Market-Based demand forecasting promotes informed strategic financial planning - Statistical Data Included

Healthcare Financial Management, Nov, 2001 by Alfred J. Beech

Market-based demand forecasting is a method of estimating future demand for a healthcare organization's services by using a broad range of data that describe the nature of demand within the organization's service area. Such data include the primary and secondary service areas, the service-area populations by various demographic groupings, discharge utilization rates, market size, and market share by service line and organizationwide. Based on observable market dynamics, strategic planners can make a variety of explicit assumptions about future trends regarding these data to develop scenarios describing potential future demand. Financial planners then can evaluate each scenario to determine its potential effect on selected financial and operational measures, such as operating margin, days cash on hand, and debt-service coverage, and develop a strategic financial plan that covers a range of contingencies.

Financial planners use various organizational and market elements to produce financial projections that reasonably predict an organization's financial outlook. Many of these elements involve unknown or uncertain variables, however, which create financial risk for an organization. Management's challenge is to minimize the uncertainties and manage the risk, or at least to identify their potential effect and develop possible responses.

Perhaps the most fundamental uncertainty facing a healthcare organization is the demand for its services. A common method used to estimate future demand is simply to adjust the previous year's volumes up or down by a subjectively determined percentage. The problems with this approach are that it fails to take advantage of a significant amount of available information about the underlying determinants of demand and it is prone to error.

A more accurate, objective approach to predicting demand is market-based demand forecasting. Market-based demand forecasting minimizes the guesswork involved in estimating future demand for a healthcare organization's services by using specific, quantitative data as a basis for making explicit assumptions about the factors that determine demand. Such data pertain to the organization's service area, patient population, utilization rates, and market share.

Market-based demand forecasting uses informed judgment, together with an analysis of historical data and a set of explicit assumptions regarding those data, rather than just educated guesses based on limited information, to describe and compare various potential future demand scenarios. In addition, the data gathered for demand analysis can be used for other purposes, including achieving a better understanding of an organization's financial risk.

Market-based demand forecasting provides a fundamental link between strategic planning and financial planning. Strategic plans define the services that will be offered and how they will be offered. Market-based demand forecasting provides a rational basis for assessing how many patients may be expected to use those services, thereby assisting financial planners as they assess whether the organization can fund the strategies.

Although market-based demand forecasting requires more time and effort than a simple percentage adjustment or extrapolation, it is relatively easy to perform using currently available data and software. (a)

THE FORECASTING PROCESS

Market-based demand forecasting is performed using the following information:

* The organization's service area;

* Patient population within the service area;

* Service-area utilization rates and market size;

* The organization's market share; and

* Demand for the organization's services.

Service area. A healthcare organization usually identifies its service area by using the zip codes in which most of its patients live. The service area typically is divided into a primary service area (PSA) and a secondary service area (SSA). For example, the PSA may be those zip codes from which the organization draws 75 percent of its discharges, and the SSA may be those zip codes from which it draws the next 15 percent of the remaining discharges, so that the PSA and SSA account for 90 percent of total discharges. The actual cut-off points for the PSA and SSA usually will depend on the geographic locations of the zip codes, and they generally will be contiguous, rather than being defined on a strict accumulation of percentages. The discharges not included in the PSA and SSA typically are scattered across a large number of zip codes, most of which are in distant areas that are beyond the reach of the organization's marketing efforts.

In some instances, the service area may be defined by zip codes from which the organization draws a specified minimum percentage of discharges (eg, at least 2 percent), or by zip codes in which the organization has a market share exceeding a certain threshold (eg, 10 percent). Service areas may be defined for each service line, not just in the aggregate.

In defining its service area, the organization also should consider the scope of the geographic area in which it intends to focus its efforts over time. Ordinarily, an organization performing market-based demand forecasting would regard the PSA and SSA as static. However, an organization could assume that the service areas are likely to expand as a result of strategic initiatives, such as placement of a referral facility in a new geographic area or addition of new service lines that draw patients from more distant locations. The organization also may anticipate that its service area could contract if competitors are poised to engage in large-scale strategic initiatives to attract more patients from the current service area, such as when a competitor decides to open primary care sites within the organization's PSA.