At the Helm

Why health systems need to stop treating cost-cutting like that new dieting fad

by Christopher Kerns and Emily Connelly

Editor's note: This blog post was updated on May 17, 2018.

Managing health care margins isn't new, but it's certainly getting more difficult.

In 2017, hospital and health system profitability margins hit a low they haven’t seen in a decade. Cost growth continued to outpace revenue growth by a wide margin; the difference swelled from 0.7% in 2016 to 1.2% in 2017. What’s worse: we don’t expect these financial pressures to abate in the near future. Hospital and health system leaders are facing an unavoidable margin management challenge.

It seems as if revenue is under attack from all angles. Volumes are increasingly vulnerable as patients with high-deductible health plans forgo care and population health efforts intentionally reduce utilization rates. The Medicare productivity adjustment, commercial denials, and site-neutral payments pose a direct threat to pricing. A range of new payment models and MACRA create pressure for clinicians to adopt risk-based payment. And the shift from privately reimbursed procedural care to publicly insured medical care continues to be driven by national demographics, threatening long-standing cross subsidies.

These trends reveal a long-term, revenue-driven margin challenge. They are all structural changes to the health care economy and will persist even if the near-term cost growth tempers.

While revenue fuels the problem, expenses will be at the heart of the solution. Unfortunately, hospitals' and health systems' ability to cut costs has been like many peoples' efforts to be healthier. That new dieting fad may help us to lose weight initially (like one-off cost-cutting efforts may lead to lower costs), but it won't be sustainable without broader lifestyle changes. Eventually that catches up with us and we're back where we started… or in a worse position.

When hospitals and health systems could rely on continuous—or even accelerating—revenue growth, cyclical cost-containment tactics were often sufficient. But today's margin pressures are structural in nature, and providers must double-down on cost efforts to counter revenue challenges.

But there are a few pieces of good news:

Cost avoidance—rather than absolute cuts—is likely sufficient

As long as hospitals and health systems keep growing revenue, cost avoidance is likely sufficient to sustain healthy margins. Providers will still spend more on operating expenses in 2025 than in 2018, they will just spend less than they otherwise would absent intervention.

This means that, while containing cost growth is critical, organizations cannot lose sight of growth and revenue-capture efforts. Without top-line growth, absolute cuts would be necessary.

There are ample opportunities to rebase and bend the cost curve

At first glance, it may seem like providers have already squeezed out all possible savings from their budgets. But our new research uncovered a range of opportunities across all major expense categories remaining at even the most advanced health systems.

Advisory Board's Cost Control Playbook includes our top resources to help you identify these opportunities at your organization and tackle runaway expense growth. This one-stop destination provides the tools you'll need to secure a sustainable financial position in the market.

You're not starting from scratch

All hospitals and health systems have experience controlling costs. While there some new sources of rapid expense growth, the overarching strategies necessary to contain costs in the long term are not wholly new in kind. Rather, providers must culturally shift away from campaign-like cost cutting initiatives to comprehensive and durable cost-containment strategies that will continue to sustain savings over time.

We will continue to conduct and publish additional research to help hospitals and health systems both achieve and maintain the cost savings they'll need to thrive amid challenging economics.

 

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