At the Margins

Putting workforce productivity in perspective: Are you taking what matters into account?


John Johnston, CPA, MHA

It seems barely a week goes by in the news lately without a story of a health system announcing they need to cut labor costs—and significantly.

Even in the absence of dire immediate financial circumstances, executives are anticipating the need to shore up margins as a hedge against an uncertain future. At roughly half or more of the typical hospital's total operating budget, workforce constitutes by far the largest expense category, so the road to significant cost reduction will inevitably lead to workforce expenditures.

With staffing levels already leaner than in previous eras of cost reduction, this is a challenge; very little low-hanging fruit remains. Maximizing the efficiency of clinical and non-clinical staff is at center stage and with it the imperative to set—and meet—productivity targets that optimize the output of our most valuable and most expensive asset: our people.

Progressive organizations are working to develop productivity targets that are ambitious yet sustainable by taking a multidimensional approach that answers three questions:

  • How much of our budget can we afford to spend on workforce?
  • What are the right productivity targets for our cost centers?
  • How can we maintain target productivity and avoid costly inefficiency?

Begin with revenue

The biggest mistake hospitals make today is to begin a labor cost reduction initiative by going straight to a cost center benchmark analysis. Don't misunderstand, this is an important component. But the first step is for finance leaders to forecast how much of net patient and operating revenue can be allocated to workforce costs. That threshold determines the overall cost target, which the individual cost centers targets must work together to meet. In fact, finance leaders often ask "should we be targeting top quartile or top decile?" The response should always be the same: "which decile aligns with your overall cost target?"

So what is a sustainable level of investment in labor? It's typically below 54%, but for some hospitals, market conditions require will even lower levels. A CEO of a large system on the West Coast summed up the challenge at his health system this way: "Today we're at 55% of net patient revenue, and we can make that work for now. But next year, I'll probably only get a 1% increase in overall rates, while my labor inflation rate will increase by 3%. So if I do nothing about labor costs, we will fall behind." Most hospitals face this same dilemma.

Benchmarking as art, not science

Once the parameters for overall labor costs are in place, it's time to analyze where there may be opportunities to use these resources more effectively. Benchmarks give executives insight into each cost center's performance against organizations of similar size, service mix, and acuity. But benchmarks have to be used wisely. On the one hand, no two hospitals are alike, so there is no perfect comparison. On the other hand, leaders too often zero in on a comparison that defends the status quo instead of seeking insights into improvement. A better approach is to identify a benchmark range for each cost center (e.g. between top quartile and top decile), then set an exact target that reflects the specific circumstances of the cost center at your organization. As an example, one recent client faces periodic minimum staffing situations in a few of their clinical cost centers, so has to adjust levels accordingly.

The last point to make here is to calibrate overall targets to account for outliers. Another recent client was facing a large workforce reduction in order to avoid tripping bond covenants. Following the benchmarking process above, it turned out that several larger cost centers would need to reduce overall staffing by a significant percent to fall within the target benchmarks. When this occurs, an incremental approach is needed to getting to target to avoid compromising quality. At this client, we capped the improvement target at 15% of (the current) productivity, with a plan to get to the final target over a longer period of time. This enabled those cost centers to make changes without negatively impacting patient care, but it also forced other cost centers to set a more aggressive productivity target in order to hit the overall labor cost goal. This is an extremely important part of the process, and finding the right balance is as much art as science.

A multidimensional definition of productivity

Meeting a benchmark target number of worked hours is essential but certainly not sufficient to optimize productivity. All the inputs need to be taken into account in order to optimize the output: utilizing staff of all levels effectively to provide the best care. That means understanding the cost of work hours, who (what role) is performing specific tasks, the timing of the work, and ultimately what kind of work is being performed. One area that consistently holds opportunity is premium pay.

Clinical leaders should evaluate all premium models and ask whether they address current circumstances. There's a good chance outdated shift premiums still exist that have outlived their usefulness. And there are numerous other considerations that need to be taken into account in developing a multidimensional understanding of productivity. It's a challenging, and often complex, undertaking, but given the preeminence of productivity in preserving quality of care and financial sustainability in today's reality, well worth our attention.

This article previously appeared on the hfm Healthcare Finance Blog.

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