Using product line management to meet strategic objectives - Financial Manager's Notebook

Healthcare Financial Management, Oct, 1991 by Daniel E. McCormick

To control profits when payments are based on diagnosis related groups, a financial manager must study the costs associated with a hospital's patient mix. What frequently complicates this analysis is the need to balance "big picture" financial issues with the temptation to cost out expenses to the last cotton ball. To evaluate the success of a patient service and determine whether a facility's strategic financial objectives are being met, financial managers can carry out a five-step product line assessment.

Step 1: Financial analysis. Developing product-specific financial statements is the first stage in evaluating a patient service's success. Financial managers should look for trade-offs associated with a lack of specific cost information and the need to put together a meaningful financial statement that can be used as a tool. This approach can be used:

* To ease the analysis and create a less confusing starting point, product-specific financial statements should follow the same format as a facility's existing financial reports;

* Product-specific financial statements should tie in total to organizational financial statements, ensuring that all costs are accounted for in the new statements;

* Initially, direct expenditures should be allocated because they are the easiest to identify; and

* Overhead expenditures are most difficult to allocate and represent an area of great contention. Potential allocation methods include:

* Using the step-down approach currently used for cost reporting;

* Assigning costs based on the percentage of total inpatient volume, adjusting total inpatient volume to reflect diagnosis related group cost weights, and assigning costs accordingly; or

* Using any other reasonable approach that accounts for all non-direct costs that must be allocated.

The objective is to develop documents for use in discussions. Too often, gross revenue by clinical service receives much of hospital executives' attention, with cost being compared only to aggregate, non-service specific departments.

Once financial statements are refined to accurately portray the costs of individual clinical services, physicians who control each product line should be brought into the process being developed. An ability to illustrate costs associated with a physician's program often provides important education that may allow standing orders and other practices to be successfully challenged.

Product-specific financial statements naturally lead financial managers to identify areas needing improvement. Separate analyses can be used to determine potential effects on a hospital's bottom line, including:

* Conducting a cost-benefit analysis of services provided in-house (maintenance, housekeepingm, dietary, security, and others) versus services handled under contract to identify potential advantages of changing delivery approaches;

* Carrying out a cost-benefit analysis of capitalizing costs versus expensing some supplies (for instance, intravenous pumps may have different set-ups that reduce operating costs but also require new pumps);

* Identifying revenue that could be billed as outpatient charges but currently charged are inpatient expenses (such as durable medical equipment); and

* Studying product-specific staffing patterns that might increase productivity (such as a surgical nursing unit that has a large amount of same-day surgery admissions but maintains low staffing levels until patients begin to arrive from recovery).

Developing even cursory product-specific financial statements can lead financial managers to better analyze the revenue and expenses of patient services. Financial management changes are more easily illustrated to executive management or board members.

Step 2: Demographic analysis or market study. In this phase, the focus on product line management shifts to a hospital patient population. By examining the patient mix, financial managers can take advantage of a service's strengths and correct weaknesses. The following data should be analyzed:

* Patient age;

* ZIP code of patient origin;

* Market share; and

* Secondary data sources, such as state health plans, disease incidence levels, and payment levels.

Once this information is gathered, a financial manager can construct a product-by-product profile of patients the hospital already serves and compare this information to the market in which it competes. Comparative information can be difficult to gather, but potential sources include:

* Local hospital groups;

* Local healthcare business coalitions;

* State hospital associations;

* State departments of health; and

* National data abstracting services.

Once they complete a market profile by product line, financial managers can asses a hospital's position within it. Deficiencies can be identified, and strategies for better positioning products within the market will emerge. The level of detail from this step identifies strong services and llows executives to change or eliminate weaker product lines.

Step 3: Competitive assessment. Along with determing valuable market share statistics, a hospital's financial managers should study the strengths of competing facilities so that niche strategies can be determined. Publicly available information will allow them to develop a competitive cost structure. If a competitor cannot renovate its building because it carries a large debt, for example, the hospital (if it is not in the same position) can carve out a niche of "newness" through upgrades. Other items that can be included in a competitive assessment include: