a small boost to the top line. It’s also critical to bring new discipline to portfolio, vendor and physician management. Frank, thorough evaluations of each of those areas and of the balance sheet can yield significant savings. 

And headcount reductions may not be the only way to lessen the payroll burden. In our experience, hospitals can often find efficiencies in the way staff are deployed. Before laying off nurses, for example, it’s wise to scrutinize their schedules. A hospital may be able to eliminate overtime by reducing hours and tweaking productivity standards. 

Tell the hard truth to get buy-in on hospital cost-saving initiatives

Of course, nurses won’t be thrilled about losing their overtime pay. That’s why it’s critical to make sure they understand exactly why that decision was made—and preferable to the alternatives. Transparency with all the stakeholders will be absolutely essential to seeing the organization through to a stable solution. From the board to physicians to front-line staff to residents of the community, everyone needs to understand that unless change happens, the hospital’s future will be in jeopardy. 

“The key to this entire process is making it clear to everyone involved that if we do this right, we can make it work,” Michael Roeschenthaler, a partner at Whiteford Taylor Preston, said at the HRC. “But if we don’t all reach a deal, an implosion will happen.” 

Roeschenthaler was referring to negotiations not only with staff but also with bondholders, lenders, health insurers and other stakeholders. Those discussions will need to happen early in any restructuring, and the results will help determine not only whether a hospital must seek bankruptcy protection, but also what levers the leadership and their advisors must pull. 

Finding ways hospitals can cut costs should go hand in hand with finding leverage

Those levers are more limited for hospitals than for many other businesses. A typical restructuring would likely begin with a close inspection of two important pillars of working capital: payers and payables. But, for a hospital—and especially a community hospital—the primary payers are most likely to be Medicare and Medicaid, federal agencies that don’t often negotiate contracts the way a typical business customer would.

And hospitals must be extremely careful negotiating payables. If a vendor to the hospital’s emergency room walks away, it could lead to shutting down the ER—a major revenue source for any provider. So it’s vital to understand which vendors are essential and tread carefully in negotiations with them. 

Use emotions and intangibles as leverage with lenders and bondholders as you reduce hospital operating costs

BRG Healthcare Restructuring Conference (2018).

BRG Healthcare Restructuring Conference (2018).

If hospital executives and their advisors are extremely limited in negotiating with payers and on dangerous ground with vendors, whom can they hope to press for better terms that might shore up the facility’s finances? One area where we’ve seen success: lenders and bondholders. 

In either case, intangible factors can provide hospitals with useful leverage. Lenders may be based in the same communities and subject to the same public and reputational pressures exerted on hospital leadership. And bondholders may decide they don’t want to wind up in front of a judge who has a personal interest in the institution that cares for his family and neighbors, and who may be inclined to use the hospital’s community mission to take liberties with lender priorities.

“The bondholders know they can’t just say ‘pay us,’” Roeschenthaler said at HRC. “The emotions are all over the place, and that can create leverage.”

In the end, a hospital’s creditors will likely view the courts as an option of last resort. In that way, they’re usually aligned with hospital leadership. Creditors are also more likely to support a restructuring plan—and the concessions it may require—if they believe it will end with a transaction.

The end result of hospital cost-cutting strategies? Finding the right partner

The search for a partner to consummate a sale or merger has to begin early in the restructuring process. That means engaging serious outside experts and investment bankers—a strong signal to creditors, vendors and other stakeholders that leadership is serious about driving toward a long-term solution. 

The search for a partner to consummate a sale or merger has to begin early in the restructuring process.

But to get any deal done, and to ensure it sets the hospital up for longevity, a distressed hospital must address operating issues like the ones we’ve enumerated here. And here again, the peculiarities of the nonprofit provider will play a factor in determining valuation and finding a partner. 

Getting the board to embrace hospital cost-reduction strategies and partnerships before it’s too late

Just as a hospital’s board will be reluctant to endorse painful cost cuts, it may be slow to shift its expectations in a restructuring scenario. A mission-focused board may be intent on building a new outpatient center to serve its community’s aging population. Unless directors let go of that idea, it will almost certainly point potential buyers to a lower price. 

Realistically, managing and selling a distressed hospital sometimes requires a different set of directors. At the very least, it requires existing directors to shift focus. The provider’s community-service mission can never be abandoned, of course, but it may need to share billing with—or, in a crisis, line up behind—the financial realities. 

Caruso started his successful restructuring process in West Virginia at the board level—before the system entered a liquidity crisis. He appointed a six-person executive committee of the full board and shifted the focus of board meetings. Rather than listening to reports on operations and clinical data for two hours, he limited those reports to 15 minutes and had directors spend the remaining 105 minutes discussing strategy.

“By the time we had a liquidity crisis,” he said at HRC, “the board understood what the problem was—and what had to be done.”

More than anything else, that understanding—by directors and all stakeholders—is likely to be the differentiator between the community hospitals that survive and those that perish in the coming years.

Peter Chadwick and Haywood Miller are managing directors for Berkeley Research Group. They both have extensive experience in healthcare and restructuring.

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