Building the business case for clinical quality: hospital performance improvement projects that focus on reducing costs risk undermining clinical quality, while failing to achieve any real financial benefit. A better approach is to focus on improving cost efficiencies

Healthcare Financial Management, Dec, 2006 by William J. Ward, Jr., Lynn Spragens, Ken Smithson

Are your hospital's performance improvement efforts reaching the organization's bottom line? That's a question that is gaining importance for many hospital CFOs. Consider the following scenario:

Your hospital's fully loaded costs for an ICU bed-day average $2,500. The critical care performance improvement team has implemented the "Surviving Sepsis" guidelines promoted by the Society of Critical Care Medicine and, through improved outcomes, shortened overall length of stay for sepsis and severe sepsis patients by 100 days per year. Using the data from the cost accounting system, the team estimates it has saved the hospital $250,000 a year and a celebration ensues.

As CFO, you are invited as an honored guest to share in the success of the team. When you arrive at the party, however, you take note that despite the reduced LOS, there were no reductions in staff, and that aggressive therapy actually increased the costs of supplies and medications. You give the team your elevator speech on why allocated expense reduction does not equate to operating income. The party gets very quiet. You then explain that, because many of the ICU days eliminated by the project had been paid per diem or by discounted charges, the project resulted in reduced revenue of over $100,000. Rather than put an even bigger damper on the party, you hold off the announcement of the meeting to reevaluate ICU staffing until another time.

How is it that improved clinical quality can be at such odds with the financial well-being of healthcare organizations? That's a question that CFOs need to address more than ever today, as the nation's increasing focus on pay-for-performance reinforces the mission-critical need for clinical performance improvement measures while the costs of those measures soar.

A Financial Shortfall

Not long ago, hospitals considered performance improvement activities to be a price of doing business. And because the costs of these activities tended to be modest, hospital senior financial leaders seldom gave them a second thought.

No longer. Hospitals are now being asked to expend millions of dollars for projects such as computerized provider order entry and electronic intensive care unit systems, all designed to improve the quality of care. Finance executives need to take a hard look at such projects to make sure they make good financial sense, and they must be on the same page as clinical improvement experts regarding the expectations for these projects. A thorough benefit-cost analysis is required, as befits any major investment. But as a recent article in Health Affairs points out, efforts to examine the business case often lead to frustration when projected cost savings fail to reach the bottom line (Leatherman, S., et al., "The Business Case for Quality: Case Studies and an Analysis," Health Affairs, March-April 2003).

Why do so many performance improvement activities fail to pay off? Results of a national performance improvement project in critical care led by Irving, Texas-based VHA Inc.--a provider alliance comprising more than 2,400 member organizations--suggest that problems arise when the business ease is based on the wrong expectations. Too often, the focus of the project is on reducing costs, and the business case is made without a clear understanding of a hospital's fixed and variable costs.

Hospital cost structure lies at the root of the problem of evaluating the financial benefits of performance improvement. Hospitals represent huge investments in plants, people, skills, and equipment. A study published in JAMA estimated that hospital fixed costs are on the order of 85 percent to 90 percent (Roberts, R.R., et al., "Distribution of Fixed vs. Variable Costs of Hospital Care," JAMA, Feb. 17, 1999). That puts hospitals more in a league with transportation or heavy manufacturing than with most other service industries. When performance improvement teams have only 10 percent to 15 percent variable costs to work with, opportunities for significant short-term cost reductions are minimal. Results of a study by an Australian researcher, Nicholas Graves, indicate that, given hospitals' high fixed costs, it is difficult, if not impossible, for clinical improvement programs to reduce expenses enough to cover costs ("Economics and Preventing Hospital-Acquired Infection," Emerging Infectious Disease [serial online], April 2004, www.cdc.gov/ncidod/EID/vol10n04/ 02-0754.htm). What's more, by focusing on cost reduction, larger opportunities are missed.

The Financial Executive's Perspective

Another reason hospitals' performance improvement efforts have not achieved clear financial benefits may be that, in the past, such efforts have not enjoyed the full support and involvement of senior executives. Results of a survey by VHA disclosed that although virtually all American hospitals are actively involved in clinical improvement--and have been for more than a decade--only one-third of the hospital executives surveyed could estimate the financial return on their hospitals' investment in performance improvement. Of the executives who could estimate an ROI, two-thirds did so based on anecdotal information rather than solid financial data.